In the early days of Etsy a site sprang up called Regretsy that made me (and many others) laugh to the point of tears. Their tagline was “where DIY meets WTF” and it was simple but brilliant. They would find tragically bad works on Etsy and share them with a brief comment. At first, Etsy members were upset about it. But then they discovered that the traffic from Regretsy was helping them, and they learned to tolerate if not love it.
Page ahead to the Etsy IPO and what had been a joke was presented an institutional investment as the category leader in the “craft ecommerce” space. It was a hot IPO with the rare combination of both Goldman Sachs and Morgan Stanley as lead underwriters.
All the trends seemed to be in Etsy’s favor including:
- Growth in freelancing and the so-called “gig" economy
- Continuing spread of online commerce to businesses and consumers
- Trend towards more local sources and smaller producers
- Easier commerce across nations and geography
- Much of Etsy’s traffic growth has been organic rather than paid for
Some of the key thrusts in their messaging was about creating “a person to person” economy and building an “authentic, trusted marketplace.”
We published a note on Etsy back at the time of the IPO in April of 2015. (See our full post “Can Etsy Survive an IPO” for all of it) but here are some useful snippets:
- The IPO itself is a major event and brings in a whole new facet of "community" in the form of investors who may, in fact, care much more about sales and profits then relationships, creating social good and long-term thinking.
- Etsy has made a major shift from organic, word-of-mouth-driven growth to a more traditional method of spending heavily on marketing. For example, they doubled marketing spending from 17.9M in 2013 to 39.7M in 2014. As a percentage of revenue, marketing went from 14% in 2013 to 20% in 2014.
- Long-term financial goals call for gross margins to decline 10 points from the current 62% to 50-52%as a result of growth in revenue from new value-added services. Besides going in the wrong direction these revenues more typically boost rather than wilt gross margins. There is something wrong with that picture in our eyes.
- The user population is still quite narrow. There are 1.4M active sellers and 19.8M active buyers on the platform today. The vast majority, over 80% are women. Although they don't talk about it much in the roadshow, a large portion of the Etsy business is related to selling craft supplies (like a Michael's Stores) and Jewelry. Etsy is diversified, but even so the site has not shifted their demographic profile much in the past several years. For Etsy "active" means activity within a 12-month period.
- Scale may be difficult. How large can the Etsy platform be and retain the hand-crafted and vintage sensibilities that sellers and buyers identify with? There's more to it than simple supply and demand. As the number of discrete items and customers grows it gets difficult to find and filter products. In the same way, your local craft shop can't "scale up" and retain the same feel and identity. Etsy may be planning to use M&A to create more of a "federation of small platforms" but this carries risks as well, and so far management hasn't said they would go in this direction. (Although they have made a couple of small acquisitions like Grand Street and A Little Market.)
Despite the great story and successful pricing, Etsy has not done well as a public company. At the time of the IPO, we published an IV model indicating that $15 (the mid-point of the IPO range) was the right valuation.
Now with the shares at $9 and almost a year behind them we take a look at the situation with fresh eyes and update our forward view on the company, valuation, and investment merits.
First of all, there are a few post-IPO observations that have to add to the original analysis:
- The proliferation of mass-produced and clearly non-crafted items continues on the site. It could be the pressure of being a public company but for whatever reason little if any effort has been made to preserve the aspects of Etsy that made the items for sale there special. Some can certainly still be found on the site but they exist in a sea of standard items.
- Amazon (NASDAQ:AMZN) launched “Handmade” and is exploiting their advantages to create a desirable alternative to Etsy. At the other end of the market Shopify (NYSE:SHOP) has made it very easy for small businesses to create their own online stores where they can control their brand presentation and customer experience.
- Surprisingly very basic features of the Etsy website don’t work. Specifically functions like “sort by price” which are rather simple do not arrange listings by price. I’ve tested this over the last few weeks using different computers, operating systems, and browsers, and it doesn’t work. Perhaps it’s not a big deal, but it indicates a profound lack of attention to details that provokes an uneasy feeling about management.
- After carefully listening to the CEO address questions during earnings calls and conference presentations we’re left with an impression that he is very smart and well-informed but does not consider new ideas and initiatives. In some cases, answers to fairly interesting open-ended questions about the business are met with discouraging non-answers. There’s a tendency to thinking small rather than big and slow rather than fast. Probably not ideal for an e-commerce business.
The Etsy Bullish Case
Although the company has a questionable positioning and management team there are some fundamental merits for a long position in the stock. Some are concrete while others are speculative. Here’s my list:
- Hard assets – Etsy has close to $300M in cash and is cash flow positive. That puts the valuation at 3x book. Since cash flow is positive book value should increase.
- Low expectations – Of the eight analysts following the stock 6 have “hold” The consensus target price is just over $10. Only three analysts asked questions on the last earnings call. In short, not many people are even paying attention.
- Potential surprises – Although we haven’t been impressed by management in the past it doesn’t mean they won’t surprise us with some positive developments. Here are some:
- Etsy could become a launching platform for new products to mainstream retail Back in 2011 Urban Outfitters was exposed for boldly stealing an Etsy member’s jewelry design. Etsy could take steps to legitimize this process for designers and create a streamlined process that would support scaling up from small batches of product to larger volumes.
- Seller services could be expanded to provide greater support and create something more like an “SMB-stack” that includes additional services like legal, accounting, marketing, supply chain management or even employee recruiting and management.
- Might Etsy dip slightly into the crowdsourcing or P2P financing area? Kickstarter has maintained strong momentum. There’s certainly aggregate demand and success for angel investing and P2P lending. There’s a marketplace there where Etsy may have some powerful advantages.
- Lastly, there’s a new world of opportunity unfolding around improved automated fabrication technologies like 3D printing, computer-controlled and robotic manufacturing. So far Etsy has done nothing special to promote this trend but if they did it might create another facet of value and business for them.
- Finally with the stock at this level a quarter or two of continued “as or better than expected” results can spur an upgrade or two.
Etsy IV Model Changes
Relative to our IV model dated April 7, 2015 we’re making the following revisions:
- Revenues are lower but gross margins are higher. This is due to less growth in sales volume but a layering on of more “seller value-added services” that increases the amount realized per sale. More specifically, management changed their GM guidance from 50-52% to “mid-60’s” during their most recent quarterly earnings call.
- Our target P/E ratio is dropping from 30x to 22x. This is based on the decline in the longer-term revenue growth rate from about 30% to 22%. If Etsy can meet expectations and support our current IV model estimates the ratio could be a point or two higher next year.
Our updated model is below. Although the IV is $11 for 2016 it will soon be time to consider 2017 values which suggest a $16 working IV for ETSY shares later this year.
See the this content with the model as a PDF using this link: Etsy or Regretsy?
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