Overview And Recent Updates
Etsy Inc. (ETSY) is already up almost up 126% over the last year, and it almost quadrupled from its March low of around $30. The stock reached an all-time high of $135.52 before pulling back to the current $123.69 a share. Is it cheap? No. Is its price reasonable? Absolutely. Buying it at 13.0x LTM EV/Revenue still offers a great opportunity for long-term, growth-oriented investors.
Etsy’s platform connects sellers (small businesses and individuals) with buyers. The company specializes in handcrafted vintage items, and it recently received extra attention thanks to the COVID-19 pandemic, with crafters responding to the surge in demand for face masks by selling handmade ones through Etsy’s marketplace. As of September 2020, Etsy was the 4th largest e-commerce platform with an estimated monthly traffic of 222.5 million visits, only behind Walmart (WMT), eBay (EBAY) and Amazon (AMZN).
Etsy charges fees for listing, completing transactions and processing payments, and even without considering the boost coming from the pandemic, the company has shown solid growth. In 2019, Etsy drew 2.7 million sellers and 46.6 million buyers, generating $5 billion in gross sales. This compares with 2.1 million sellers and 39.4 million buyers in 2018, generating $3.9bn in gross sales. Today, the platform connects more people than ever:
|Metric||Q2 2017||Q2 2018||Q2 2019||Q2 2020|
|Active buyers||30.6 million||35.8 million||42.7 million||60.3 million|
|Active sellers||1.8 million||2.0 million||2.3 million||3.1 million|
|Gross sales||$748 million||$902 million||$1.1 billion||$2.7 billion|
Source: Etsy quarterly reports
Active buyers and sellers include anyone who has made at least one purchase/sale within the last 12 months. Etsy had an impressive run so far: the company doubled its active buyers count since Q2 2017, while active sellers grew more than 70% in the same period. Etsy has achieved these results by attracting more loyal buyers and bringing more value to sellers. Out of the total active buyers, repeat buyers (buyers who have made purchases on two or more days in the last 12 months) reached 26 million in Q2 2020, or a 51% YoY. Habitual buyers who have made six or more purchases on different days increased to 4 million, +64% YoY. Active buyers spent 5.9% more in Q2 2020 versus the prior year, with the average active seller achieving 15% more in gross sales. Clearly, this is a picture of a business model that is working.
Thanks to its amazing top line performance, Etsy reached a record net income of $96 million and operating cash flow of $250 million in Q2 2020. It is a cash-generating machine, and all this new cash pouring into the business, together with the $1 billion of cash & equivalents already on the company’s balance sheet, will give management extra flexibility. Undoubtedly, results were heavily influenced by the COVID-19 pandemic, with $346 million sales generated by coronavirus masks (sold by more than 100,000 sellers). However, three of Etsy’s six top product categories still saw triple-digit YoY gains in Q2 2020: homewares & home furnishing +128%, craft supplies +138% and beauty & personal care items +187%. Overall, non-mask sales increased 93% YoY, vs. +137% including face masks, while the slower product category (apparel) still grew at an impressive 59%.
With no supply chain, no brick-and-mortar stores and no warehouses, Etsy is well-positioned to navigate the coronavirus disruption. Its unique offering, an asset-light business model and constant innovations such as the implementation of AI and augmented reality to improve customer experience, will help Etsy to take advantage of the short-term coronavirus boost to further scale up its marketplace. Etsy already reached a scale where profits are growing even faster than revenue, with EBITDA reaching $222.7 million in Q2 2020, compared with $131.7 million in Q2 2019.
With management forecasting another 85-115% YoY revenue increase, Etsy should have plenty of new cash to expand the platform and keep the momentum rolling:
Our strong conviction [is that] Etsy has significant opportunities for further growth and that investments in technology, marketing, product, and people will yield both near- and long-term benefit
(Source: CFO Rachel Glaser, Q2 2020 earnings call)
But asides the great financials, what is even more impressive is Etsy’s ability to scale its business while maintaining a unique identity. The company is driven by a clearly defined mission: “keep commerce human”. And this “small store feeling” you get when navigating Etsy’s platform (for instance, some sellers are sending handwritten notes along with the items) attracts millions of visitors each month.
The big question that everyone is asking is: how can Etsy, a $14 billion company, compete with a giant like Amazon? When Amazon started its Amazon Handmade in 2015, that naturally raised the question on whether a business like Etsy could survive. But so far, Etsy has done extremely well. A big reason for the company’s success, asides from the experience it provides to both buyers and sellers, is lower fees. Etsy charges sellers a 5% transaction fee after the sale, a $0.20 listing fee and between 3.0%/4.5% payment processing fee. On the other hand, Amazon Handmade charges sellers with a 15% referral fee upon the transaction’s completion. Investors should always keep an eye on competition, especially when one of their direct competitors is Amazon, but at least for now, Etsy has been able to keep its top spot as the best e-commerce platform for handcrafted and vintage items.
A Deep Dive Into Etsy’s Financials
Etsy has experienced stellar growth, with revenue growing from $273.5 million in 2015 to $818.4 million in 2019. The company has constantly expanded margins, with EBITDA margin growing from 4.7% in 2015 to 14.4% in 2019 (19.8% on an LTM basis). In Q2 2020, revenue reached $429 million, with marketplace revenue representing the most significant portion:
|Metric||Q2 2020||Q2 2019|
|Marketplace revenue||$332.0 million||$135.2 million|
|Services revenue||$96.7 million||$45.9 million|
|Total revenue||$428.7 million||$181.1 million|
Source: Etsy’s Q2 2020 10-Q
In May 2020, Etsy started charging sellers for Offsite Ads, whereby sellers will pay the company an advertising fee of 12-15% of the value of the sale, if that sale is generated from an advertisement placed on third-party internet platforms. These revenues are recognized on a gross basis into Marketplace revenue.
Etsy is in a safe financial position. As of June 2020, total debt outstanding includes the 2019 Notes ($517.5 million fair value, 4.00% effective interest rate) and 2018 Notes ($312.2 million fair value, 4.75% effective interest rate). On February 2019, the company also secured a $200 million RCF, and as of June 2020, it has not used the line of credit. Total debt comes in at $861 million and includes finance lease obligations of $57 million (of which $8.1 million is the current portion). Etsy has $1.0 billion of cash & equivalents, of which $365.7 million is in short-term investments, bringing its net cash position to almost $200 million. Thanks to its incredible top line performance, the company generated $250.1 million in operating cash flow in Q2 2020, compared with $81.3 million in Q2-19.
Analysts are expecting revenue to reach $2.07 billion in FY2022, with EBITDA margins going from 14.4% in FY2019 to 30.2% in FY2022. In the DCF model shown below, top line growth is expected to taper off from FY2026, while EBITDA margins are capped at the 30.2% expected by analysts in FY2022. NOPAT is adjusted to factor in NOLs of $143 million as of December 2019, of which $30.4 million is federal NOLs, $21.5 million is state NOLs and $91.4 million is non-US NOLs. As a result, NOPAT margin is expected to stabilize around 20%, assuming a 25% marginal tax rate. NOLs are expected to be entirely used in FY2020, generating $36 million in deferred income taxes. EBITDA is expected to reach $1.6 billion in FY2029, with the Unlevered FCF/EBITDA ratio normalizing around 70-71%.
Capex/Revenue has been quite volatile, ranging from 13.1% in FY2016 to 2.1% in FY2019. In the model below, Capex are projected as 6.5% of revenue for the first few years as Etsy keeps investing in its platform; as the company matures, Capex/Revenue is modelled to taper off and reach 3.0% in FY2029.
Cost of Equity is calculated through a CAPM approach, with beta fading to 1.0 in FY2029. The normalized risk-free rate (2.5%) and ERP (6.0%) are from Duff & Phelps estimates. Pre-tax cost of debt is the weighted average interest on outstanding debt (4.00% on 2019 Notes, 4.75% on 2018 Notes) and is kept constant throughout the model.
Enterprise Value is adjusted to factor in (1) value of options outstanding: as of June 2020, there are almost 6 million options outstanding at a weighted average exercise price of $19.93, 7.23-year maturity, with a total estimated value of $457 million (61.57% annualized volatility, 2.5% risk-free rate). Note that all options outstanding, and not just vested ones, are considered (2) non-operating assets of $73 million in long-term investments & financial assets, which include $2.0 million in certificate of deposits, $13.8 million in long-term corporate bonds and $57.3 million in US government & agency securities. According to the company’s most recent 10-Q, long-term investments could be liquidated at short notice and with minimal penalties if needed, but they are still treated as non-operating assets in the model below.
Below is the summary of a high-level DCF:
Source: S&P Capital IQ, Duff & Phelps for normalized risk-free rate and ERP estimates, NYU Stern, proprietary research. 2020-2022 Revenue and EBITDA from CapIQ estimates. Please note: The above DCF only offers a rough fair value estimate. Valuation as of Monday 28, 2020 market close.
The model combines two valuation approaches to arrive at an estimated value per share:
- Exit EV/Revenue multiple – Estimated exit EV/Revenue of 4.1x, in line with competitors such as Amazon (5.0x), eBay (3.7x). This implies an exit EV/EBITDA of 13.4x. Adjusted for options outstanding and non-operating assets, fair value estimate comes in at $120.14, a 2.9% premium.
- Terminal Growth approach – Long-term growth of 2.5%, capped to the normalized risk-free rate, and terminal WACC of 8.2% (8.5% cost of equity, 3.2% after-tax cost of debt). Fair value estimate comes in at $115.49, a 6.6% premium.
Etsy offers a compelling opportunity for long-term investors, given its strong platform growth and improving margins as the company scales up its business. The stock is not cheap, currently trading at 13.0x LTM EV/Revenue (13.3x if adjusted for options outstanding and non-operating assets), which is well above public comparables, and the company might be exposed to higher volatility in case of any execution missteps. Note how Etsy appears to be slightly cheaper on a cash flow basis compared with Amazon, with Etsy trading at around 40x LTM P/FCF compared with 57x for Amazon.
However, the current price is in line with a reasonably conservative DCF, and long-term investors should consider paying a slight premium given the company’s strong growth prospects. I believe Etsy will be a long-term winner, and it currently represents around 8.0% of my personal portfolio.
Disclosure: I am/we are long ETSY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.