John Penney
In February of this year, I concluded that Niche is Nice in the case of Etsy (NASDAQ:ETSY) as shares came under a lot of pressure amidst the pullback in technology names, while the world was at the forefront of a major political event of course.
I concluded that Etsy was facing tougher comparables with the pandemic fading, yet I still liked the long term positioning and uniqueness of the platform versus many other peers. Trading at 40 times earnings multiple, I was happy to start buying the dip there.
Former Take
Etsy is the marketplace for unique and creative goods, connecting millions of sellers with tens of million of buyers which are looking for non-standardized merchandise in a treasure hunt, allowing e-commerce to remain more human. These conditions make that engagement and loyalty of users is higher as Etsy hereby could attract fewer issues surrounding antitrust and consumer groups.
The company doubled sales to $1.7 billion in 2020 on which real and big GAAP earnings of $350 million, or $2.70 per share were reported. That was a big achievement, yet with shares peaking at $250 in 2021, the resulting $35 billion valuation translates into a 20 times sales multiple and about 100 times earnings.
Shares fell back a bit in the spring of 2021, as Etsy pursue dealmaking in the months following with a $1.6 billion deal to acquire fashion resale marketplace Depop, at a big and equivalent sales multiple to which its own shares were trading. After this short pullback shares rallied to a high of $300 in November of last year, pushing up multiples even more. The resulting $45 billion peak valuation was equivalent to just over 20 times sales of $2.1 billion and 100 times earnings just shy of half a billion.
By February of this year, shares fell substantially to just below a $20 billion enterprise valuation, translating into a realistic roughly 10 times sales multiple and 40 times earnings. This started to look compelling, as while 18% revenue growth in the third quarter kept slowing down, the number of active buyers rose by 38%. This highlights less activity of existing buyers/users, but on the other hand it confirms the popularity of the platform. Based on all these observations, I started to initiate a small position in the $120s, of which I cut a small position at $150s in the weeks thereafter already.
Since May shares have essentially been cut in half again, now trading at $80 and despite this dramatic move lower, shares are up 20% from the lows again.
What Happened?
Later in February, Etsy posted its fourth quarter results with growth slowing down to 16% as revenues rose to $717 million, for an annual number at $2.3 billion. GAAP earnings rose 9% to $161 million, as full year earnings rose by more than 40%, coming in a couple of million short to the $500 million mark. The company did not yet provide a full year guidance, but noted some headwinds in the operations, amidst pressure on consumer spending of course given the political end economical events taking place.
In May, the first quarter results came in a bit light with the pandemic fading as total GMS rose 3% to $3.3 billion, with small declines posted in the core Etsy business. Reported revenues were up 5% to $579 million as the slower growth resulted in meaningful profit retreat with net earnings falling from $144 million to $86 million. Moreover, the company guided for flattish results, with second quarter sales seen at a midpoint of $565 million, indicating that no quick recovery is in sight.
The 147 million shares now trade at $80, translating into an $11.8 billion valuation, or about $13 billion if we factor in net debt. This reduced the sales multiple to about 5-6 times sales, yet with half a billion in earnings out of the question, perhaps coming in closer to $300 million at the current run rate, expectations rise to 40 times earnings again.
And Now?
The truth is that shares have been significantly repriced, down essentially three quarters from the high just over half a year ago. This is obviously not the time to get bearish, yet the appeal has only partially improved earnings multiples have compressed quite a bit, but in relation to revenues the company remains incredibly profitable.
Nonetheless, the earnings multiple of roughly 40 times earnings remains quite demanding, as earnings have taken a huge beating, as other trends certainly create real headwinds as well. Higher interest rates obviously hurt the valuation in terms of the discount factor and multiple being applied to the business, as modest net debt makes that the company incurs some higher interest costs as well now.
The bigger issue is that of lower demand with consumers faced with the opportunity to spend money outdoors again following the pandemic subsiding, with less money to spend amidst higher interest rates, inflation and other headwinds. Furthermore, many sellers have issued their dissatisfaction with the platform as well amidst higher commission rates and longer payment terms, hurting their income and making them aware how reliable they are on the platform. This is despite the niche position of the platform itself, as loyalty between all participants was always the big strength of the business.
Adding Here
Having made a partial round trip on my initial position at $120, I find myself trading near break-even on that position. Yet this position is very small, as the continued reset in the valuation makes me cautiously optimistic despite the profit declines in the first quarter and soft second quarter earnings outlook. Overall, this remains a solid platform being positioned well in case demand picks up again.
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