Last year, the black swan called COVID-19 swept across the world. The virus continues to hold the world in suspense to this day, and many things are no longer as they were until the beginning of 2020. The virus has caused a lot of suffering, and many companies are still being hit negatively by the effects of the pandemic today. However, there are also companies for which the past year has been a blessing. In previous years, the secular trend from offline to online progressed only slowly. Throw in a virus invisible to the human eye and you get a massive (!) acceleration of this trend. Etsy, the company I’m covering in this research report, was capable of achieving its 2024 (!!) growth target in 2020.
Etsy’s business model
In short, Etsy operates two-sided marketplaces. The core marketplace is Etsy.com, a global destination for unique and creative goods. Freelancers operate their stores on Etsy.com, targeting people who want to stand out from the crowd with personalized, handmade, and individual products.
To get a better sense of the products sold on the platform, I recommend browsing through Etsy.com.
Huge TAM, excluding India, which is >2x of core countries
Etsy massively improved its market position in 2020 and still has a low single-digit market share in an underpenetrated yet growing market. The TAM was estimated at $170 bn in 2019 (prior to Corona!) for 2023. However, this only includes Etsy’s six core countries: the US, Canada, Australia, UK, France, and Germany.
India is not covered in the assessment of TAM. The company has been operating there for about 3 years but does not yet provide much information on its success. The Indian market is >2x the size of all other six core countries combined, based on population.
In addition to competitive advantages (mainly network effects), high and scalable margins and high returns on capital, and a long growth runway, the business model is also very asset-light and the investments move through the P&L mainly as marketing costs, as the company has only very little tangible Capex.
Based on the quality of the business model and growth prospects, I think the shares fall into the GARP category. Not cheaper, but reasonably priced and with (much) upside over the next five years.
I already bought some shares and I’m happy to buy more if the stock prive might fall below $200.
Management summary of Etsy Inc. investment case
Etsy operates two-sided marketplaces with more than 4.4 million active sellers and 82 million active buyers worldwide. Etsy.com, the major business segment (besides Reverb, a marketplace for musical instruments), is the global destination for unique and creative goods. Buyers come to the Etsy marketplace to be inspired and delighted by items that are crafted and curated by creative entrepreneurs and are thus ‘special’.
COVID-19 has already antedated the growth of the years 2021 to 2024 to the year 2020. With many stores worldwide being forced to close due to lockdown and still being closed, the secular trend towards more e-commerce and more individualization/’special items’ was intensified in 2020, resulting in a massive shift from offline to online. The growth figures in 2020 speak for themselves:
- Gross Merchandise Sales (GMS): +107%
- Active sellers: +62%
- Active buyers: +77%
- Revenue: +111 %
- EBIT: +378% (!)
- EBIT margin: +13.7 percentage points, coming in at 24.6 %, up from 13.8 % in 2019
Two-sided marketplaces tend to deliver superior returns since these businesses (1) tend to produce high returns on someone else’s capital, (2) they benefit from network effects, (3) they collect countless amounts of data, which they evaluate and thereby become even better.
Besides, Etsy has a first-mover advantage. There is no comparable competitor on this scale. 2020 was a godsend for the company, as harsh as it sounds. Etsy was able to noticeably raise the bar for barriers to entry. Potential new competitors will have a very harsh time to take the bread from Etsy’s mouth and replicate a platform of this scale globally. Moreover, without COVID-19, it would probably have been much more expensive to attract the same number of buyers.
So how big is the market?
While Etsy buyers and sellers are located worldwide, Etsy is currently focused on the six core countries of the US, Canada, Australia, UK, France, and Germany. A 2019 market study conducted by management (before the pandemic!) showed a TAM in the six countries mentioned for online and ‘special items’ of $100 bn. The GMS which represents the dollar value of items sold on Etsy’s marketplaces, was ~$5bn in 2019, giving Etsy a market share of just 5% (which is still low for a first-mover!), suggesting that the market is still underpenetrated, and the company still has a long growth runway ahead.
The market study also revealed that the TAM is expected to grow +70% to $170 bn by 2023. The company is expected to present new figures for the TAM, possibly before the end of the year.
Also, Etsy has an opportunity for further growth in the Indian market, where the company has been investing for about 3 years. The Indian population (~1,400 million) is >2x the population of Etsy’s top 6 countries combined (~611 million). India, with a GDP per capita of $2,000, is a much poorer and less developed country than the US ($65,000 GDP per capita). As more and more Indians are gaining access to the Internet through increasing Internet penetration and thus have the opportunity to sell handmade products worldwide, creates a new chance both for the sellers and Etsy. The company is still keeping tight-lipped about its success in India in its announcements. Notabene, India is not included in the above-mentioned TAM, so there is only upside but no downside here.
Etsy aims for diversified revenue generation. Ultimately, the platform has to bring buyers and sellers together, but that goes without saying. Transaction revenues, payment revenues, and offsite ads revenues are considered as marketplace revenues, while Etsy Ads and Etsy Shipping Labels are classified as services revenues. Firstly, this ensures that Etsy digs further and further into the seller’s value chain so that the switching costs for the sellers increase. On the other hand, the additional services also provide for additional monetization and thus for overall increasing take rates (the percentage commission that Etsy retains from the GMS), which results in increasing margins due to only low marginal costs. It is remarkable how Etsy increased its EBIT margin from 2.7% in 2017 to 24.6% in 2020.
As described on my website www.stock-market-research.com, I am looking for companies that meet the following criteria:
- Competitive advantages so that high margins and high returns on capital can be achieved
- Long growth runway, so that I can remain invested for a long time as a long-term investor and the compounding effect can develop in its full splendor
- I prefer companies whose business model is already profitable or at least shows a positive trend towards a tangible break even
- A clean balance sheet structure with little or no debt is also an important point that I pay attention to
- Asset-light business models with sufficiently large organic growth are often scalable and enable high cash generation
- Last but not least, I do not want to pay an astronomical price, but a reasonable one
If I specify the fourth point from ‘little or no debt’ to ‘net cash positive despite debt’, points 1 to 5 can be ticked without a doubt.
What about the valuation?
Indeed, I would have preferred to buy the stock 12 months ago at $70. Today it trades at $200. Is the stock still cheap, given its growth prospects and the quality of the business model?
I think so. I would consider Etsy a GARP at the current price level: Growth at a reasonable price. Based on my planning assumptions (compare chapter 4), the stock is currently trading at the following multiples:
- EV/Sales (FY21): 13.4
- EV/Sales (FY22): 11.1
- EV/EBITDA (FY21): 49.3
- EV/EBITDA (FY22): 40.2
This is not cheap, but I’m not a fan of multiples anyway. For me, multiples are only a point of reference based on which I would never buy or sell shares.
The more important question (for me!) is the following one: Which future growth is priced into the current stock price?
The current market price roughly corresponds to a scenario with GMS growing by 16.8% p.a. to terminal value in 2030, while assuming that there is no increase in the take rate, the EBIT margin rises to around 30% due to economies of scale, the company pays 21% taxes with immediate effect and stock-based compensation is cash-effective. Keep in mind that the GMS grew at a CAGR of 24.3% from 2013 to 2018, pre-COVID-19! Based on these findings, make your own decision whether you consider the shares to be cheap or expensive. The following scenario analysis shows the DCF per share as a function of growth (ceteris paribus).
Author’s ownership disclosure: At the time of publishing this research report I hold shares in Etsy Inc.