Etsy (ETSY 2.89%) wants to be more than just Etsy.

After the successful 2019 acquisition of Reverb, an online marketplace for musical instrument resale, Etsy is extending its M&A strategy by taking over Depop, a London-based online marketplace for clothing resale targeted at Gen Z. Etsy will pay $1.625 billion, primarily in cash, for the fast-growing e-commerce company. Wall Street cheered the deal as Etsy shares rose 7.1% on Wednesday.

A young person shopping in a clothing store.

Image source: Getty Images.

What is Depop?

Founded in 2011, Depop could be described as half social media site, half fashion marketplace. Sellers have Instagram-like pages where users can follow them to see what goods they've posted for sale. In fact, the site was originally conceived as a social network where readers of PIG magazine could buy products from the young creatives featured in the magazine.

Over the last decade, Depop has evolved into a leading fashion marketplace with Gen Z, as it is the 10th most-visited shopping site in the U.S. for Gen Z consumers. 

It's also a fast-growing business -- its gross merchandise sales (GMS), or the sales volume on the platform, more than doubled last year to $650 million, which was likely aided by the pandemic. It also brought in $70 million in revenue, meaning Etsy is paying roughly 23 times sales for the company. That's a steep price, as Etsy trades at a price-to-sales ratio of about 11, but management was thrilled about the deal.

CEO Josh Silverman said: "We are simply thrilled to be adding Depop -- what we believe to be the resale home for Gen Z consumers -- to the Etsy family. Depop is a vibrant, two-sided marketplace with a passionate community, a highly differentiated offering of unique items, and we believe significant potential to further scale."

Why it's such a big move

Nearly two years ago, Etsy acquired Reverb for $275 million in cash. Today, management seems overwhelmingly pleased with that deal, as it's ramped up sales on Reverb and improved margins. In fact, Silverman noted on the recent earnings call: "It's now been about 18 months since Etsy acquired Reverb, and we couldn't be happier with how that partnership has evolved."

Gross margin at Reverb has increased from 33% in third-quarter 2019, the quarter Etsy acquired it, to 53% in first-quarter 2021, and  GMS per marketing dollar spent also improved in that time period from $20 to $27. Reverb's GMS increased by around 50% in the most recent quarter. While the brand got some tailwinds from the pandemic, those figures are a testament to Etsy's ability to improve the marketplaces it acquires.

With the Depop acquisition, Etsy hopes to extract similar value, and the move essentially reveals Etsy to be more of an online marketplace holding company rather than just its namesake platform. Five years from now, Etsy could own five or more e-commerce marketplaces, including the three it now has with the Depop acquisition.

Management believes it has a formula for successful M&A, which includes its flywheel model where it invests in the buyer experience, to grow GMS and attract more sellers, which in turn expands inventory and attracts more buyers.

That formula has helped Etsy gain nearly 2,000% since CEO Josh Silverman took over in 2017, and Silverman seems to believe that formula can be applied to any online marketplace that shares Etsy's values and focus on keeping commerce human.

After less than two years, the Reverb deal already appears to be a success. If Etsy can do the same with Depop, this could be the beginning of its evolution into a much larger e-commerce company.