Etsy Should Emerge Stronger as Cyclical Pressures Abate; Wide Moat Continues to Look Intact

Equity Analyst

Sean Dunlop

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Etsy has carved out an interesting competitive niche, jockeying for e-commerce wallet share across a variety of heterogeneous verticals in the long tail of unbranded products. The firm’s marketplace properties—Etsy, Reverb, and Depop—all target non-commoditized inventories (artisanal crafts, used musical instruments, and vintage clothing resale), generate commissions on third-party, peer to peer sales, and strive to create a “treasure hunt” experience around a unique, customizable, and consequently less price elastic product suite. The firm's core "Etsy" marketplace accounts for roughly 90% of consolidated gross merchandise volume, or GMV. 

We view Etsy’s competitive strategy as sound, with the quickly growing firm capitalizing on a surge of COVID-19-induced demand, providing one of only a handful of outlets through which customers could purchase face masks during the nadir of the pandemic. Though mask sales have dwindled, the platform has remained sticky, with Etsy seeing its consolidated active buyer base swell to 95 million at the end of 2022, roughly level with 2021 figures and more than double the firm's prepandemic figure. As the marketplace leans into brand marketing to increase its unprompted awareness, invests in platform search functionality and filtering, and reduces purchase friction with its buyer protection program and better platform policing, we see a viable route to mid-single-digit growth in average annual per buyer spend over the decade to come.

In the future, we expect Etsy to onboard unique inventory, to expand its burgeoning international operations (45%-50% of GMV), and to expand its suite of seller tools and advertising options, while periodically targeting competitively advantaged tuck-in acquisitions that offer exposure to similarly differentiated end markets. Particularly important will be efforts to increase repeat purchase behavior, with the long-term driver of GMV growth likely to be increased average revenue per user in lieu of buyer acquisition after the firm achieves saturation in its six key markets—getting buyers to go to Etsy “not just for the cushions, but for the couch.”

Business Strategy & Outlook

The e-commerce industry is extremely competitive, featuring almost perfect price transparency, fostering little customer loyalty, and engendering relentless competition to shave a few basis points from costs, or to improve fulfillment speed by a couple of minutes on the margin. Attributable to a surfeit of investor interest in the space, and minimal barriers to entry, the channel has seen everything from the conception of myriad niche marketplaces (with five to 10 dedicated to some form of clothing resale) to spinoffs of traditional retail companies’ e-commerce apparatuses, laying the groundwork for what appears to be an inevitable consolidation of digital shelf space over time. Operators positioned to emerge from the maelstrom, in our view, are those that dig moats around enduring competitive advantages: durable marketplace network effects, access to unique customer data or inventory, or scale-driven cost advantages. In our view, Etsy is one of the few companies poised to emerge as one of e-commerce’s long-term winners, eschewing competition in commoditized categories like fast-moving consumer goods as the firm has recognized its inability to effectively compete for sales that are driven principally by price and fulfillment speed considerations. Instead, the firm has built a competitively advantaged marketplace around a catalog of non-traditional, unique, customizable, and artisanal inventory, deriving a competitive edge from a network that grows more valuable as additional buyers and sellers join the platform. Further, Etsy benefits from access to an almost entirely non-standardized suite of more than 100 million products, with those items mapping to neither stock-keeping units nor universal product codes, allowing the firm to develop search algorithms that would effectively be impossible for peers to emulate. While Etsy’s narrow purview naturally limits its long-term total addressable market, it has allowed the firm to mobilize a network of some 7-8 million largely untapped sellers (disproportionately from craft fairs and live selling events) and more than 95 million active buyers at year-end 2022, en route to a commanding share of a fragmented craft market. Our wide moat rating suggests a horizon for excess returns upwards of 20 years; a view embodied by our forecast for 48% average annual adjusted ROICs (including goodwill, capitalized development, marketing, and general and administrative costs) through 2032, healthily exceeding our 8.7% weighted average cost of capital estimate.

We believe that a complete discussion of Etsy’s competitive advantages demands consideration of the nature of the firm’s network effect moat source and its quantitative underpinnings, the importance of search engine optimization in the category, and a brief consideration of available alternatives.

Accordingly, considering the firm’s network effect, we view a marketplace platform that grows increasingly valuable as buyers and sellers are onboarded as one of the most powerful and rarest moat sources in our coverage. While buyers are widely viewed as the economic engine of a marketplace, the buyer experience is beholden in some capacity to the quality and depth of the seller pool. Access to a platform with more and better sellers improves the buyer experience, reduces search costs, and improves product discovery, all of which continue to improve as more sellers are onboarded. On the seller side, access to a larger pool of buyers, particularly buyers with purchase intent and interest in their category, often results in better sale prices, quickened inventory turnover, and reduced illiquidity-induced discounts to product fair value. Thus, the seller experience improves as new buyers join the platform, incentivizing further growth on both sides—a demand flywheel that is difficult to stop beyond key tipping points, which we've estimated as 10% of the internet-using population in a geography in past research. Ultimately, growth does not constitute an enduring competitive advantage. Rather, the hallmark of an enduring network effect, and a direct reflection of the value added by a marketplace operator—in the form of demand aggregation, enhanced trust, payment facilitation, dispute arbitration, and business development tools—is the firm’s ability to effectively monetize its platform without driving participants to the exit.

In our view, Etsy scores well on all these counts, connecting 95 million active buyers and 7-8 million active sellers across six key geographies (the U.S., U.K., Germany, France, Canada, and Australia) on a marketplace that accounted for more than $13 billion in gross merchandise volume, or GMV, in 2022. The firm’s position looks durable, in our view, with World Bank data and our calculations suggesting that Etsy’s active buyer count is good for 15%-20% penetration across the aggregate internet-using population in those six geographies. Perhaps more poignantly, the firm has been able to effectively monetize that cohort, with our estimates suggesting a consolidated take rate (Etsy’s take of $1 of platform sales) of 19.3% in 2022, driven by listing fees, final value fees (6.5% on the core marketplace), payment processing, offsite advertisements, shipping labels, and seller services. The firm’s growth has lifted results for both Etsy and its platform sellers, with a 33% GMV compound annual growth rate (CAGR) over the last five years outstripping the 24% annual growth in broader U.S. e-commerce, despite Etsy’s take rate increasing by 580 basis points during that period. While a high-teens take rate falls well shy of wide-moat Amazon’s high-20% figure, it stacks up nicely against more relevant competitors like narrow-moat eBay (14%) and niche marketplaces like recently acquired Depop (10%), with the lack of a proprietary fulfillment arm at Etsy accounting for the lion share of divergence with the e-commerce behemoth.

Further, the firm provides a suite of valuable services for its buyers and sellers in support of its marketplace. Buyers receive access to a truly unique product suite, catering to an audience that values self-expression, unique decor, and supporting local artisans and entrepreneurs. The platform reduces uncertainty, easing fears of fraudulent transactions and intermediates post-purchase conflicts, while adding a uniquely “human” twist to notoriously depersonalized online shopping through a messaging platform. On the seller side, Etsy amalgamates demand in an extremely fragmented end market, offering access to a buyer base of more than 95 million potential customers, with language processing services allowing sellers to tap into a global audience that otherwise would be inaccessible. Further, Etsy offers a clean, easy to use user interface (UI) for smaller sellers, featuring a seller handbook and attractive advertising rates that are likely much cheaper than rates to “go it alone.” For example, Etsy’s offsite advertising commissions are currently 12%-15% of sales prices and only charged for sales which convert (a cost-per-action model, the most favorable for sellers). For sellers who choose to go it alone, utilizing white-label solutions like narrow-moat Shopify, we’d expect much higher advertising outlays--particularly considering the advertising spend among the largest direct-to-consumer brands on public markets, which range from the midteens to the low-30s, by our estimates. Finally, and not inconsequentially, we surmise the firm’s search engine optimization efforts--underpinning our data-driven intangible asset moat source--lead to better conversion and demand aggregation than would likely be available on competitors’ sites. Innovation continues to be seller-friendly, adding video and augmented reality to make listings pop, investing heavily in platform development, and working relentlessly to translate search terms to search intent.

The firm’s competitive position largely insulates it from competing on the basis of price and fulfillment speed, with an emphasis on non-commoditized products—often crafted, handmade, and customized—disincentivizing multihoming and (generally) exempted from 24-hour delivery expectations. In fact, internal surveys provide us with two important data points: first, that 87% of sellers agree that Etsy has items on its site that you can’t find anywhere else, and second, that only 56% of Etsy sellers are multichannel sellers (implying that 44% derive all of their sales through Etsy). Critically, Etsy is the primary sales channel for the vast majority of its sellers, with the second most prevalent being craft shows and live selling events--dispelling the popular misconception that Amazon Handmade or eBay compete heavily for category share. The firm’s top categories: home furnishing, jewelry and personal accessories, craft supplies, apparel, paper and party supplies, and beauty and personal care, reflect its strategic emphasis, but naturally limit the viable total addressable market. To this point, our analysis of e-commerce volumes in the U.S. and the firm’s consolidated 2022 average revenue per user figure ($132 on the core marketplace) suggest that Etsy customers only deploy about 4% of their e-commerce dollars on Etsy, a figure that offers plenty of white space but will likely never approach the figures of larger marketplaces with a larger mix of business-to-consumer, or B2C, sales like eBay ($500s) and Amazon (estimates range from $600 for nonprime members to nearly $2,000 for prime customers). Nonetheless, we’re encouraged by positive cohort spending trends over time, with the firm’s habitual buyers (7%-8% of active buyers) now accounting for 40% of marketplace GMV, raising the “glass ceiling” for GMV growth over time, since the biggest growth lever in the long term will likely shift toward user monetization in lieu of user acquisition. In effect, we believe that Etsy is competitively advantaged and can continue to grow its share of consumer wallets, but it’s unlikely that we’ll see the degree of monetization we do from marketplaces that sell conventional B2C products—and that’s OK.

Briefly considering the firm’s subsidiary marketplaces (Reverb, Depop), which we haven’t figured into our moat calculus yet (representing 10%-15% of consolidated GMV), we take a positive view of the firm’s efforts to poach potential winners in advance of category consolidation. Time will tell whether the market demands specialists in every category--apparel, handmade goods, musical instrument resale, sneaker resale, home goods, and so on—but it certainly strikes us as unnecessary to have myriad specialists within those categories, likely catalyzing near- to medium-term consolidation now that access to capital has tightened up. Reverb, for example, competes for share with Sweetwater and a handful of smaller marketplaces for musical instrument resale spending, while Depop operates in an uber-fragmented clothing resale market that has seen micro-niches run the gamut from luxury resale to subscription services to social selling. Take rates upon acquisition reflect lower platform value exchange, generally clocking in around 10%, but back-office rationalization, marketing best practice sharing, and modest cross selling could help accentuate the more attractive features of those marketplaces, particularly if investor interest wanes and competitors are forced to get fit quickly, as we've seen in 2022 and 2023. The option to process payments through the Depop marketplace offers one vehicle for monetization, while advertising products are gradually being introduced across the firm's smaller marketplace properties. Given that the apparel resale marketplace has only recently worked toward integrating search customization (different results based on user search history), we surmise that there are plenty of benefits "within the family" to sharing best practices for marketing, search, and back-office functions.

Considering the firm’s intangible assets, we view a proprietary product database of more than 100 million listings and aspects for unique goods--without a stock-keeping unit or unique product code identifier--as a meaningful edge over peers who attempt to compete in the space. Given a seller base that skews toward individual proprietors and micro-businesses, Etsy’s algorithm is forced to translate search intent--"men’s cocktail apparel” should yield navy blazers, ties, or other items that share no key words with the query--into meaningful results, without the benefit of typical merchandising experience among sellers. Recognizing that a dress is approximately equivalent to a gown, or that a search for a blue desk shouldn’t uncover “blue desk lamps” requires constant tinkering and deep learning algorithms (with natural language processing continuing to represent one of the most complex applications of artificial intelligence) but offers a meaningful edge over peers with fewer items for sale or more homogenous products. In our view, the firm’s algorithm is likely to get better as it gets bigger, perpetuating the demand flywheel by increasing conversion, optimizing the “treasure hunt” search experience, increasing the value of incremental impressions, allowing the firm to spend deeper into its marketing curve, and closing the loop by further improving the algorithm. Recent efforts like “Xwalk," which collect 11 times the amount of data per search query, should continue to drive improvements in search, with Etsy now privy to newer data like dwell time, which has proven important. Look no further than GMV growth per dollar of product development--averaging nearly $30 over the next five years, by our estimates--to evaluate the efficacy of those efforts.

Ultimately, we view a wide-moat rating as appropriate for Etsy, with our research suggesting that the firm’s network has reached critical mass in its key six markets, presenting a nearly insurmountable barrier to success for new, like-minded entrants. While Etsy will continue to compete for sellers with local consignment stores, niche marketplaces, social commerce, and white label (DIY) offerings, we view the firm’s easy-to-use seller services (catering to the firm’s smaller clientele), self-reinforcing marketplace network, and the continuously improving underlying value position as sufficient to defray competitive pressure. We view Etsy as one of the likely winners in a quickly evolving space, with access to a unique, differentiated product suite, strategic investments in the platform experience, and a strengthening marketplace network auguring well for economic value creation through the 20-year period implied by our wide-moat rating.

Wide

Economic Moat

Etsy

Etsy, Inc. engages in the operation of online marketplace. It offers handmade products such as shoes, clothing, bags, and accessories. It operates through the following segments. Etsy, Reverb, Depop, and Elo7. The company was founded by Haim Schoppik, Robert Kalin, Jared Tarbell, and Christopher Maguires in 2005 and is headquartered in New York, NY.

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Etsy, Inc. engages in the operation of an online marketplace. It offers handmade products such as shoes, clothing, bags, and accessories. It operates through the following segments: Etsy, Reverb, Depop, and Elo7. The company was founded in 2005 and is headquartered in New York, NY.

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Etsy, Inc. (NASDAQ:ETSY ) Nasdaq 49th Investor Conference December 6, 2023 8:00 AM ET Company Participants Josh Silverman - Chief Executive Officer Rachel Glaser - Chief Financial Officer Conference Call Participants Matthew Cost - Morgan Stanley Matthew Cost Great. Well, hello everyone and good afternoon.

Etsy, Inc. (ETSY) Nasdaq 49th Investor Conference Call Transcript

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