A Deep Dive Into Etsy

In this episode of Industry Focus: Consumer Goods, host Emily Flippen and Motley Fool contributor Dan Kline bring you all the most important and relevant facts about e-commerce niche player Etsy (ETSY 0.49%). They'll cover its business basics, what makes it unique and gives it an edge over the competition, as well as financials. They'll also talk about the management team, explore various possibilities for the company's future, and much more.

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This video was recorded on Sept. 8, 2020.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, Sept. 8, and this is your Consumer Goods focused episode. I'm Emily Flippen, and today I'm joined by Motley Fool contributor Dan Kline to take a deeper look at a company that has risen nearly 150% in 2020 alone -- that is, Etsy.

Dan, thank you for joining.

Dan Kline: I'm excited about this one, and because we do this on Tuesday, I now know what day of the week it is.

Flippen: [laughs] I always feel the need to remind people. It is, in fact, both Tuesday and a Consumer Goods episode, but I'm happy that we're taking a little bit of a break here from the retail letdowns that have been 2020 to talk about a company that has actually performed pretty well. So, today we're going to be discussing some of the business basics of Etsy, its competitive strategy, and its financials. But before we do so, Dan, let's bring the listeners in on why we're talking about Etsy today.

Kline: Well, because Etsy was moved to the S&P 500, along with two other companies, and they moved up from the S&P MidCap 400. So, this isn't as big a deal as maybe if Tesla has moved up, because they were already being tracked by companies that track these other S&P indexes, the MidCap 400. Those companies are going to replace H&R Block; Coty, which is a beauty brand that's really struggling; and Kohl's. All three of those were downgraded to the midcap tier. But, Emily, the real surprise here is that Tesla didn't get added.

Flippen: Yeah, I like how you pointed out that it's not as big of a deal for Etsy to be added, since Etsy is a company that was already being recognized by the S&P 500 in the midcap tier, but because of its impressive growth recently has obviously been upgraded. But it's probably a big deal that Tesla, which is a $400 billion-something company, got actively left out. So, what are your thoughts on that decision?

Kline: Yeah, I'm going to mirror your thinking. We share a document beforehand, and you basically nailed it. So, here's the problem: There's no rule saying they have to add them just because they're big. And right now, as I'm sure you're seeing, whether you're listening to this when we release it on Tuesday or later in the week, tech stocks, some of them, are very volatile, and Tesla stock has been all over the place, between the split, between some of the volatility, the variability in the stock price. The various indexes that follow the S&P 500 would have to buy shares of Tesla, and depending when they do it, that price could vary greatly. That's something the S&P 500 people don't want. So, do I think they'll add Tesla? I do. But I think they'll add Tesla at a time where it's not moving in 15% or 20% chunks over the course of a day or a trading week, I actually think this is more technical than a dis on Tesla.

Flippen: Yeah, this is an interesting decision though, because it really was a foregone conclusion from analysts, myself included, that Tesla would be added. Because in my mind, if you're a committee who is looking at some of the 500 biggest companies here in the U.S., Tesla is a hard company to miss. But to your point, when you have passive indexers who are investing in the S&P 500 funds that track this index, they're doing it because they don't necessarily want the volatility that's associated with picking individual stocks, Tesla itself is such a volatile company that you can kind of forgive the decision. Although, I understandably believe that many [laughs] Tesla investors may not forgive that decision so easily.

Kline: Yeah, I think, obviously, that's part of the reason why we're seeing a Tesla sell-off. That being said, if you're an investor in Tesla because you believe in Tesla, nothing has changed, if you were a trader who is betting, hoping they'd be added to the S&P 500, well, you should probably have known the risks when going in. This is why at Motley Fool, we are buy-and-hold, long-term investors. If you have a 5- or 10-year threshold, you're not concerned about this piece of momentary technically bad news that doesn't really mean anything for the fate of Tesla's business.

Flippen: You nailed that. And instead of focusing on all the things Tesla could have done or lack thereof to get into the S&P 500, let's talk about a company that seems to have, A, done everything right over the past couple of years, but more importantly, B, benefited a lot from the pandemic, that was added. And obviously, that is Etsy. What can you tell us just about Etsy's business?

Kline: Yeah. So, Etsy is a platform where, I don't know if you'd call them crafters or creators, but people who make stuff. So, it might be someone who makes homemade candles, it might be someone who knits wool hats. In this case, people who make, create a face mask. We talked about Disney earlier, and there are a lot of custom-made Mickey Mouse ears on it, you know, skirting some of the copyright rules. Disney has shut down certain things, like people who are making baby Yoda dolls, which violate copyrights, but the Mickey Mouse ears are something you can make. So, it's a giant platform full of creators. That's half the puzzle. So, that's the marketplace. That's, you know, your local farmers market where there's tables all around. Then they also have a massive amount, I believe it was 50 million users. So, it's about 3 million sellers and 50 million people buying. So, basically, it's a huge marketplace.

Well, what did the pandemic do for them? A lot of people needed masks. And, OK, in the short-term, that's a one-time bump. You know, we're only going to need masks for, whatever it is, three months, six months, nine months. I hope it's not much longer than that. And certain people may buy masks for flu season going forward. We might look more like other countries with some people using masks and it being normal.

That said, we've talked about this with lots of businesses, Amazon, Netflix, Disney+. All of the new customers who came to Etsy looking for masks or creative gifts during the pandemic, those people, Etsy now has their information, they can market to them. It's much easier for them to make a transaction on the platform because Etsy already has [their] credit card. This lowered marketing spend and accelerated growth for Etsy in a way that can't be measured -- it's really strong.

Flippen: Yeah, and I already see that as we're talking here, we have a question come in from a live listener who is asking, "Well, how much of this growth is tied to COVID masks versus how much is sustainable?" It's a really good question. If you look at their previous quarter, they had merchandise growth. So, the growth of just sales on their platform was up nearly 150%, but Etsy was smart, they broke out what they call [laughs] non-mask sales. And that's not to say non-pandemic sales, because the amount of people that went to the platform during the pandemic and related to the pandemic is hard to break out. But if you just look at the sales that were related to things that were not masks, that still grew 93%. So, even taking the very clear immediate impact of mask sales out of Etsy's business, it still looks like a really strong platform.

Kline: Yeah, and this is like so many of these other pandemic-driven platforms. This was a strong business before the pandemic and it's going to be a strong one after. What we don't know is exactly when sales growth will catch up to one-time sales growth. So, look, the second the pandemic is over, we'll probably see a surge in in-store shopping, of people who just were afraid to go out, didn't go out, and they just want to go to a store. And that might lead to less Etsy shopping.

That said, it's much easier to find a clever, say, birthday gift on Etsy than it is to go to a bunch of different places to find that gift. This platform serves a need, and right now masks are part of that. But you know what also you can get there? Winter hats and gloves and anything people can make with a personal level of flair. It's like going to like a giant crafters fair where there's just an endless supply of things. And I know, as a husband who struggles to buy gifts, it's a platform I'm a member of or, you know, a buyer on, and it's one that, yeah, I did go to Etsy looking at masks during the pandemic. I didn't end up buying any there, but I do think people have more connection to it. And a lot of people that launch side-gigs selling on Etsy, if they had success, they might continue to do that, and some of them may actually pivot and make that their job going forward. So, some of this growth might get given back, but eventually, this is a platform that's going to get bigger and bigger and bigger.

Flippen: And I know there's a lot of listeners who maybe aren't familiar with Etsy's platform, or maybe know the name but haven't shopped on it themselves. So, when they look at Etsy as a publicly traded company, it can feel like, "Well, is it really that investable?" To put some numbers behind Etsy's business, Etsy has nearly 3 million active sellers. Those are people, artisans, as they call them, who are making goods and selling them, handmade items on Etsy. But their platform has nearly 50 million active buyers. So, that's a number of people who are mostly based here in the U.S. but they actually have business across, I believe, six different countries across the world. But just tons of people have been flocking to this platform. And that number of both sellers and buyers has consistently risen since the company has been public.

Kline: Yeah. And one of the things we talk about a lot is moat. And in theory, Emily, there's nothing stopping you and I from launching "Craftland" an Etsy knockoff. But here's the problem: You have to attract the people who want to sell on the platform. That's not easy, because they're only going to want to come to your platform... It doesn't matter what your fees are, it doesn't matter if you take less money, if you don't have shoppers. If I build a mall in the middle of nowhere three hours from anybody, it doesn't matter that the rent is cheap, because who's going to come to my mall? Etsy already has the customers. The amount of money you would have to spend to equal Etsy would be daunting for anyone. I can't imagine even Amazon wanting to play in this space, because it's just such a robust platform.

Now, would someone want to buy into this space? Maybe. You know, an eBay-Etsy matchup makes a lot of sense. I don't know who would be the acquirer in that scenario.

Flippen: [laughs] eBay could dream.

Kline: Yeah. But you know, getting people to both sides of this transaction, and it's additive. The person who's crafting, who tells their craft group or their friends who craft, "Hey, by the way, I'm on Etsy and I'm selling well and the platform works great." Well, that's going to get their friends to try it. This should grow and grow and grow. They also have a lot of optionality about what they actually allow to be sold on the platform. You know, I could make lots of things and I'm not sure what the exact rules are for Etsy, but they can grow.

And you mentioned, they're only in six countries. When they enter a country, they don't need to attract crafters in that country, they can use the existing products they have and just market for an audience in that country. And obviously, once they have an audience, some of those people will also be creators and will join it. So this is a company that's in the very early stages of its growth.

Flippen: I love the fact that you pointed out Amazon, because this is a company that has clearly carved out a niche for itself in e-commerce, but the question always comes up: What about competitors competing in this space? As Etsy raises their fee -- and that is how Etsy makes money, they charge a fee to the sellers for listing and selling their products on their platform. They've consistently raised that fee, they haven't lost sellers, but they've raised the fee. Theoretically, they could raise the fee to a point where sellers would then leave the platform and go somewhere cheaper. So, what's preventing a company like Amazon from coming into the space and launching its own third-party website? And Amazon has actually tried to compete in the space in the past, right?

Kline: Because you'd have to spend a massive amount of money to lure creators to the place, and then guarantee them that there'd be buyers. And Amazon is, let's look at, say, wool hats. Amazon sells wool hats that are mass-produced and are really inexpensive. So, sure, could I buy a really cool one from an Etsy creator that was, you know, $40 instead of $10 on Amazon? I could. At some point it eats itself, it becomes, you know, you're competing against things that aren't like-minded. So, could Amazon do it, could eBay do it? Sure, throw enough money at it. But look at all the attempts there have been to compete with Twitch. The biggest advantage Twitch had; that's people stream live playing video games, and for some reason, people watch that. Even when Microsoft lured over some of the top Twitch players, people were like, "Meh, yeah, whatever, I'm just going to stay here at Twitch." Being the entrenched winner gives you some leeway.

You know, if they went from 3.5% to 5% on their seller fees. Sure, if they went to 20%, yeah, that would be bad. If they go to 5.25% next year and eventually get to 6%, that's still really low compared to, let's say, you know, you're the best person in the world at making handmade candles. And you walk into your local craft market and you need to rent a table or you want to be sold on consignment in a local store. It's going to cost you a higher percentage than that to do business. If you launch your own Shopify store, you can do that, but who are you? Who knows about Emily's Handmade Candles and Wool Hats? Nobody knows. So, you have to advertise or [get] word-of-mouth. This is an easy way to build a business. If you have a product that people are looking for and it's unique enough, Etsy has a user who will buy that product. You know, even if you're paying 10% in total fees between the listing and the percentage they take of the sale that, to me, seems like a really tiny amount.

Flippen: Dan, do you know a company called Redbubble?

Kline: I don't.

Flippen: I didn't expect you to, it's an Australian company, but I think it's one that's worth pointing out in the context of Etsy, because you reminded me of this company when you were talking about competitors coming into the space. Redbubble is an Etsy-esque -- that's a hard word to say -- it's an Etsy-like company that's based out of Australia that has tried to recreate the success Etsy has had in the U.S. in Australia. And I know from our Australian Fools who were burned by investing in the company about just what a money pit Redbubble has become. And while the company has performed well during the pandemic for exactly the same reasons you can say Etsy has done well during the pandemic, it has been just in a burning state of cash as it's attempted to expand out its business beyond just Australia. And it really hasn't gained the notoriety that Etsy has, despite the fact that it has a lot of the same appeal as a platform like Etsy. So, it really does just go to show some of the competitive advantages that exist with -- you called it moat, I think that's a good word -- the moat that exists with Etsy right now.

Kline: Yeah. I mean, Etsy would have to do something to scare its audience away. And look, historically that's happened. I'll give a fairly recent example; BlackBerry was so arrogant that it basically didn't release a new phone for more than two years. Well, that might get people to try an iPhone. So, Etsy could, in theory, have policies that scare people away. That said, despite there being a lot of leadership turnover, this is actually a company that's been pretty well-run.

Flippen: Yeah. And that's an important thing to talk about; the culture and the management team that exist at Etsy. Because to the extent having the network [does] create a moat, you could also make a really strong argument that Etsy's culture and maybe its management team, probably more debatable, [laughs] but at least Etsy's culture is within itself a competitive advantage.

Kline: Yeah, absolutely. And look, if you're going to be a platform for crafters, you have to put the crafters first. You know, there's a lot of comments about Amazon. And the problem is, Amazon is not geared to care about individual vendors. So, if I choose to use Amazon as a third-party marketplace, as a store, Amazon has all those services and they'll let me use them, but they're going to charge me dearly for them. They're not going to welcome me into the fold. Because here's the reality: They don't need me. And realistically, Amazon might want to pick off like the guy who's selling in volume, but crafters aren't generally selling at volume. Most crafters don't have a team of people making their product, it's a really difficult business to emulate. And it has to come, kind of, from the ground up. People on Etsy, there's a community aspect to that that's very difficult to build from scratch.

Flippen: Completely. And when you look back at Etsy's founding story, it's not pretty; I'll say that much. It was founded by three co-founders all of which have left the company -- typically not a super-great sign for companies that we invest in. But the management teams that have taken over since the founders left have actually really kept up with that same style, we call it the ESG, the environmental, social, and governance aspects of Etsy. That is to say, they put the artisans first.

I think it's worth talking about a man named Chad Dickerson, who was the company's CEO from 2011 to 2017, really ran the company with the foresight of artisans-first in mind, putting females, especially, ahead, both in terms of board tenure as well as the fact that females tended to be the artisans on the platform and tended to be the purchasers. And he actually left the company, [laughs] it wasn't great at financial management, when the company had to go through layoffs, Dickerson decided that he was one of the people that had to leave.

Kline: This is a peculiar story. So, either he understood he wasn't the right person for the job, and in the history of CEOs, he would maybe be like the first -- one of five who fully understood, "Wow! I've taken this as far as I can go, I need to be replaced" -- that happens. Maybe he was more worried about the value of his equity, I don't know what the situation is. It seemed to me that he could have said, "Hey, I'm going to forgo my salary for the next year while we get things on pace." It's really strange to step down, so I'm not entirely sure I take this as like a crazy selfless act. And I have seen scenarios where people have done this because they no longer believe that because of the layoffs the company is making, that it's poised for success.

But part of the story is that with some of these tech companies, and I'd say Etsy is a very stable tech leader now and retail platform or whatever you want to call it, but there's going to be bumps in the road. And that in 2017, things looked fairly bleak to the point that the CEO laid himself off. A very, very bold move. But maybe he saw that the next guy in line was the right person to take over the company. And that, of course, would be Josh Silverman. And he actually was the one who raised prices, which we talked about a little bit before, Emily.

Flippen: Yeah. Maybe I painted that picture too pretty there. The reality is that while he did step down, Dickerson was not a favorite of the board of Etsy because of the fact that the company was loss-leading, it just was not producing any money. They thought there needed to be more financial discipline. And when he did step down, Silverman, who came from the board to replace him, did put that renewed focus on financial stability. And as you mentioned, Silverman was the one who raised the endpoint transaction fee from 3.5% to 5%, which doesn't seem like a lot, but when you're making either your entire living or a part-time living by selling products on Etsy, it's enough to make you a little angry. Despite that -- "outrage" is a strong word [laughs] -- despite the concerns from both sellers and employees, ultimately it ended up being a really great decision for Etsy, because it really turned the corner in terms of Etsy's profitability.

Kline: Some of it's about transparency, if you communicate to your audience, your employees, and the sellers on the platform -- here's why we're taking this money. A percentage of it's going to go into marketing. We believe you're going to grow your overall sales or that you can charge more, you know, up your prices by this 1.5%, and you'll have more of an audience to buy it. As long as that's well-communicated and the reasoning for it is, "Hey, this is going to help us be more survivable, be in a better situation." Etsy's sellers want Etsy to succeed. I think the opposite example of this, and I don't like to pick on this company, we use this company at Motley Fool; their CEO did an interview on the platform last week, but Upwork. Upwork raised its fees for pretty much all freelancers on it to 20%, to a very high level. And when we talked about it with them from a business point of view, not from a freelancer point of view, they basically said, well, we need to be profitable. And it's like, OK, but I'm a freelancer, who's making $40 an article for -- not, of course, for Motley Fool, I'm talking about the lower level of people on the platform, you have to work hand-in-hand with your whole community.

And, yes, people who are invested in Etsy, do not want Etsy to go away, so going up 1.5% is not overly strong. And while people would like everything to stay the same, it's a pretty minor move. And as long as you're explaining what you're doing, and look at what happened, the platform grew and many sellers likely made more money. Now, obviously, some sellers are constrained by how much they can create. If you're making, you know, time-intensive wood carvings, like a friend of mine does -- so, she makes cutting boards in the shape of different states, and it's very time consuming -- she'd have to charge more. Well, there's more audience, charging more might work. They handled everything well. And for a non-founder-led company, it's been really well-run.

Flippen: Completely. And let's dig into those financials just a little bit more, because while we did mention that the company has turned a corner since raising their fees and COVID had certainly been a help, ultimately Etsy still consistently, previously generated strong free cash flow. If you were Etsy, and you're generating cash now, you've upped the prices on your members, and you're in a position where you are now a sustainable business, you could just go on like Etsy is right now forever. But you're generating cash, you got all this money -- what would you do with it?

Kline: I'd continue marketing. I mean, look, they're at a small percentage of the total audience, and marketing goes in two folds, like, yes, you want more buyers, but you also want more sellers. And I don't know what their other opportunities are to sell, because I'm not that familiar with every category they sell, but whatever it is, find adjacent categories and move into those.

The other thing, and we didn't talk about this, they own a product called Reverb. Reverb is a marketplace for selling used musical instruments. And I wouldn't have thought this would be a great business; this is actually a great business for them. And I don't know if it's simply because the people who play instruments are maybe adjacent to the people who are buying or making crafts, so it's a cheaper marketing spend. I think they should also look at other clever opportunities to acquire things that will change their business and give them more optionality, more ways to say to their customer, "Hey, this is a new part of the Etsy family, we think you might like it."

You know, there are some marketplaces out there for different things like lesson plans for teachers, and that might be some of the areas, maybe some art stuff they could move into more heavily or photography or whatever it is. I think there's a lot of areas they can expand the brand. And when you have cash, you have choices. That said, continuing to make sure that during the pandemic people know who they are and get hooked on the platform I think is really, really important.

Flippen: I think Reverb, that acquisition -- Reverb is a smaller niche, I believe, music and instrument marketplace. And it was an acquisition that they made ...

Kline: Yeah, they sell used instruments.

Flippen: Yeah, there we go. It was an acquisition that they made last year and it was interesting, because historically, Etsy hasn't really been acquisitive and it raised the question of: What is Reverb doing that you can't do, Etsy, right? What's preventing someone from selling instruments on your platform? And I think it was an important, kind of, discussion point to show that the reason why Etsy has succeeded over a company like Redbubble is because customers knew to go to directly Etsy, right? They didn't have to convince somebody to go to their platform from another platform, people knew Etsy, people browsed on Etsy, they had the end consumer. They don't have the end consumer for the music industry. People who are looking to buy instruments or lesson plans, whatever it may be, don't think to go to Etsy to get those things. So, acquiring these smaller players in different industries was actually really smart and it's actually really strategic for Etsy, because they can take the scale that they have right now and the lessons they've learned and apply those to lots of different niches in the future.

Kline: Yeah. I'm guessing they did a market study and recognized that the person who is looking to buy a used violin or a used guitar or some used recording equipment, whatever it is, there's probably a pretty heavy overlap from the Etsy community. There's probably a lot of parents who are, you know, part of the Etsy community. And it is expensive when your child decides they want to play a musical instrument. If you're an adult and that's your hobby, it's expensive. And we've seen many of the national chains, your Guitar Centers of the world, they haven't been in great financial situations. So, their ability to capitalize on this growing trend of resale and consignment, they haven't been able to do that.

eBay, which used to be a big marketplace for this, has kind of fallen by the wayside from its auction model. And part of the joy of Reverb is, because they specialize in this, there's a better chance you're getting what you think you're getting, and that it's, sort of, self-policed in a way.... It could be a challenge, if you go -- and I know a lot of people are doing this right now -- you buy a used laptop on Amazon or on another platform, eBay would be one, well, you really don't know what you're getting. Reverb, because it's all about music, the reviews matter. You know, just like on eBay, if the seller has really strong reviews, you know you can trust that seller. That's kind of where they're going with Reverb. And that creative person who's buying a guitar, well, they might want a more personalized gift or they might also be someone who builds stuff. So, these aren't directly related businesses, but if you put them next to each other in a mall, they'd kind of make a lot of sense. And I think that's a good way to think about their strategy.

Flippen: Before we wrap up here, I'm seeing that we're getting a lot of questions about acquisitions, and not about Etsy's acquisition of Reverb or what Etsy could acquire next, but what if somebody acquired Etsy? So, Etsy is around a $13.5 billion business at the time that we're taping this; [laughs] who knows what will happen in the future. If you're looking at Etsy, I mean, $13.5 billion is huge, right? So, if you are looking at Etsy, do you think that their business could stand to be acquired, and if so, by whom?

Kline: So, if I was Walmart, I'd be talking to Etsy. If I was Amazon, I'd be talking to Etsy, but I wonder if regulators would allow that. If I was Target, I would think this would be an absolute masterstroke, because you could take some of these crafted products on Etsy and put them into production under Target owned and operated brands. I would think an Etsy partnership, not acquisition, with Kohl's might work, where you can have an Etsy section and give people a reason to go to them. Etsy knows what it's selling. And look, it's not all a person in their room knitting something, some of it is, call it handmade mass-produced, where they have the ability to scale up and bring other people in. I think any of your big retailers -- look, if I was Simon Property Group and I was looking at digital properties and interesting things, I would think about, could I take a stake in Etsy and have an Etsy store in each of my malls? Because we would know what the best is, what would make sense locally. I actually think this is a company that could be acquired if it wanted to be acquired. I'm not so sure that Amazon would be interested in Etsy if the Etsy leadership team, and its workforce, at large, didn't want to stay. And I do think, if it happened, it would be a Microsoft-LinkedIn situation, where LinkedIn runs very separate from Microsoft.

I do think there's a lot of retail roll-ups that would make sense here. This would give Walmart a big edge in its marketplace, where it struggled against Amazon, where all of a sudden, it could keep Etsy as it is, but it could also list those products where appropriate and add to those sales. So, I think Etsy will have plenty of suitors, but I do think management has a lot of leverage, because I'm not sure you want to take this company over, I'm pretty sure you want to keep the management team in place.

Flippen: Well, if Walmart now makes a bid for Etsy, we'll say, you heard it here first. And, Dan, I think you should get a cut of that deal.

Kline: I'll take 2%, that would be fine.

Flippen: [laughs] Dan, thank you so much for joining for the conversation today.

Kline: Thanks for having me.

Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or you just want to reach out, you can always shoot us an email at [email protected] or tweet at us @MFIndustryFocus.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear.

Thanks to Tim Sparks for his work behind the screen today. For Dan Kline, I'm Emily Flippen, thanks for listening and Fool on!