Etsy: Attractive Business, Rich Valuation, Counterfeit Risk

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Etsy: Attractive Business, Rich Valuation, Counterfeit Risk

SeekingAlpha, by Spencer Platt

Arts & Crafts
We here are Ironside Research are fans of online service businesses that have tangible, real-world impacts, particularly ones that act as market makers by connecting buyers and sellers in some physical way (for example, see our recent write-up on Airbnb). Etsy, Inc. (NASDAQ:ETSY) is just one of those businesses, connecting independent store owners who provide myriad services to buyers while collecting fees along the way.

However, we think that at this time the Etsy, Inc. business is both overvalued and currently has other issues under the hood that need to be addressed. We will outline those issues here.

The Business
Etsy operates its business in two main segments: Marketplace and Services.

Marketplace consists of the actual transactions between buyers and sellers. It covers the listing, transaction, payments, and offsite ad-listing fees. With almost $2 billion in annual revenue, Marketplace makes up with lion’s share of Etsy’s revenue.

With 25% of overall revenue, Services makes up the rest. Services includes on-site optional advertising and services that facilitate buyers completing their transactions with ease, such as providing shipping labels.

The ecosystem that Etsy has created is quite large. Gross merchandise sales (GMS), which is the total dollar value of all transactions across the platform, were $13.3 billion in 2022 between 7.5 million sellers and 95.1 million buyers.

Growth?
In 2022, Etsy, Inc. posted a 10% year-over-year gain in revenue, from $2.3 billion to $2.5 billion. The company posted a net loss for the year as well, losing $5.48 per share in 2022 versus a gain of $3.88 in 2021 (both figures basic, not diluted). The main reason for the loss was not operational mismanagement, but a one-time goodwill impairment charge of over $1 billion.

Despite the one-time nature of this charge, we suspect that Etsy’s fastest growth days may be behind it. Given its rich valuation, this is a cause for concern.

Historic growth rates for Etsy have been in the double digits - as high as 70% per year in the early days. Despite an uptick in revenue in 2021, however, growth has consistently slowed.

Analyst estimates for earnings per share have similarly fallen off.

From their peak in 2021, analyst 2- and 3-year forward earnings per share estimates have declined. While estimates still remain elevated above pre-pandemic levels, the outlook for hyper-growth seems to have faded to the rearview mirror.

Rich Valuation
Given that growth is slowing, it would be reasonable to expect that valuations would fall as well. This would be correct.

However, despite falling, valuation levels remain high in our opinion (which we’ll qualify in a moment). Forward price to earnings currently sits at 33x, and EV/EBITDA at 21x.

First, if we are going to buy a company posting growth rates in the low teens or even high single-digits, we would expect a much lower EV/EBITDA multiple than 21x.

Second, the valuation seems especially pricey once investors consider that Etsy, despite being profitable, has a significant amount of debt and is currently equity-negative. The company ended 2022 with $2.3 billion in assets and $3.1 billion in liabilities, resulting in a negative shareholder’s equity of $547 million.

Some may point out that the turn to negative equity was driven by the aforementioned goodwill impairment of $1 billion. However, we would point out that this amount of goodwill was the main reason that the company posted positive shareholder equity in 2021, and, as a general rule, we tend to be fairly skeptical of management goodwill estimates (especially in tech).

Stock-Based Compensation
Like many other tech companies, however, we find Etsy’s level of stock-based compensation (SBC) to be concerning. From 2020 to 2021, SBC expenses grew 115% year over year to $139 million. In 2022, they grew another 65% to $230 million (almost 10% of revenue).

Those who disagree with our negative view may point out that while, yes, Etsy does partake in generous SBC, it hasn’t impacted the overall share count (and thereby diluted investors) too dramatically.

The above chart clearly shows that, despite a jump in 2021, the overall share count has remained steady since then. In fact, it has even declined a bit.

We want to point out that simply viewing the share count can be a bit misleading. Etsy has, after all, been a buyer of its own stock for several years.

Since 2018, the company has had a positive buyback yield, meaning that the company has been actively repurchasing shares. Since the stock doesn’t have a dividend, stock buybacks would typically be welcome news for investors - however, we suspect that this buyback activity actually masks the dilutive effect of Etsy’s SBC expenses. This, in essence, creates a feedback loop where the company allocated capital to cover the expense of SBC.

As negative as we are about high levels of SBC, we are even more negative about companies utilizing precious capital to buy back shares that are concurrently being diluted by it.

Counterfeit Risk?
On February 16th, famed short seller Andrew Left of Citron Research released a report about Etsy, alleging that the company is carrying a massive amount of litigation risk by allowing counterfeit goods to be listed on its site.

We strongly recommend that investors at least peruse the report because the allegations are serious. The report references search results for Disney (DIS), Nike (NKE), and Rolex products that appear to be very obviously counterfeit. Left notes that such questionable search results do not appear on competitor sites like eBay (EBAY).

Whether or not investors agree fully with Left’s analysis, it is important to point out that without stringent anti-counterfeit measures, Etsy does have a significant risk of running afoul of the government.

To give a sense of the significance, the U.S. Chamber of Commerce estimates that counterfeit goods cost the economy almost $500 billion per year, and research from North Carolina State University estimates that the counterfeit economy topped $3 trillion in 2022.

Given that these dollars largely escape the purview of tax collectors and debase the value of goods sold by corporate taxpayers, the government has a strong incentive to take action.

While nothing has yet taken place, we think this is a risk that all online marketplace providers (and their investors) must be aware of.

The Bottom Line
We believe that Etsy, Inc. runs a good business - we just happen to think that it is currently overvalued, and has potential hidden risks. Our main reasons for this thinking are:

Growth rates seem to be slowing. Analyst forward estimates echo this.
Debt levels are high relative to assets, as evidenced by the company’s current negative equity position.
Stock-based compensation is growing rapidly, and its effect is - in our opinion - largely masked by the company spending capital to buy back stock.
Etsy may need to re-assess its anti-counterfeit enforcement policies in the near future. Doing so could raise the cost of maintaining the marketplace and potentially affect revenue.
For these reasons, we will be staying away from Etsy, Inc. stock for the time being.

There’s a lot in there, but I was intrigued by the counterfeit bits.

On February 16th, famed short seller Andrew Left of Citron Research released a report about Etsy, alleging that the company is carrying a massive amount of litigation risk by allowing counterfeit goods to be listed on its site.

We strongly recommend that investors at least peruse the report because the allegations are serious. The report references search results for Disney (DIS), Nike (NKE), and Rolex products that appear to be very obviously counterfeit. Left notes that such questionable search results do not appear on competitor sites like eBay (EBAY).

Whether or not investors agree fully with Left’s analysis, it is important to point out that without stringent anti-counterfeit measures, Etsy does have a significant risk of running afoul of the government.

Etsy may need to re-assess its anti-counterfeit enforcement policies in the near future. Doing so could raise the cost of maintaining the marketplace and potentially affect revenue.
For these reasons, we will be staying away from Etsy, Inc. stock for the time being.

Amazon cracked down on counterfeits (albeit nearly involuntarily under great external pressures), and it was good, At least for me (and I assume, other good sellers). However, did it contribute to Amazon’s current economic woes? Did America turn away to a degree, not from Amazon but rather to cheap illegal knock-offs?

IDK, but it feels sometimes, with retail theft (including scammy returns) that a certain large segment of the retail consumer demographic is aggressively, and intentionally looking for petty crime to engage in while (or perhaps instead of) shopping?

Am I nuttier than usual, with this line of thought?

Nope. How many youtube videos, reddit threads, etc. tell people in minute detail how to get stuff for free? Heck, even my beloved local shipping store (where I buy all my mailing supplies) is an Amazon return point and in his INSTRUCTIONS to customers told them to select ‘Invalid Description’ as the return reason so they “don’t have to pay return shipping.” But I digress.

But ^^ that news makes me very happy. Etsy is my biggest marketplace and the bad eggs on there are giving it a very very bad reputation. If they can clean it up, all the better.

Although I question whether Amazon is much better. I sell Art and when I search the best sellers in the handmade photography category 1/2 of them are Harry Styles air fresheners (really).

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It was good, until they automated it and the bot they made to handle counterfeit searches, mated with the pesticide bot, and now everything is either counterfeit or a pesticide.

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Several years ago, hundreds of my jewelry listings were deactivated for being pesticides.

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Selling these? haha

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no, but with over 2000 favorable ratings, maybe I should try? lolol

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Stats show that you could sell ~320, 12 packs per day during the peak season…

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Can I pretend it’s handmade? Maybe if I say I got it from Alibaba…

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:rofl:

Made by the little hands of children sadly.

Funny not funny and sadly true.

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Reminds me of the PXG back off joke by Country Club Adjacent.

“PXG- Made here in Arizona by Mexican Chinese children… PXG! We do things differently”

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A big part of the problem with cracking down on counterfeits is the inability for an untrained human prototype lacking understanding of the products, or an Amazon bot to define what is a counterfeit.

The entire Advertising Collectibles category, for example. is vulnerable to incorrect identification as counterfeit by an unintelligent entity.

If Etsy cracks down in anyway, short of using highly knowledgeable humans, it will see the same results as Amazon in much of its “vintage” listings. I have no clue how much of their revenue comes from “vintage” items but they cannot afford to lose even 20% of their revenue.

As for stock valuations, there appears to be no rational justifications for most web based business’ price/earnings multiples. so I invest with the knowledge that should the stock market behave rationally some day, many stocks will be selling for a lot less, even if they continue their growth at historical levels.

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:thinking:

So you are saying Etsy can’t afford to stop counterfeits and/or enforce IP rights…

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Not quite saying that. They could raise their fees to levels similar to Ebay or Amazon but I am not sure how many of their sellers will find it necessary to drop out.

I am as mystified by Etsy performance as I am by the meme stock phenomena.

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This may be an unpopular opinion, but I’ve never been opposed to Etsy raising fees in the past. IMO it helps weed out hobbyists who don’t run a real business. Those folks tend to have horrible customer service that reflects poorly on the site as a whole.

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I don’t know how unpopular that is.

But I have always thought that Etsy was mostly hobbyists and the artists and artisans used it for publicity, and sold their good stuff offline to their own customer base.

The craftspeople I know, use it for a reminder to their customers that they still exist, but rely on shows and galleries for their sales, and creating new customers. Their items on Etsy are old designs.

So many craftsmen who show their items on Internet sites get their designs ripped off, so defense by keeping the good stuff off the net is pretty common.

When I sold on Etsy, it was evident that many Etsy sellers were selling to other Etsy sellers and did no true retail, but that was quite a while back. Etsy vintage was the worst selling venue I every experienced online, the fee did not matter because the sales were crap.

Maybe Artfire was worse, hard to remember that site.

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Interesting! I wonder how many others feel the same? I’ve been on Etsy since 2011 & it has always been my bread-and-butter (I’m not a huge seller, but sell well there annually). I honestly moved to Etsy because I didn’t want to do shows and/or anything in-person - after having my portrait business I was over dealing with people. :wink: I have my own website, but it’s nearly impossible to push customers there. I have steady sales, but they trickle.

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I started on Etsy 2008 and ArtFire a few years later. Both did acceptably for a while, considering that my main business was in-person shows, and online was supplemental. ArtFire tanked (5 years ago?) when the owners had a fight and the guy who built it left and the remaining guy ran it into the ground. I finally got out of AF fall 2021. Etsy sales have been dwindling to the point where I haven’t renewed anything in 2023 and don’t plan to any time soon. I can’t compete with hobbyist prices, and certainly not with Chinese garbage.

My competition on Etsy now are scrapers who grab images from free stock sites and sell them on Etsy for $4-6/download. If you look up, say “Highland Cow Print” you’ll find 50-100 different download shops selling the exact same image. My only saving grace is having things they don’t. So I keep chugging along! I thank goodness every day that Amazon doesn’t allow digital downloads (yet).

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I have literally thousands of public domain images which are not being offered anywhere online, or at least could if I thought it was worth the effort to scan them.

It is hard enough to sell the original prints, which were traditionally part of a used bookseller’s inventory.

At $4-$6/download it is not worth having a customer but some people are hungrier than others.

I’ve been on Etsy since 2008 and so I’ve seen a lot. Actually just hit 10,000 sales on Etsy last week haha.

The thing is I think Etsy is stuck. It needs the revenue it gets from cheap imports, ip theft, counterfeit etc. Sure it could raise fees and I have zero issue paying fees if I’m getting sales….I just don’t think Etsy could pull it off. I think their reputation has been tarnished and honestly I’m not sure “handmade” is even really trendy anymore. Etsy has subbed in the word unique for handmade what 5 years ago? Amazon handmade has not really promoted handmade at all in the last few years look how the promotion of the amazon handmade birthday has dwindled from huge giveaways a few years ago to barely a gift card giveaway on social media.

I’ve been seeing the Whatnot app now starting to dabble in handmade and I think live streaming could be a thing that really benefits handmade because your actually getting to know your artisan. I’ve gotten a few sales but I don’t have much time to grow a live streaming platform. I also don’t know if they have what it takes to go in the right direction as they already seem to have their hands full with collectibles and counterfeits.

I’m also just not sure how many people really care about handmade items anymore. With all the doom and gloom of the economy at the end of the day how many people really have the extra $$$ laying around for luxury. The thing is people don’t have extra money but still want nice things why else has counterfeit items become such a popular thing. Why pay $300 for a legit purse when you can pick up a counterfeit for $50 and who really is going to know the difference?

At the end of they day all these marketplaces want to do is make money, and there isn’t much money in handmade. It’s sad but it is what it is.

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