One of the pillars of Etsy's (ETSY 0.34%) growth strategy has been to assemble a "House of Brands" to go after opportunities that are outside the core focus of its namesake online marketplace. While the Etsy marketplace focuses on handmade and unique items, the company's other acquired marketplaces expand its total addressable market to other areas.
Up until Tuesday, this House of Brands had four members. The Etsy marketplace is by far the biggest. In the first quarter of 2023, Etsy generated $2.7 billion of gross merchandise sales out of $3.1 billion total. The rest came from the company's other three marketplaces: Reverb for buying and selling musical instruments, Depop for fashion resale, and "Etsy of Brazil" Elo7.
Pulling back
Etsy paid $217 million in 2021 for Elo7 to break into the Latin American market. The company's other marketplaces operate globally, but Elo7 was already a top 10 e-commerce company in Brazil when it was acquired. When the deal was announced, Elo7 had 1.9 million active buyers, 56,000 active sellers, and about 8 million mostly made-to-order items for sale.
Etsy believed it could take its expertise in running capital-light, two-sided marketplaces and apply it to Elo7. The opportunity was significant: The Latin American e-commerce market was projected to reach $29 billion in 2021 and grow by 26% annually from there. Elo7 gave Etsy a solid foothold in the region.
Unfortunately, the acquisition didn't go according to plan. In a filing with the U.S. Securities and Exchange Commission on Tuesday, Etsy disclosed that it had sold Elo7 to a Brazilian corporation. Etsy CEO Josh Silverman explained the move: "Although the Elo7 team has worked very hard to build a beloved marketplace and vibrant community in Brazil, we have not seen the performance we had anticipated when we made this acquisition two years ago, in part due to the macroeconomic environment."
The deal to sell Elo7 is expected to close in the third quarter. Once that happens, Etsy's House of Brands will be down to three.
No details of the transaction were disclosed, which likely means that Etsy is taking a loss. Elo7 was a pandemic-era acquisition, and just like Etsy's core marketplace, it's likely struggling to retain the customers it gained over the past few years.
Time to buy Etsy stock?
Etsy grew like a weed during the pandemic as consumers flocked to the company's core marketplace. Some of that growth is now unwinding. Gross merchandise sales were down 5% year over year in the first quarter, while the number of new buyers in the quarter slipped 6%.
Thanks to higher fees, Etsy has been able to grow revenue in this environment. Total revenue was up 11% year over year to $641 million in the first quarter. It also remains solidly profitable, although those profits have been eroding. Net income was $74.5 million in the first quarter, down 13.4% year over year.
The company is becoming a bit more focused with the Elo7 sale, which may be a good thing in this environment. The company is working to improve the buyer and seller experiences as a way to prevent both groups from fleeing its platforms. The company is using AI technology to help shoppers search for items, improve shipping speeds, and more aggressively curate its selections to ensure that its core marketplace remains a haven for handmade, unique merchandise.
Etsy's growth will be challenged for the foreseeable future, and the disposal of Elo7 removes what was once a key part of the company's long-term growth story. Still, with the stock down about 68% from its all-time high, the company looks reasonably priced, given its dominance in the handmade e-commerce market. The company generated free cash flow of just over $650 million last year, putting the price-to-free-cash-flow ratio at about 18.
Etsy's strategy has taken a hit with the sale of Elo7, and that may be a reason for investors to be a bit more cautious. But in its core markets, Etsy is still the dominant player. It may take a while for the company to return to growth, but for patient long-term investors, Etsy stock looks like an interesting proposition.
