Etsy: A COVID E-Commerce Winner That Will Keep Winning
An early stage growth opportunity with unique advantages and solid management
Etsy (NASDAQ: ETSY) is a two-sided online marketplace focused on unique, handcrafted and vintage goods. It is the fourth largest e-commerce site in the United States (behind Amazon, eBay and Walmart) with almost 70 million active users and 3.7 million active sellers.
Unique offerings, a reputation for selling high quality craft products and a focus on human connections between buyers and sellers differentiate Etsy from other mass online retailers. Products sold on the marketplace have a personal touch not found on other online retailers since the vast majority (80%) of Etsy sellers are one-person businesses.
While Etsy was growing at respectable rates before COVID-19, the e-commerce boom caused by the pandemic is an important inflection point for the company's trajectory. Since the end of 2019, Etsy has added 23 million active buyers (+50% vs the end of the year) and 1 million active sellers (+37%). As a result, Etsy has a tremendous opportunity to convert these new users into repeat customers and accelerate growth. Given different initiatives that current management had put in place before the pandemic, I believe the company is in a great position to capitalize on this massive influx of new traffic.
Etsy boasts several key competitive advantages as well. Etsy’s marketplace business model is highly scalable and benefits from network effects: the more users, the better the platform gets. Its differentiated product assortment (much of which can be customized) stands out compared to mass e-commerce sites that sell largely the same products and brands. Lastly, the pandemic proved that Etsy sellers can adapt quicker than any large corporation in anticipating new trends (like masks and breadmaking).
In 2020, Etsy is expected to clear around $10 billion in gross merchandise sales (GMS), which still only represents a tiny fraction of its market opportunity. At $24B market cap, the company is only getting started. With a strong management team that has delivered results since taking over in 2017, I believe the company will continue to execute its mission of “keeping commerce human” and also rewarding long term shareholders.
Etsy has two online properties: Etsy and Reverb. Reverb is a marketplace for buying and selling musical instruments that Etsy acquired in August 2019 (it's a very small portion of total GMS and revenues). Etsy started as a website, but the majority of its visits and sales (60%+) now come from their mobile Etsy app.
Buyers can find all sorts of items on the Etsy, with pretty much every major category covered except for consumer electronics. The largest categories on the marketplace are homewares & home furnishings, jewelry & accessories, craft supplies, apparel, paper/party supplies and beauty/personal care. These top six categories represent nearly 80% of total sales, but the breadth of items available on Etsy is quite expansive. Based on a quick search, I found are over 80,000 listings for dog treats (compared to 9,000 at Chewy.com), over 12,500 listings for “office desks” above $250 (compared to 10,700 at Wayfair.com) and 140,000 listings for “formal dresses” (compared to 1,800 styles on ASOS, an online fashion and cosmetic retailer).
Source: Investor Day 2019
A large portion of items are Etsy are made to order as well. About 30% of items on Etsy can be customized with conversations between sellers and buyers facilitated on the platform. This personal interaction between both sides simply does not happen on a site like Amazon. Here are examples of personalized holiday gifts:
The United States is Etsy's largest geographic market, generating two thirds of last twelve month GMS. The remaining one third of sales is considered international (at least one buyer or seller comes from outside the US). Other than the US, the company considers the UK, Canada, Germany, Australia and France as core geographies.
The company was founded in 2005 by a trio of friends including Robert Kalin, who was looking for a better way to sell his handcrafted furniture online. Fueled by venture capital funding, Etsy grew rapidly in its early years, but did not have a track record of profitability. By 2011, all of the three founders were no longer with the company and Chad Dickerson, Etsy's then CTO and former Yahoo! employee, took over as CEO.
Under Dickerson's leadership, Etsy went public in 2015 but its first two years as a NASDAQ-listed company were rocky. In those years, Etsy struggled to balance its culture of social activism with also meeting quarterly financial expectations from Wall Street. In its S-1 filing, Dickerson said the company would not provide quarterly guidance since it was “misaligned with Etsy’s mission”. This approach of not playing ball with the Street did not help Etsy's share price. The IPO was priced at $16/share, but declined all the way to a low of $6.90/share by February 2016.
By 2017, the company's GMS and revenue growth rates were declining and activist investors were targeting the company. "The house was burning and nobody was paying attention,” said Fred Wilson of Union Square Ventures and chairman of Etsy’s board. The board fired Dickerson and executed its first ever lay off in the spring of 2017, appointing Josh Silverman as CEO and a completely new executive management team that is still in place today.
Silverman identifies as an “entrepreneurial executive” with an impressive record prior to leading Etsy. A Stanford MBA graduate, he co-founded the social event planning site Evite.com and also held leadership positions at eBay (CEO of Shopping.com and Skype) as well as American Express. As CEO of Skype, he doubled revenues and tripled profits as the platform added 300 million users during his two and a half year tenure. He took the company from a sub-$2 billion valuation to a sale to Microsoft for $8.5 billion.
Joining Silverman to round out a new team was Chief Financial Officer Rachel Glaser and Chief Technology Officer Mike Fisher. Prior to Etsy, Glaser was CFO at online content company Leaf Group and prior to that, CFO of Move, Inc - which she helped lead to a sale to News Corporation. Prior to her CFO gigs, Glaser held various roles at Yahoo! and Disney. Fisher was previously CTO of Guigo (an ad-targeting network that was sold to AOL) and former VP of Engineering at Paypal.
As soon as Silverman took over Etsy, he focused all operations to solely serving its sellers and driving marketplace GMS growth. Any side projects not directly impacting GMS were abandoned and many employees were assigned to new roles in just a matter of weeks. These changes were difficult for some Etsy employees to swallow. Morale declined and many left the company, but sales growth started to pick up.
In addition to re-igniting GMS sales growth, the new management team moved to improve profitability. In July 2018, Etsy increased transaction fees from 3.5% (excluding shipping) to 5.0% (including shipping). At the time, Silverman explained to sellers via Etsy's podcast that Etsy's fees were lower than peers and the funds generated from the increase would largely be re-invested in the marketplace. On top of that, the increase would solve the problem of sellers inflating their shipping prices since they would not be paying fees to Etsy on that portion of the transaction. Research showed that buyers were willing to pay premium prices for high quality products, but not for shipping. A similar fee increase for Reverb was executed in August 2020.
In July 2019, Etsy announced that priority placement in search results would be given to shops that guarantee free shipping to domestic buyers on orders of more than $35. Based on buyer surveys, the high cost of shipping was a top complaint from buyers. Today, over 70% of item views are eligible for free shipping and according to Silverman, the “perception of pricing on Etsy being more competitive generally has really benefited, [which] set us up really well for the COVID moment” (Deutsche Bank 2020 Virtual Technology Conference).
As a result of both the transaction fee increase and free shipping initiative, Etsy was able to re-accelerate both GMS and revenue growth going into 2020. These projects seem like no-brainers, but the company's ability to execute and maintain seller engagement was impressive.
How Etsy Makes Money
Etsy makes money when its sellers make money. The company categorizes its revenue into two main buckets: marketplace revenue and services revenue.
Marketplace revenue (76% of last quarter's revenues) is comprised of the fees a seller pays for marketplace activities, including:
Transaction fee of 5% of sale, including shipping
Listing fee of $0.20 per item which is good for four months
Payment processing fees (around 3 to 4.5%)
Foreign currency transactions
Revenues from commercial partnerships
Reverb.com marketplace revenues, including a 5% transaction fee (increased from 3.5% in August), a payment processing fee and flat fee per order
Services revenue (24% of revenues) is comprised of the fees a seller pays for advertising services and shipping labels.
“Etsy Ads” which allow sellers to promote their product listings Etsy search, category pages and other areas of Etsy.com and the Etsy app. Sellers who opt-in to this service can set a daily advertising budget. They are charged on a CPC (cost per click) basis.
“Offsite Ads”, launched in Q2 of 2020, is a fee for sales generated via by Etsy advertising on search engine and social media behalf of sellers. For sellers making more than $10,000 in sales, Etsy will charge a 15% fee for sales that are generated via Offsite Ads. This fee added to any other listing and transaction fees. These sellers do not have the ability to opt-out of the program. Stores making less than $10,000 are charged a lower 12% rate and can decide to opt-out. Last quarter, management reported the opt-out rate was 2%.
Paid shipping labels are the last component of Etsy's services revenue. Etsy leverages their scale to offer discounted shipper labels to their sellers in the US, UK, Canada and Australia, which is a win-win for both parties.
Esty's cost of revenue consists of credit card processing fees, uncollected refunds issued to buyers, cloud infrastructure expenses and advertising expenses for Etsy Ads and Offsite Ads. This marketplace model enjoys high Gross Margins (71% TTM).
Total Addressable Market
In 2018, Etsy management estimated their TAM to be ~$100 billion. How they got there: the online market size for Etsy's categories in the core geographies is about $250 billion, multiply that by 40% of the population that are “expressives” and “seekers” who are in the marketplace for special handmade items.
For 2020, GMS is expected to come in around $10 billion which would mean Etsy still only commands a 10% market share assuming that its addressable market has not increased since 2018 (obviously not the case).
While it is a futile exercise to pinpoint Etsy's exact TAM today, it is clear that $100 billion is probably too low. This is especially true when we we consider the self-defined TAMs of certain single category online retailers: Wayfair at $600 billion, Farfetch $430 billion and Blue Nile at $400 billion. Either way, Etsy still has only scratched the surface of its market and is still early in its growth cycle.
Unique assortment of Items that cannot be found anywhere else
In an online world where the same products and brands can now be found on hundreds of sites, Etsy carries items that are not available on other e-commerce platforms.
Products sold on Etsy are not produced on an assembly line: they don't have SKUs and mass distribution in across outlets. Therefore, it is no surprise that 88% of buyers said that Etsy has items that you can't find anywhere else. Furthermore, a high percentage of Etsy purchases involve conversations between the seller and buyer and about 30% of items sold on the marketplace can be customized. As a result, Etsy provides a personal connection that simply does not occur on the big box sites like Amazon.
Consumers also flock to Etsy for gift or design ideas: Etsy is a trendsetter. As the annual report states: “a large portion of buyers come to Etsy not in search of a specific item, but to browse and be inspired”. On Instagram, #etsy has over 37 million posts while #etsyshop has over 20 million. By comparison, #amazon has less than 13 million tags and #wayfair is under 250,00. Among recent purchasers, the Net Promoter Score is over 70 (2019 Investor Day).
As Neal Sampat explained in a Medium article:
When everything in demand becomes cheap, the only differentiator will be exclusivity. This is the heart of Etsy’s business model.
Network effects: Etsy gets better with more users
Etsy's marketplace is highly scalable and highly defensible. Etsy benefits from a strong self-sustaining ecosystem that only gets stronger with more users: more sellers on Etsy means more robust, unique product offerings leading to more buyers and sales, which in turn attracts more sellers...and then the cycle repeats itself. On top of all of that, the marginal cost of adding an additional Etsy buyer or seller is essentially zero.
MBI Deep Dives further explains this phenomenon, stating: “[Etsy's] suppliers are reasonably differentiated which means increasing supply of sellers improves buyers experience further...I believe Etsy is in the tier 1 of the marketplaces: highly scalable and highly defensible”.
A dynamic marketplace where sellers can adapt quickly to emerging trends before the big box e-commerce sites react
Etsy does not have to predict shopping trends because the marketplace does it for them. Etsy sellers are able to shift quickly to meet consumer demands much faster than larger manufacturers. As Silverman explained during the Q3 2020 earnings call: "[Our sellers] respond to trends within days. They can literally look at what keywords are really getting a lot of traction, where is the search volume happening and start making product within hours or days of the trends that they're seeing".
When masks were hard to find in stores, the Etsy marketplace quickly added supply with over 60,000 sellers offering masks on Etsy by early May. When bread-making all of the sudden became a popular pandemic hobby, breadmakers also turned to Etsy to find baking supplies while other stores were out of stock.
Socially conscious mission that attracts users and talent
Etsy was founded as a mission-driven company with a goal “keep commerce human”. Over the years, Etsy's social impact is undeniable: its ecosystem has provided economic opportunities for millions of its sellers, most of whom are women.
When it comes to holding itself accountable to ESG , Etsy really “walks the walk”. A substantial portion of their Annual Report is dedicated to explaining their extensive goals and progress on key ESG initiatives. Last year, Etsy became the first e-commerce company to offset 100% of its emissions. In terms of gender diversity, 4 out of of 7 executive team members is female, 52% of overall company management is female and half of its board is female. Lastly, almost 40% of technology roles are female which is close to double Facebook and Google.
So why does this matter? Shoppers feel good buying at Etsy: 90% of Etsy buyers stated that environmental sustainability matters to them. Furthermore, it helps attract and retain top talent - giving them a leg up against larger tech companies. As CTO Mike Fisher said, “Many of our candidates have offers from the likes of Google and Facebook and Spotify. We even have engineers that leave for these big companies and they come back” (Etsy Investor Day 2019). As of Q4 2018, Etsy's attrition rates were well below its industry benchmark.
Bear Thesis and Risks
Seller Retention and Competition
Etsy sellers have many options to sell their products, including in person arts/craft fairs and online e-commerce options such as Shopify, Facebook Shops, Instagram, eBay and Amazon Handmade. Despite these many options, Etsy has historically been very resilient and "sticky" among both buyers and sellers because of its reputation as the go to place for handmade items.
Etsy has even survived Amazon entering their market in October 2015 when Amazon Handmade went live. At the time, it was dubbed as an “Etsy killer”, but Etsy's total active sellers have only accelerated since the launch of Amazon Handmade. It is important to also note that 61% of Etsy sellers are already on multiple channels. So even if an Etsy seller leaves for to start their own Amazon, Shopify or Instagram store, I believe Etsy will still be an important channel for generating sales for these sellers.
Over the years, Etsy’s intentional steps to improve its take rates over the years has alienated sellers. Fee increases, free shipping, offsite ads all caused concern among sellers, who obviously are not be happy when Etsy's cut of their sales increases. If these sellers do not see the value in the % of sales that Etsy takes (increased marketing, better seller support, etc), then there is a risk that they will leave the platform all together.
Earlier in 2020, The Verge declared that “Etsy is trying to get bigger, and it’s pushing away small sellers”. Despite this headline, the author ultimately did come to the conclusion that Etsy is still the best place to sell handmade goods:
The problem for sellers is they often have no other place to go. They can sell through their own online stores, advertise on Instagram, or take a crack at Amazon Handmade and eBay. But Etsy remains the go-to place for shoppers looking for crafty goods, and many have built their businesses around the platform. If Etsy makes a change, they often have no choice but to go along for the ride.
Etsy is just a short term COVID beneficiary with mask sales
Non-Mask GMS actually grew in Q2 and Q3 of 2020 by an identical +93% in both quarters. Masks are definitely a short term tailwind, but it would be irresponsible to ignore the GMS growth in other categories.
Furthermore, user engagement (measured via purchase frequency and average order value) is improving - and it's not just masks. In the third quarter of 2020, nearly 75% of GMS was generated from users that joined the marketplace prior to 2020. Their non-mask GMS purchase value increased on 50%.
Source: 2020 Q3 Earnings Presentation
Etsy has been spending a lot on advertising to remain competitive
Etsy's advertising as a percentage of revenues has actually remained relatively flat in recent years. In the first three quarters of 2020, marketing expenses represented 26.2% of revenues - which is the same amount the company spent in 2018.
In the short term, the company is expected to spend more on marketing expenses but there are good reasons for that change. Etsy is taking advantage of lower than normal traditional TV advertising rates as many sectors have cut back on their marketing spending. In addition, Etsy's marketing ROI has improved significantly this year since buyers are spending more (exemplified in the previous chart), which has increased the lifetime value of each active buyer.
I am not concerned about any short term margin compression due to increased marketing investment. In fact, I think management is making a very prudent decision to opportunistically ramp up marketing spend while costs are lower than usual.
Looking Ahead to 2021
Consensus revenue growth for next year is currently +12% among analysts, with EBITDA growth of +5%.
After taking into account management's take rate guidance of “high 16s to low 17s” (Citi 2020 Global Technology Conference), the 2021 consensus revenue estimates are implying just a 9% increase in GMS for next year.
This 9% GMS growth next year is extremely conservative for a number of reasons:
The worst YoY GMS performance Etsy has posted since going public in 2015 was +11.8% in Q2 of 2017.
Etsy has already added 23.3 million active buyers compared to the end of 2019 and the ramped up marketing investment that hit the airwaves all throughout the holiday season.
Active buyer growth before COVID was consistently around 17-19% going back to 2016.
Before COVID, management's long term guidance for GMS growth was 16-20%.
Google Search trends can provide some additional insight on user growth. Looking at the past year, interest in Etsy continues to rise in the fourth quarter of 2020, already +25% vs April highs:
While Etsy's GMS growth has been historically correlated with active buyer growth, there is also a large opportunity to increase frequency of purchases. In 2019, the majority (59%) of Etsy buyers only shopped on the marketplace once a year so there is tremendous upside next year as buyer engagement improves. Lastly, Etsy completed a two-year in February 2020, which further set itself up for success. The company's upgrade of its systems to Google Cloud (completed Feb 2020), improvements to personalization in its search results and launching seller videos on the site are initiatives that should help convert buyers into repeat and “habitual” buyers.
I am anticipating a blowout Q4 for Etsy and strong 2021 guidance from management.
Etsy has had a tremendous 2020. Year to date, earnings have grown 211% and the stock price has appreciated 331%. On top of all that, the company was added to the S&P 500 Index. While the Etsy will have to lap COVID driven numbers next year, I believe the marketplace is just getting started in becoming a mainstream destination among online shoppers who are increasingly looking for special items (not “Amazon basic”). Given that Etsy commands less than 10% market share based on a conservative TAM estimate, increasing frequency of purchases of existing buyers and massive investments in marketing, the future is bright.
I believe Etsy will continue to be an attractive long term investment given its sustainable competitive advantages, management team with proven track record and long runway to increase market share in a large and expanding total addressable market.