Etsy: House of Brands, Revisited.
(ETSY: Q4 2021 Earnings)
The last time I wrote a stand-alone memo about Etsy (“House of Brands”) in Q2, my thoughts were as follows:
“The biggest question for me rests upon how buyer frequency and retention pans out over the coming 12 months. I am in no doubt that Etsy is a greater business today than it was pre-pandemic. Brand exposure, buyers, sellers, are all more significant and more widely dispersed. Whilst the next 12 months may be choppy, a great deal of insight as to whether or not this business has longevity will be extracted from the results.”
It is my opinion that the pull-forward exhibited in this business stands to be a net positive, regardless of how the share price might behave in the interim.
The last 24 months have brought in 43M new active buyers to the Etsy ETSY 0.00 marketplace, as well as 2.6M new sellers for a grand total of 90.1M buyers (+9.2M YoY) and 5.3M sellers (+900K YoY). Including Reverb, Elo7, and Depop, the consolidated business stands at 96.3M buyers (+18%) and 7.5M sellers (+72%). Etsy managed to surprise investors in Q4, putting up greater than anticipated revenue ($717M/+16%) for the period, as well as record GMS ($4.2B/+17%). All things considered, this quarter amounted to a ~5% beat on sales, a ~17% beat on EBIT, and a lofty 46% beat on earnings per share ($1.43 vs $0.98). As you can see from the chart below, the number of earnings surprises has fallen for the second successive quarter, so Etsy bucked the trend there.
But with soft guidance leaving analysts feeling a tad flaccid and volumes of chit-chat surrounding the headwinds that Etsy face leading into 2022, investors quickly gave up the post-earnings gains when reality set in. I now share some of my thoughts on the quarter and for the business as a whole.
Revenue: $2.3B in 2021 (+35%) / $717M in Q4 (+16%)
Consolidated GMS: $13.5B (+31%) for 2021 / $4.2B (+17%) for Q4.
Etsy GMS: $3.8B (+12%), with a take rate of 18% for Q4.
Non-US GMS: Grown 600bps (36%→42%) from last year.
Share of GMS for 2021: Etsy GMS $12.2B (90%), DePop $294.4M (2%), Elo7 $32M (<1%), and Reverb $948M (7%).
Consolidated Take Rate: 17.1% (flat YoY, despite the inclusion of new brands, a good sign).
Etsy Marketplace Take Rate: 18%, up 90bps YoY.
Gross Profit: $1.7B for 2021 / $508M for Q4.
Gross Margin: 71.8% (2021) vs 73% (2020).
Operating Income: $466M for 2021 / $142M for Q4.
Net Income: $494M (+41%) for 2021 / $161.6M (+8%) for Q4
Expansion of C-Suite: Kim Seymour was hired as Chief Human Resources Officer (first since 2017), Raina Moskowitz was promoted to Chief Operating Officer. Raina (COO) will be tasked with further defining Etsy’s global marketplace services, and will lead two revenue-driving functions in payments and fulfilment.
I’ll talk to the financials in some time, but the honus for Etsy in 2021 was to prove whether or not they could retain and engage the surplus of buyers and sellers that flocked into the marketplace during 2020. Later, the absorption of acquired subsidiaries would be tacked-on. I feel they did a great job in that respect, and that’s going to be the central theme of this particular memo.
But looking ahead, there are many factors that are now competing for wallet spend when compared to last year. On the supply side, we have no stimulus, interest rates are expected to rise, inflation is here and… not… transitory, rent forgiveness is over, and student loan payments are back. On the demand side, people want to travel, dine out, be outside, and spend their income in different ways. This will no doubt be a headwind for Etsy. To demonstrate the flux in digital commerce spend, one just has to observe the quarterly contribution of e-commerce in US retail sales (Etsy’s largest market) over the past 24 months. The long-term upward tailwind still stands, but it had some bumps along the way.
Both Etsy marketplace sellers & buyers have grown at a ~29% CAGR across the past five years; with sellers 1.9M→5.3M and buyers 33M→90M. As we will see momentarily, the concerns over retaining buyers and sellers from the covid-bump appear to be non-material as we look into the rear-view mirror. After welcoming more than 35.2M (+77%) new active buyers in 2020, Etsy added a further 9.1M (+11%) in 2021. More importantly, the base of repeat and habitual buyers has grown sequentially over this time period too. Whilst first-time buyers are important, converting buyers that purchase 1x item a year into those who frequent Etsy for purchase decisions in the 2-5x per year range, is going to be more conducive to long-term GMS expansion. 53% of all active buyers in 2020, returned in 2021 to make a purchase, and 37% of new buyers in 2020, returned.
International & Mobile
More broadly, a core part of Etsy’s thesis is the creation of ‘lightening in a bottle’ in each new international segment they expand into (discussed “Etsy House of Brands”).
The process is typically; open access in a new country, leverage existing sellers to fulfil supply at inception, and eventually create a self-serving network effect between domestic buyers and sellers which Rachel Glasser calls ‘two-sided vibrancy’. In the Cannacord Forum, Glasser remarked that “in both Germany and the U.K., we've reached that two-sided vibrancy” with France, Canada, Australia (and eventually India) being worked on next. Today, 70% of all UK & German GMS is generated from domestic sales; a pleasing outcome from the intensity with which Etsy has focussed on ROI-driven advertising in these regions. It bodes well for the prospect of repeating this process in other core markets.
On India, it was interesting to hear Glasser briefly touch on that market; citing that the groundwork is being built for it to eventually become a domestic self-serving market.
She later remarked that this was part of the incentive to purchase Elo7; a smaller marketplace located in South America, that already had the presence of a two-sided vibrancy. Thus far, Etsy is making good ground on their international business, with non-US GMS (formerly international GMS) expanding 600bps this year, reaching 42% of total GMS with a total of 31M buyers.
I show mobile alongside that, to demonstrate the progress on one of Etsy’s other priorities; converting web users to the Etsy app (downloads were +47% versus 2020).
In 2021, Etsy’s flagship marketplace reactivated 21M buyers compared to 22M in 2020 and 13M in 2019. As a testament to Etsy’s ability to attract new customers, the company welcomed 35M new buyers last year, just 3M fewer than in 2020, and well above the 19M recorded in 2019. GMS retention rates per new buyer show that, after the initial drop-off from Year-1, buyers do come back to spend again at Etsy. The data suggests that with each new cohort, the retention rate tends to be stronger in the following year, with the obvious omissions of Year 4 in the 2017 sample (2020) and year 2 in the 2019 sample.
Excluding the anomaly of 2020, the nominal GMS per new buyer cohort has been improving. My feeling is that whilst the overall retention of new buyers is suboptimal (Mostly Borrowed Ideas discussed this well in “Why I Sold Etsy”), Etsy’s more pressing issue is understanding their engaged buyers; repeat (2+ per year) and habituals (6+ per year). These cohorts, particularly habituals, drive a disproportionate amount of the marketplace’s GMS. Habituals, which grew 25% in 2021 (to 8.1M) account for just 9% of active buyers, but drive ~45% of total GMS, up ~500bps from last year. That’s up from 8% in 2020, and just 5% in 2019.
Whilst the habitual buyer cohort is by far the most important, I would attest that the repeat buyer cohort, which accounts for ~40%, is equally as important. A quote from the latest 10-K remarks that Etsy is “particularly focused on converting our repeat buyers into habitual buyers”, for these are the lowest hanging fruit; the buyers with the greatest propensity to consume, and the highest likelihood of converting to a habitual.
The average purchase days per repeat buyer has steadily been improving from 4.5x per year in 2017 to 5.25x per year where it stands now. Granted, the recent surge was a byproduct of covid, but it’s impressive that Etsy not only retained but improved upon this metric in the following year. The path from repeat to habitual would see a buyer purchase 2-6 items per year to one that purchases more than 6x per year with a total basket size of $200 or more. As these two cohorts continue to eat up an increasingly larger share of active buyers, the GMS per active buyer will continue to climb. In Q1 of 2020, when habituals account for just 5.5% of active buyers, GMS stood at $104 per active buyer. Today, with habitual up a further 450bps, that metric stands at $136.
So not only is Etsy converting more habitual buyers, but these habitual buyers are also spending more. I do think that there is considerable room for growth here. In reality, 6x purchases at $200+ per year is a low bar. Even adding a further 1M buyers to that cohort, would see Etsy drive that base by 12%.
Thus, the challenge is (a) figuring out what creates a habitual buyer and; (b) how to convert more buyers into habitual buyers.
Part (a) is apparently not solved. Glasser remarked in the Cannacord Forum that she “[doesn’t] think there's any one thing about habituals that we've been able to lock on to that [set them apart as a] habitual”. But she did have some observations. One being that habituals tend to become habituals because they exhibit a higher propensity to cross-category shop.
This makes perfect sense, considering that these buyers, on average, purchase ~1x item each month. Assuming all buyers are not naturally predisposed to cross-category shop, how does Etsy ensure that the inverse of that assumption takes place on the platform?; that buyers become habituals because they begin to cross-shop. I believe part (b) boils down to increasing the value proposition of the buying experience at Etsy. During the earnings call, Silverman suggested that “in 2022, you'll see us doubling down on increasing buyer frequency through product and marketing experiences designed to inspire and reengage”.
What has Etsy done thus far?
Whilst the addition of video reels for sellers adds to the inspiration element, I find the most promising product enhancements come in the form of improving the perception of reliability for buyers. The inclusion of XWalk, Etsy’s real-time graph retrieval engine has allowed Etsy to minimise dead-ends in the search experience, improve the recommendation engine, and allow buyers to find what they want faster. In 2021, 95% of searched purchases were found on the first page of results, up from 85% in 2020. XWalk will be applied to non-US searches sometime this year. This year, nearly 100% of US listings had delivery date coverage (98% had tracking coverage) which is a marked upgrade from 2020, when fewer than 70% of purchased orders have delivery date disclosure. These are subtle enhancements, but go a long way in improving that (potentially) first purchasing experience with Etsy.
All in all, I am surprised by the extent to which Etsy managed to retain and expand its buyer base in 2021, more importantly, its highly engaged base. I have no superior insight as to whether or not they do as great a job in 2022 but believe that improving the reliability of the buying experience will assist with the goal of converting new→repeat→habitual buyers. I don’t expect metrics like GMS per active buyer to go up in a straight line, but am confident that throughout the last two years, tens of millions of consumers have experienced Etsy for the first time, and this platform now has mindshare in a significant number of those consumers’ wallets.
Powell isn’t the only one hiking rates, for Etsy’s 5.3M sellers will, effective as of April, be subject to a 150bps increase in the seller transaction fee (5%→6.5%). Management remarked that Etsy has delivered enough additional value to sellers since the last major upstep in transaction fees (2018) and that, like in 2018, the majority of the incremental revenues will be reinvested into the seller program across seller tools and marketing. Without the influence of the 6.5% transaction fee, the Etsy marketplace reached a take rate (GMS/Revenue) of 18% in Q4, up 90bps from last year and 170bps from 2019.
It does make me wonder just how far Etsy can push sellers before this becomes a gripe. Around one year ago, when I first began researching Etsy, my takeaway, when the take rate stood at 17.1%, was as follows:
“The way that Etsy increases its take rate, is primarily through marketplace fees and seller services costs. These come at the expense of the seller. So long as the trade-off between paying the fees to sell on Etsy and leaving the marketplace remain favourable for the seller, they will stay.”
It’s my opinion that Etsy has provided sellers with additional value to warrant an upstep in fees. The most obvious of which being the fact that the platform now boasts ~2x the number of buyers it did just two years ago. Then you have the reinvestment into enhancing the buying experience, which equates to more engaged buyers, which equates to more repeat custom and demand for sellers. Mostly everything Etsy does to improve the platform helps both sellers and buyers. The Star seller program (launched in Q2 2021) helps strong sellers stand out from the crowd whilst simultaneously signalling to buyers that these sellers are of higher quality. Sellers in the program drove 31% of Etsy GMS in the fourth quarter.
Glasser shared some remarks about the initial reaction from sellers during the Canaccord Forum a few weeks back, suggesting that sometimes you have to give sellers what they need and not what they are asking for. This reminds me of the notion that if Henry Ford had asked the consumer what they wanted in 1902, they would have called back; “faster horses”.
Assuming this pricing event is absorbed with relatively no impact on GMS, as it was in 2018, it bodes well for the replication of Etsy’s model across Reverb, Elo7, and Depop. Reverb and Depop have seller transaction fees of 5% and 10% respectively. On a consolidated basis, the Etsy business take rate was flat on the year, at 17.1% which one might find impressive, considering the introduction of several lower take-rate marketplaces. It should be noted that Depop and Elo7, both acquired in 2021, accounted for <3% of total GMS this year, however.
In contrast to the buyer cohorts (to be expected), sellers in each annual cohort tend to increase the amount of GMS they generate on Etsy marketplace, with the obvious bubble periods of 2020.
Without a crystal ball or any superior insight into how Etsy sellers will take this latest pricing event, I can only track this metric, listen to what sellers have to say, and read between the lines. Early rumblings have seen some sellers propose to strike (stop selling) for one week beginning April 11th, the day the fees come into effect. The article from March 30th suggested that as many as 5,000 sellers are engaging in the strike with 16,300 buyers signing a petition to boycott Etsy.
As well as demanding a halt to the fee hike, the abolishment of the Star Seller program (for fear of added pressure), and more control over advertising. Typical fluff and outrage, and immaterial at this stage.
Concerns over how Ukraine and Russia may impact Etsy should be contained. Both markets represent a small % of total GMS, and Etsy “don't expect a lot of GMS hit from it because we can satisfy that supply with others”. Glasser remarked that ~1% of GMS is Russian, and ~2% is Ukraine, but argued that the substitution effect will smooth out that initial impact on GMS.
Reverb, Elo7, and Depop
With Etsy comprising 91% of the consolidated businesses’ GMS ($13.5B), this warrants a quick update; and note that for Elo7 and Depop, their contributions are partial numbers, based on the time of inclusion within the business during 2021.
For fear of recycling commentary from prior posts, Etsy’s house of brands strategy largely plays into the idea that, through these acquisitions, they can bolster its presence in particular categories (such as apparel for Depop, music hardware for Reverb) and geographics (such as South America for Elo7).
Reverb appeared to have an okay year, with GMS growing 16% despite the headwinds it has faced. For Elo7 and Depop, however, said headwinds have had a more profound impact. Buyers on the Depop platform declined 5% YoY (3.9M→3.7M) whilst sellers remainder flat, and for Elo7 buyers declined 5% (1.9M→1.8M) with a 2% decline in sellers (56K→55K).
It’s clear that Etsy carries the weight of this “House” of brands and will continue to do so for the foreseeable future. With the two newer entrants (Depop and Elo7) being so fresh, some slack is given with respect to Etsy getting them firing on all cylinders. Below is a summary of priorities for each subsidiary.
Of note, was the remark that Etsy would soon begin “testing performance marketing for the first time with Depop”. Anecdotally, Depop’s advertising presence in the UK (their largest market) has been non-existent for a number of years. Similar apps have frequented our screens here in the UK over the last decade. Once upon a time, Depop was all over TV, but copycats like Vinted (particularly prominent right now), as well as Shpock, and Gumtree have all had their rounds in the spotlight. Hopefully, Etsy can remind the UK that Depop exists.
I don’t have a great deal of commentary on the subsidiaries this quarter outside of what I have already cited in previous memos. It remains a “show me” story. One thing that did make the hairs on my neck stand to attention was Silverman’s “sum of the parts” comment during the earnings call.
Whilst probably a throwaway comment, I do hope he doesn’t consider Etsy a SOTP play because most often SOTP businesses do not get valued for… the fair value of the sum of their parts.
Echoing the successful retention of Etsy’s customers (buyers & sellers), revenue growth of 35% YoY (GMS growth of 30%) was impressive after a paramount year in 2020. The noticeable sales leverage that was afforded to Etsy in 2020 has caught up with Etsy as the company reinvents in businesses and absorbs the dilutive additions of Elo7 and Depop. Consequently, applying pressure on gross and EBIT margins.
Whilst Depop and Elo7 are additive to GMS (~5% in Q4), both remain loss-making enterprises (Reverb is EBITDA-positive) and created a ~2% contraction to adjusted EBITDA in Q4. Further evidence that the Etsy marketplace is driving results here. As remarked in the past, Etsy is a business that reinvests through its income statement (being capital-light), with marketing being its core operational expense.
Two years of tremendous aggregate demand for e-commerce, as well as reams of sales leverage, has seen the composition of marketing as a % of revenue decline 400bps from its peak in 2018. Nonetheless, the nominal annualised spend has increased by ~9.3x over the same period. It just so happens that annualised revenue has grown ~10.6x over the same timeframe. With both Depop and Elo7 set to embark upon performance marketing-driven user acquisition strategies and revenue growth set to face tough comps heading into H1 of 2022, we may see that balance come back to equilibrium in the near future.
Despite Etsy’s surprisingly strong Q4, the guidance they provided for Q1 was a tad soft, remarking that January was strong, with a notable deceleration in February, followed by some difficult comps in March, a quarter in which management believes added ~8% of growth on the back of stimulus checks and lockdowns. Two components that are non-existent in 2022. Management remarked that revenue would be in the ballpark of $565M to $590M whilst GMS would be expected to come in at between $3.2B and $3.4B. This, with the caveat that H2 growth is expected to accelerate relative to H1. This equates to 5% growth for both metrics at the midway.
In an alternate, covid-free, reality, Etsy could have grown revenue by 35% in Q1 2021 ($307M), followed by another year of 35% growth ($414M) and nobody would have batted an eyelid. But, today with expectations so high and nuance oft-ignored, investors are more focussed on a percentage point, contrary to the fact that nominal revenue is far ahead of where it ought to be, and that Etsy is demonstrating they can retain that exceptional onboarding of commerce spend.
For me personally, I don’t care if the headline states 5% YoY growth, I just see 150% over 2-years, and $350M of additional revenue across the period. Like my mash potatoes, I don’t mind a touch of lumpiness. The macro-environment is still choppy, we can’t be sure how consumers will behave but, for now, it appears that Etsy is stronger coming out of covid.
Pretty clean, with $780M in cash, and a further ~$300M or so in investments and cash equivalents for a current ratio of over 2x, and a cash ratio of 1.3x. LT Debt has ballooned ($1B→$2.3B) in the last 12 months, but the first of those maturities ($~$650M) don’t mature until 2026, with the remainder due in 2027 and back-end-loaded into 2028 (where $~$1B is due). No major liquidity concerns from me.
Cash Flow Statement
As the sales leverage afforded in 2020 winds down, free cash flow as a % of revenue has floated down to pre-covid levels, accounting for 27% of revenue, or $623M, in 2021. Backing out SBC shows a FCF margin of ~21% in 2021. Much of which is being used to offset the dilution of stock-based comp.
Notably, Etsy has allocated just shy of $1.7B this year by acquiring Depop and Elo7 (Depop acquired for $1.6B), a sum which was partially financed by the issuance of ~$1B in convertible notes.
Has Etsy managed to retain the influx of buyers and sellers from 2020? Yes, they have. Has Etsy come out of Covid a stronger business? The Etsy marketplace, thereby the consolidated business, has indeed. The same can’t be said for the subsidiaries that populate this “house” of brands. Each requires reinvestment, and each is still yet to prove they are not a fathomless pit of capital-burning inferno. The jury is still out on that one. Thankfully, for now, Etsy is still the largest area of focus for me as an investor, and with the marketplace deriving some 90% of total GMS, I feel that’s warranted.
Will growth slow down in 2022? Eh, duh. The question for me is not whether superficial YoY growth rates dwindle in 2022, but more so focussing on how Etsy can build from this pulled-forward base they have established after covid. Early signs of buyer retention hint that Etsy will retain all of the ‘gains’ pulled forward in 2021, which is more than can be said more some companies. I find it helps to detract from the covid-narrative here. Without it, Etsy likely wouldn’t be putting up the numbers they are today.
Etsy currently trades at ~$16B (~$17.4B EV) and is priced at approximately 37x trailing earnings and 30x forward earnings. Put differently, that’s ~6.8x trailing sales or ~5.7x forward sales. Slice Etsy’s multiples many ways, and you’ll find that it trades around the lower end of the historic norm for each of them. A “historic norm” which is still a young public entity, having never experienced life on the exchange romped by anything more than the temporary setback of March 2020 and existing largely within one short market cycle.
But who cares about the past. Analysts suggest that Etsy is expected to grow revenues at a ~20% CAGR over the next 3-years, with EBIT growing at a ~27% CAGR over the same period. The continuance of a 20% revenue CAGR into 2025 would result in Etsy more than doubling its revenues across the next four years.
If we consider that Etsy trades at ~34.6x trailing EBIT today, essentially at the lows, then the multiple could contract to as low as 20x by 2024 (on the estimates EBIT) and churn out a positive return of ~20% or so.
At a multiple of 25x, that would be closer to 51%. This isn’t necessarily how I think about valuation on the whole, but a glance at Etsy’s competitors will highlight that Etsy trades relatively cheaply compared to its peers, many of whom are not expected to grow as fast over that period. For me, this is more so a means of assessing whether Etsy’s valuation is demanding here, which I don’t believe it to be, assuming you align with the bull case.
As for me, I have already made my bed with Etsy and intend to maintain ownership until evidence suggests otherwise.
Questions on my mind are; (a) can Etsy replicate its success with Depop and Elo7, (b) how will the seller fee hike be received, (c) will Etsy continue to demonstrate they can retain buyers after distortion from covid and, (d) whether we might see further bolt-on M&A this year.
Thanks for reading.
Author of Investment Talk