Etsy, Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 5/5

Etsy is a global e-commerce marketplace that connects buyers and sellers of unique and creative goods.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview Etsy’s marketplace is a unique ecosystem that brings together independent sellers and buyers. It primarily caters to handmade, vintage, and craft supplies, differentiating it from mass-market retailers like Amazon and Walmart. The company doesn’t manufacture its own goods, it generates its revenue through transaction fees, listing fees, payments processing fees, and other seller services.

Revenue Distribution: Etsy’s revenue is segmented into Marketplace revenue and Services revenue, with Marketplace revenue largely generated from transaction fees charged on sales.
- Marketplace Revenue: This segment includes the core Etsy marketplace, where sellers list their products, and buyers make purchases. The bulk of the revenue comes from a fee charged on each transaction.
- Services Revenue: This segment encompasses revenue derived from a range of value added services offered to sellers that help them to run their business, such as advertising and shipping labels, among others.
Industry Trends: The e-commerce market is experiencing continued growth, although there’s a shift towards unique and handcrafted goods. The demand for personalized, sustainable, and ethical products is rising, which plays into Etsy’s strengths. Additionally, there is increasing competition from new players as well as from large marketplaces expanding into handmade items.
Margins: Etsy’s gross profit margins remain relatively strong which is due to a low cost model. For the first nine months of 2023, Etsy’s gross margin stood at approximately 75.3% with operating profit margin of 12.5%. However, this includes a significant decrease in operating margin as compared with previous periods, and this is mostly attributed to the cost of growth.

In general, Etsy’s growth over the years has come at the expense of a decline in profitability, as the company has increased operating expenses to fuel growth.

Competitive Landscape: Etsy’s competitive landscape can be described as a mix of niche and broader marketplaces. Competitors include mass-market retailers with “handmade” sections as well as smaller online marketplaces. Companies that operate more vertically and maintain operations, such as Amazon and Walmart, or other companies such as Shopify also compete with Etsy.

As mentioned above, Etsy operates in a highly competitive space and is fighting against behemoths of retail that enjoy more flexibility, capital, and influence than Etsy.

What Makes Etsy Different: Etsy differentiates itself through its focus on unique, creative, and often handmade goods, connecting independent sellers with buyers interested in one-of-a-kind items. It’s also positioned itself as a more values-driven company. They also provide a full range of services for sellers, including marketing, data analytics, shipping labels, and payment processing. They have recently started to experiment with generative AI to help sellers in their workflows.
Recent Concerns and Problems: In the latest earnings call, management has cited macro factors and the current economic environment as the cause of slow growth, in addition to “the changes in marketplace dynamics.” They have also seen decreases in GMS, a key metric that refers to gross merchandise sales. Other challenges also include the increase in marketing spending, the negative effect of international trade, and increased competition.

Management is focused on stabilizing the business and finding more revenue drivers, even if that means a slowdown in growth or more reliance on fees and costs charged to the sellers. They seem to be leaning more into technology and AI initiatives, as well as building the international part of their business.

Financial Analysis Etsy has a very healthy balance sheet, with over $1 billion in cash and short-term investments, and no long-term debt. For the first nine months of 2023, they had revenues of $1.865 billion and net loss of $102 million. Free cash flow has been largely positive over the past five years, although it has decreased for the trailing 12 months, mostly driven by lower net income. Their revenue growth has slowed down a lot in 2023 and there has been a decline in margins, which has had a large impact on net income.

Revenue: Total revenue for the first nine months of 2023 was $1.865 billion, up 8.6% from the same period in 2022. Marketplace revenues totaled to $1.3 billion. Services revenue was $567 million.
Net Income: For the first nine months of 2023, Etsy reported a net loss of $102 million, compared with a net income of $233 million during the same period of 2022.
Cash Flow: Free cash flow has remained positive throughout 2023 (at roughly $640 million) but has significantly declined as compared with previous periods.
Balance Sheet:
Assets: Total assets stand at $4.6 billion, including $1.1 billion in cash, $400 million in short-term investments, and $2.7 billion in property, plant and equipment and other assets.
Liabilities and Equity: Total liabilities equal to $1.6 billion and total shareholder’s equity equal to $2.9 billion.
There is no long-term debt. This means Etsy is very well capitalized.

The absence of debt on the balance sheet signifies the high degree of financial stability and strength that Etsy posses.

Moat Assessment: Etsy has a moat that’s rated 3 out of 5.

Network Effect: Etsy benefits from a network effect, as more sellers attract more buyers, which, in turn, attracts more sellers. The brand recognition and the quality of the experience they are trying to provide (personalized experience for customers, tools and data analytics for sellers), also makes them stickier and better than generic marketplaces.
Intangible Assets: The brand name of Etsy also creates a moat, though not an overwhelming one. Also, seller programs, such as Etsy Ad, provide a moat, which should allow for more stable and durable earnings.
Switching Costs: There are switching costs for sellers that are related to familiarity with the interface, reliance on data they obtained over time, and integration into the business operations of sellers. These switching costs are not too strong. Switching costs for buyers are quite small, but many buyers return to the platform due to a wide range of personalized items.
Cost Advantage: Etsy’s low-cost model is a small moat. Since Etsy does not own any inventory and most of its sellers are small businesses, they can run on a pretty small financial structure that has low operational costs. However, this is not a very durable moat as it is easy to replicate.

Threats to the Moat and Business Resilience

Increased Competition: Etsy faces increasing competition from larger e-commerce marketplaces that may offer similar goods and services, potentially eroding Etsy’s market share.
Dependence on Brand Reputation: Etsy’s brand image is crucial to its business, so any damage to its reputation for unique, ethically sourced products could negatively affect its customer base.
Erosion of Moats: Competitive advantages from network effects or a differentiated brand could erode if large, well capitalized competitors enter the market.
Economic Downturn: In the recent economic slowdown, Etsy has seen a decrease in sales and has struggled with lower profitability. It may continue to struggle in a recession.
Regulation: The company is vulnerable to changes in local, federal, or international regulations, especially those related to taxes, consumer safety, e-commerce, and data privacy.

Understandability Rating: I would give the business an understandability of 2 / 5. On the surface, Etsy seems pretty easy to understand, it’s an e-commerce company that acts as a marketplace. However, once you go down to the detail of its revenue structure, financial drivers and the impact of macro-economic factors, a more complex picture begins to form. Furthermore, the unique dynamics of the markets that Etsy operates in, requires extra insight to fully understand the business model.

Balance Sheet Health Rating Etsy receives a balance sheet rating of 5/5. They have over $1 billion in cash and short term investments and no long term debt. The ability to generate free cash flow for years to come and the low leverage on the business shows a high degree of stability.