Etsy is an online marketplace for artists and creators to sell unique homemade and vintage products. Etsy takes a percentage of each transaction on the marketplace.
Etsy is building a two-sided network effect of both sellers and buyers on the platform becoming the marketplace of choice for niche handmade goods.
The business is making acquisitions of other niche e-commerce platforms to build a House of Brands.
Etsy and its acquired platforms benefit from the secular growth of e-commerce penetration. The growth of gross merchandise volume ("GMV") has been explosive.
The pandemic may have pulled forward some growth for the business, but we believe the increased e-commerce penetration and growth in Etsy's brand value to be large net-positive results. Additionally, homemade face mask sales now represent a small portion of total revenue and GMV.
Key Company Metrics
A set of metrics we constantly keep updated to monitor the investment thesis.
A Niche Marketplace & The Two-Sided Network Effect
As a two-sided market, not only does Etsy provide sellers with a highly effective platform to sell, but it also helps these sellers by attracting large swaths of buyers looking for the particular items the sellers happen to make and sell. Discussed earlier, Etsy aligns its interests with the sellers as the marketplace provider only gets paid when sellers get paid. Making sure buyers and sellers are not only interacting, but actually transacting, is of paramount importance to Etsy and users alike.
Other e-commerce platforms are not exclusive to one classification of items. Amazon and eBay are known to be a general marketplaces, hence Amazon being dubbed, “The Everything Store”. Etsy takes a different approach.
As the e-commerce market penetration rate continues to increase against retail sales, Etsy's business grows alongside it. Etsy carved out a niche for itself, and it has been capitalizing well on it.
Capital-Light Business Model
Etsy hosts a highly scalable marketplace with incredible economics. The company does not hold inventory, it does not run any in-house logistics or warehousing services, nor does it require much capital expenditures to keep it running. There are also few incremental costs associated with handling increasing amounts of buyers and sellers on the website.
These factors contribute to low-cost operating model that can scale and become profitable quickly. Operating margins are positive and rising while gross margins also rise. On average, Etsy shells out less than $20 million a year on capital expenditures, a mere fraction of the total revenue brought in each year.
Over time, we think we will continue to see operating margins expand as operating leverage comes to life.
The total addressable market ("TAM") for "special" and "unique" items makes up about $100 billion of the $1.7 trillion e-commerce market. This figure continues to grow, and Etsy can supply the demand for both sides of the market (i.e., buyers and sellers). Within this market, we believe Etsy has taken strides towards carving out a sizable chunk that we think will double by the middle of this decade. Investments in marketing, partnering with Google Cloud, improving search functionality, and expanding its core market reach should provide enough volume on the website between buyers and sellers that will spur GMS rising from about $10 billion today to likely over $20 billion within a few years. As noted before, Etsy grows with its sellers. However, for these sellers to stay on the platform, the ideal environment would be one in which buyers constantly come back for more. Based on the GMS per buyer trend, it appears buyers have been continually spending more on the platform. We expect this trend to continue for the reasons stated above, and Etsy should grow as a result.
Etsy has built a well-known brand with its craft and vintage marketplace, but its acquisitions to buy other marketplace platforms allow Etsy to grab more market share and drive growth in other product verticals. Both major companies Etsy recently acquired focus on different types of products, which helps Etsy cover more ground with its consumers. This is how Etsy has been building a house of brands.
Reverb (acquired 2019)
Depop (acquired 2021)
Elo7 (acquired 2021)
The pandemic forced commerce all over the world to change as we know it. Widespread lockdowns and a recession that followed pushed many businesses into selling products online to manage through the lockdowns. Additionally, buyers were unable to shop in public, resorting to e-commerce stores and marketplaces to buy things they want(ed) and need(ed).
Etsy, as an online marketplace, witnessed a major influx in both buyers and sellers in 2020, leading to an increase in revenue, free cash flow and EBITDA. It is fairly evident that the pandemic pulled forward a lot of growth that likely would not have happened if COVID-19 did not occur. This makes us question Etsy's organic growth opportunities coming out of the pandemic.
Throughout the duration of the pandemic, demand for face masks flew through the roof. This was a primary growth driver for Etsy's sales, accounting for nearly 14% of all GMS in the first half of 2020. After this time period, face masks as a percentage of GMS have started to decline towards low single digits today.
While we believe this to be a risk, we think Etsy has a solid platform for niche goods that cannot necessarily be obtained anywhere else. Crafts, homemade goods, vintage items, and products created by small businesses for life events, decorations, and special holidays will always be in demand. If we see dips in performance coming out of the pandemic, we would not be surprised, but we wouldn't be pessimistic either. We think Etsy's platform can and will support further long-term growth.
We believe the brand awareness and active customers gained from the pandemic can be sustainable when looking towards the future as new customer penetration will ultimately be a net positive for the business in the long run.
Switching to Competition
Even if selling creative goods, Etsy is not the only e-commerce platform in town for sellers to reach buyers.
Etsy gave small business owners the opportunity to display their arts and crafts to the world. This was nearly a decade ago and now there are many competitors who can give creators the same ability.
Etsy charges high transaction fees for products sold and for payments. Unless a seller has a very high profit margin, it may not always be sustainable to sell products on Etsy.
Many users are making the switch to other e-commerce platforms such as Shopify and Handmade @ Amazon, as these platforms offer users a consolidated platform to access payments, ads, and sales tracking that give sellers more control over their entire business. For more popular and experienced sellers on Etsy, they are more inclined to open a Shopify store and notify their buyers of the switch than stay on Etsy for greater reach.
Investors should be aware of Etsy's transaction fees along with how they plan to keep its platform sticky for more seasoned sellers as its take rate can easily be competed against.