Conclusion: We’re adding ETSY as a Best Idea Short, as we think the stock has ~50% downside over a 12-month time period. The reality is that there are few business models that benefitted as much from the pandemic as ETSY, as organic revenue growth accelerated from 20-30% to over 100% over the past year and a half. In effect, ETSY pulled forward 3-4 years of growth in its model and leveraged both Gross and SG&A margins by a combined 1,000+bps and is now clocking in at a 20%+ EBIT margin, a level which is absolutely unsustainable. Our math suggests that the pull-forward in growth results in ETSY tapping into ~70% of its addressable market (Millennial and GenX females), making the model far more mature than it was pre-pandemic. At the same time it is running out of TAM, we see the company accelerating acquisition activity to grow outside of its core, which should at a minimum be a multiple deflator, and is largely dilutive to the P&L and financial returns. Pre-pandemic, this company earned between $0.60-$0.75 per share, which jumped to ~$3.00 with outsized growth and fixed cost leverage. The consensus is looking through the air-pocket of growth, and is forecasting that earnings double again over a TAIL duration to over $6 per share. We think that’s far too optimistic, and think that EPS for the next two years comes in 30% below the Street. The stock is trading near all time highs, despite the fact that the latest quarter showed a clear crack in the trajectory of buyers using the platform, and the financial deleverage that comes with it. In looking at EV/Gross Profit, which we think is the best way to value ETSY relative to other e-comm models, we see that ETSY is trading at 19x EV/GP, which is nearly double the multiple we saw pre-pandemic, and is trading at more than 2x AMZN’s multiple, which is a far superior model in every way, shape and form. As growth continues to slow and the model deleverages, this ‘peak on peak’ earnings/valuation dynamic should deflate, and by the time estimates are revised downward to what we’re modeling, we should see the multiple compress by 30-40% on a down earnings year in 2022, which suggests a stock closer to $120, or roughly $100 below where it’s trading today. We're going to host a black book on September 17th at 12:30pm to review the full thesis. Best Idea Short.
Details
ETSY is a great business and a good company, but that doesn’t make it a good stock. The ecommerce marketplace has seen a lot of volatility over the last few months, and we expect that to continue at least into early 2022. Demand flowing back to brick and mortar has pressured growth at the same time the companies are playing catchup in infrastructure investments post the Covid demand spike along with the inflationary pressures around wages and advertising. Looking at some of the leading online platform models over the last 3 months AMZN and CHWY are each up about 9%, W is down about 12%, while ETSY is up 32%. In our view of valuation in the ecommerce realm (see below), ETSY is perhaps the most expensive stock in the group and is significantly overpriced in the context of the trajectory of gross profit growth relative to peers as the company has entered a period of slower growth. ETSY saw its first quarter ever of active buyer decline Q/Q in 2Q. The best bull case we can outline right now is that a spreading Delta variant and reimplementation of mask mandates has driven some incremental demand to the ETSY platform. At peak pandemic masks were 14% of sales, falling to near zero as of 2Q, so with mandates back in the last few weeks we could see that meaning an incremental 5-10 points of revenue growth on top of the prior company outlook. Perhaps that is why ETSY has shown recent strength. But we think the market has very high expectations, and that consensus is over optimistic on gross margin and EBITDA trajectory over a multi-quarter basis. Given where the stock is trading a small misstep will mean big and rapid downside risk. We're going to host a black book on September 17th at 12:30pm to review the full thesis.
Like most ecommerce players ETSY saw massive growth during the pandemic, that growth likely pulled forward several years of customer growth, which is a good thing for the EV relative to pre-covid. But pulled forward customer growth means now pulled forward attrition and pulled forward infrastructure investments that will mean pressure on the P&L and valuation relative to the current market view. ETSY is arguably getting low on TAM in the US, it now has 90.5mm active buyers, with 60% of GMS (Gross Merchandise Sales) in the US. The model is built for millennial and GenX females, of which there are about 75mm in the US, meaning ETSY is potentially at 70% of its core US market already. International has been growing well, but the company has also been trying to boost growth through acquisitions with Reverb back in 2019, and two recent ones in Depop and Elo 7. Both Reverb and Depop get Etsy to expand into different customer segments, Depop being the more significant segment of fashion apparel resale market, which are not the ETSY core and has become very competitive. We think there is a real risk of customer growth stalling out on a 2-3 quarter basis and the company having to ramp expenses to continue to drive growth. That means we're getting to 2022/23 EBITDA about 15-20% below the street, and material multiple risk on that downward revision trend.
On valuation, we like to look at growthy ecommerce players on and EV to gross profit basis within the context of the rate of growth. Using gross profit (instead of sales) helps to normalize for the different revenue models, we also then ignore SG&A trends as companies might be in different cycles of reinvestment, as ecommerce companies often have the expectation of growth driving the long term SG&A leverage. Below is a summary of EV/GP for the major ecommerce/digital platform companies we watch. ETSY carries an EV/GP multiple as high as any, well above other dominant ecommerce models, and it has the highest growth adjusted multiple of any name actually growing gross profit. On weakening growth and downward revisions trends, we think the valuation comes closer in line with ecommerce peers, meaning an EV/GP of 9-12x. On our numbers that would mean a stock of $100 to $140 or 40%-55% downside while still trading at a growthy 25x to 35x EBITDA.
