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Etsy Looks Underpriced

|About: Etsy, Inc. (ETSY)
Summary

Etsy is an e-commerce company headquartered in Brooklyn, NY with 874 employees.

Etsy has control of its revenues.  Etsy has the ability to increase transaction fees on their business over the long-term if they so choose.

I expect overall revenue to increase 6x in eleven years with a projection of it being at $3.5 billion in 2030.

Due to a rather low R&D and marketing overhead, their model is viable long term in terms of its profitability.

Etsy is currently a $7 billion company.  I elaborate on why it should be a $8.67 billion one.

Etsy is an e-commerce stock whose shares have exploded from $42 per share to $57 per share, a 36% increase in roughly six months (since the end of November 2018). They have an interesting model, basically buyers and sellers throughout the globe buying and selling items and goods. It's in specialty retail. Etsy is similar to its other peers, such as Stitch Fix, although Etsy’s diverse product variety sets it apart from its competitors that are more focused on particular product niches. They sell all types of stuff; jewelry, clothing, home and living, entertainment, stuff for parties, art, craft supplies etc. They also have a Shipping Labels segment and a service allowing people to create custom Websites.

Founded in only 2005, Etsy had its IPO on April 16, 2015 at only $16 per share. Etsy has four founders, none of which are famous or noteworthy and the CEO is Josh Silverman who has been with company and on board of directors since November 2016 and has been the CEO since May of 2017. It is safe to say he's done a good job. He's a consumer tech expert, has a B.A. from Brown University in Public Policy and an earned an MBA from Stanford University. He's also the board member of Shake Shack and he's the Chairman of New York based coding skills company ScriptEd. Etsy has 120 million of shares outstanding and current has a market cap of $7 billion. They have $346 million in cash and $40 million in debt according to their first quarter report press release so their enterprise value is $7.1 billion. The company is headquartered in Brooklyn, NY and the company has 874 employees which is a very small number comparatively speaking. Wayfair has 10,000+, SFIX has 6,600, EBAY has 14,000, AMZN has 631,000, GRPN even has 6,600 so its interesting to have only 874 employees. The key metric since becoming public for the company is a concept called GMS growth, gross merchandising selling growth, that's what drives the company. The principle is when GMS grows, the revenue grows.

On a quarterly basis, ETSY used to not be profitable in its early days making the stock more difficult to value, but now that they are, it can be be more easily valued. When it first became public Etsy had 21 million active buyers, and 1.4 million active sellers (Q115). Compared to (Q119) now, they have 41 million active buyers, and 2.2 million active sellers, so buyers has increased 2x four every four years and sellers are increasing as well, albeit slower. Business with regards to GMS growth is becoming increasingly international, 30% in Q115 to 38% in Q119. Again, if GMS does well, revenue does well. ETSY's staple in revenue is the marketplace revenue. According to ETSY’s first quarter SEC filing this refers to " As members of the Etsy marketplace, Etsy sellers receive the benefit of marketplace activities, including listing items for sale, completing sales transactions, and payments processing, which represents a single stand-ready performance obligation. Etsy sellers pay a fixed listing fee of $0.20 for each item listed on Etsy.com for a period of four months or, if earlier, until a sale occurs. Variable fees include the 5% transaction fee that an Etsy seller pays for each completed transaction, inclusive of shipping fees charged, and Etsy Payments fees for processing payments, including foreign currency payments. On July 16, 2018, the Company increased the seller transaction fee from 3.5% to 5% of each completed transaction, and now applies it to the cost of shipping in addition to the cost of the item." "Etsy Payments processing fees vary between 3 - 4.5% of an item’s total sale price, including shipping, plus a flat fee per order, depending on the country in which a seller’s bank account is located. When a foreign currency payment is processed, an additional 2.5 - 5% transaction fee is applied." The marketplace revenue is equal to about 75% of the revenue. The other 25% of the revenue relates to promoted listings, the shipping labels, the monthly website subscription charge, and other advanced tools.

I've come to the conclusion the stock looks undervalued at the current levels based on my premises, presuppositions and projections of company’s free cash flow discounted back to present value. First, the stock, like many other GMS related companies in the space may be expected to double annual revenues by 2022, which would mean Etsy $1.2 billion revenue company in 2022. ETSY seems to be a front-runner in e-commerce with few other players relative to brick and mortar. Surprisingly, there are very few other large scale players out there. Therefore, I believe their growth is going to continue to double again for 2026 and then the company will eventually mature. My projection is that in 2030, it's going to get to $3.5 billion in revenue. Currently, the revenue number for Etsy for their FY2018 year $603 million. In 2015, they did $274 million in revenue a 2.2x increase in a matter of 3 years, so my forecasts are conservative and I think it foreshadows that one day this is going to be a multi-billion dollar revenue organization. Management has promised shareholders top line growth of “greater than 16-20%” growth for the next 5 years, but the 2019 guide is 29-32%, so I think for the majority of the next five years, it will be greater than 20%. Management has said ambiguously for the next 5 years, "revenue will grow slightly faster than GMS" (GMS is projected to grow 16-20% for the next 5 years). Another thing I looked at with Etsy is their gross margins. Their gross margins for 2018 were an excellent 68.49%. ETSY, every year is increasing margins rapidly. In 2017, they were 65.76% and then in the 2015 year they were 64.40%. To me, that's a huge plus as well. Most of the growth out of the stock has been organic growth which is also something I like so they have control over revenue in conjunction with increasing the fees long term (in the quotes above) which is another aspect I do consider as being an opportunity for growth.

Then, the other thing I looked at is whether or not ETSY has in the past or can in the future grow their business without too much of a marketing/R&D spend. Marketing for the stock increased 41% in 2018, while the company grew its revenues 34%. Since revenue was $603 million for 2018, their marketing spend was only one quarter of that, ($158 million). So to me the model is very very viable meaning they can continue to increase their marketing and by the same token revenue will not appear as if its inferior relative to marketing. Then, with R&D. revenue grows faster than R&D does. For sake of example, at the 2016 year, revenue increased 33% and R&D increased 31%, and R&D makes up less than 1/5 of revenue. Therefore, I am certainly not concerned Etsy can grow long-term without any R&D worries. As they mature, i also expect them to spend less on R&D year-over-year. Then, additionally, they've managed to decelerate their G&A expense last year; Etsy only grows G&A by so much anyhow (4-5%) making G&A not a big deal.

My belief is that both net income and free cash flow are going to grow long-term reminiscent to other companies like EBAY and AMZN. ETSY is priced on where its going, not where its gone. Currently, its a $7 billion company. I expect ETSY to continue to expand their margins over the coming years. In 2030, eleven years I think FCF, will be at $950 million, about ⅓ the size of eBay, assuming eBay continues to grow at a meager rate.  I think it is realistic that ETSY can accomplish that.  Based on all ETSY’s fundamentals and my conservative projections, I arrived at a $8.67 billion company, or a $72 stock which means shares have 24% upside.

In addition, Etsy has many other fascinating factoids used to describe the scale of their business: Sales of baby toys grew 80% in 2018. They sell a wedding ring every 90 seconds. Etsy has a "best in class search." Every minute they sell 8 pieces of clothing and one pair of shoes! In a recent survey, 78% of people agree that Etsy has products you can't find anywhere else.

In sum, the intertwining of continued revenue growth and higher profitability makes Etsy look like an attractive investment.  Thank you for reading. 

Ethan 

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.