Etsy (ETSY -0.22%) is a powerful tool for small creators to connect with a large customer base. There's a lot to like about the platform, and the company is making impressive projections as to how big it can eventually get. That said, there's a $1 billion problem that showed up in the third quarter of 2022 that the company hasn't talked about nearly enough.
How big?
To simplify the Etsy service, the company provides a website on which individuals can sell products they make. It's a huge benefit for the so-called creator community.
For example, instead of a young painter asking to put their paintings in a local store in the hope that a few will sell to the store's local patrons, that same person can use Etsy to open up the potential customer list to effectively anyone with an internet connection. It can be a game changer.
Image source: Getty Images.
Etsy believes the addressable online marketplace it serves is roughly $466 billion in size. Of that, it currently thinks it has a 2.6% market share, worth around $12 billion. That's tiny and suggests that the company can grow its business for years to come. So far, the story sounds really good.
There's more, however, because Etsy is just one of the company's platforms. It also owns Reverb (peer-to-peer instrument sales), Depop (a fashion-specific market), and Elo7 ("the Etsy of Brazil"). Management believes that these brands "deepen and expand our opportunity." In other words, though no numbers are provided by the company on the full size of the opportunity, the strong hint is that it is even bigger than the $466 billion addressable market highlighted.
The billion-dollar problem
In fairness, the last couple of years were generally pretty good for Etsy. Some of that clearly traces back to the social distancing and work-from-home trends that were part of the early coronavirus pandemic containment effort. Notably, revenue surged in 2020, more than doubling the figure in 2019.
However, the customers who found Etsy during the pandemic appear to keep coming back. For example, through the first three quarters of 2022, the number of active sellers was down just 0.9%, and the number of active buyers fell by a slim 1.9% even though the world has pretty much learned to live with COVID-19.
Perhaps even more important, despite these declines, the income statement showed that revenue increased through the first nine months of 2022, and so did gross profit, to the tune of 6.3%. That Etsy, essentially an online retailer, hasn't seen a huge drop-off in users and buyers suggests that the service it is providing is important.
But in the third quarter of 2022, the company lost $963 million. It earned $89.9 million in the third quarter of 2021. That terrible year-over-year comparison is not so good, but it is largely attributable to a single item, a $1 billion asset write-down.
According to the company's earnings statement, "Net loss was $963.1 million, down $1.1 billion year over year, reflecting an impairment charge of $1.0 billion in aggregate to the goodwill of Depop and Elo7." That's pretty much all the company said about the charges in the statement.
Goodwill is a complex accounting figure, but it is basically the amount of money paid for something that exceeds the actual value of the item bought.
In this case, Etsy believes that it overpaid by $1 billion for Depop and Elo7. A company normally takes write-downs like this when the results of an acquired business don't live up to the expectations at the time of the acquisition. That's not so good, noting that these two businesses are expected to be long-term growth drivers for the company.
If Etsy misjudged the opportunity Depop and Elo7 presented, conservative investors should probably question the long-term opportunity Etsy has laid out for its own business, too. Perhaps there's not quite as much growth potential as the company would like investors to believe.
A grain of salt
Etsy has tapped into something that is important, offering creators a way to sell to the masses. The company happily touts the massive opportunity it believes it has. But the $1 billion third-quarter 2022 write-off should cause investors to pause.
Etsy stock is up more than 600% over the past five years, even after a material pullback in 2022. In other words, investors still appear to be pricing in a material amount of good news. And yet the massive write-off may be a sign that the company's long-term opportunity isn't as large as management hopes. Investors expecting massive growth ahead should start tracking the company's performance very closely.
