Max Grigoryev
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Max Grigoryev in Fundamentality,

Etsy: Self Made Stock

Etsy is going to release their earnings tomorrow after the closing bell. I've been positive on Etsy for a while, the stock is still far away from its IPO price ($27 in April 2015). All the analysts were negative on ETSY because of tough competition with Amazon, eBay and some other e-commerce companies. From one point of view, their decision to short the stock isn't clueless, because a rare company could successfully compete with any Internet giant. But in fact, Etsy is this rare company which is able to compete and moreover have an efficient business model. 

Let's take a look at Etsy's operating metrics in order to understand how their business is going on so far. Etsy's business model is pretty much straight forward - they charge a certain fee from a transaction and charge sellers for goods promotion within Etsy's website. First revenue source they call "Marketplace" in their reports, second - "Seller services". Management achieved quite high numbers in seller services segment due to overall business growth and scalability. The key idea is following - bigger the website is, more money they can make on promotion within the website - all the sellers want to have a better placement on Etsy's marketplace. 

So the main categories which generate the revenue for Etsy are buyers and sellers. Both of them have a significant contribution to the company's top-line sales. In Q1'16 Etsy recorded $35.7M revenue from marketplace and $43.5M from seller services. As we know, one of the most important metrics is average revenue and as far as we have both number of buyers and number of sellers, we can easily calculate ARPU for both business segments:

As you can see from these charts above, the company is actively developing the seller services - ARPS have grown up almost three times since 2013. Moreover, Etsy showed in Q1'16 that this growth isn't limited as of now - 41% growth rate in ARPS compared to Q1'15. I assume that the company will able to keep this path and increase ARPS by around 40% compared to Q2'15 and reach around $28.1 ARPS and keep the same $1.43 ARPB. 

I was always concerned about Etsy's G&A expenses growth which increased by more than 33% in 2015. The company was able to handle it and decreased G&A by 7% in Q1 this year. Etsy's cost of revenue, marketing expenses and product development are still rapidly growing by 35%, 30% and 22% respectively. It's fine till revenue growth exceeds the growth of expenses. 

The most important fact that Etsy in Q1 this year reached a breakeven according to unit economics. I usually calculate the unit-economics by subtracting all the expenses per one account from average revenue. As far as Etsy has two revenue flows, it's a little bit tricky to understand how we should divide cost of sales and other operating expenses between these categories. I decided to get the total number of accounts they have, it doesn't matter whether this account is a buyer of a seller. After all the maths, I got it around 25c operating profit per one active account compared to 22c operating loss in 2015. 

In order to check whether this number is close to reality or not, I decided to calculate the average operating profit per buyer and seller separately depending on their share of revenue. Those numbers impressed me even more, operating profit per seller in Q1'16 was around $2.25 or around 8% from ARPS compared to operating loss of $1.58 in Q1'15. Operating profit per one buyer also increased from negative 12c to 12c above the zero. 

Another important metric is GMS or gross merchandise sales showing how much money buyers spend in the platform. It's also steadily going up and increased by 18% in Q1'16. An efficient marketplace fee is around 5.7% as of March, 2016 which is quite high number. Etsy keeps the same level of marketplace fee for quite a long time since 2013 year when it was 5.8%. 

Conclusion

Taking into consideration all the above-mentioned facts, I suppose that Etsy is going to report $80-86MM top-line revenue. All the companies operating profits either per buyer or seller would be above the zero. In the most conservative case Etsy will narrow its margins, but they will still be positive. I said that Etsy is a great stock to own in summer 2015, but the stock is still far away from those levels. I think it will keep recovering and will prove the analysts that they are wrong. I think that there will be a volatility jump after the earnings release, however options really expensive due to Citigroup update. 

Citi updated Etsy today and the stock soars today more than 18%. It means that buying options could be expensive, I think investors should consider shorting iron condor or butterfly.