Etsy, Inc. (ETSY) Earnings Call Transcript & Summary

All right. Thank you, everyone, for joining us this afternoon. I'm Lauren Cassel, Morgan Stanley's small and mid-cap Internet analyst. And I'm thrilled to be joined this afternoon by Josh Silverman, Etsy's Chief Executive Officer; and Rachel Glaser, Etsy's Chief Financial Officer. Before I get started, 2 quick disclosures. Please note that all personal -- all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures, appear on the Morgan Stanley public website at www.morganstanley.com/researchdisclosures or at the registration desk. And for Etsy, their safe harbor statements can be found on their website.

All right. So maybe let's kick it off, high level, big picture. Tell us a little bit about how we should think about Etsy's differentiation, market strategy and through the vision over the next couple of years?

Great. So for those of you who aren't familiar, Etsy is a 2-sided marketplace, where artisans, craftspeople, who make things themselves, can come and sell. We have about 2.7 million sellers, selling over 63 million unique items. And the one thing these items have in common is that they don't have anything in common. They're not commoditized products with the SKU number that mapped to a catalog. And they sell through a community of now over 40 million active buyers. People, just in the last 12 months, who bought on Etsy, there's more than 40 million of them doing, call it, $5 billion-or-so of trade, of sales on our platform. And in a world which is becoming ever more commoditized where we all buy the same few things that are mass-produced in the same few factories and arrive overnight from the same few factories, I think there's ever more desire to stand out, to express your identity, to show your sense of style or to show someone else that you care about them. And so we think Etsy is ever more relevant in that world. And for sellers as well in a world where automation is changing the nature of work, the ability to harness your creative energy and run a global business from your living room, we think, is more powerful now than ever.

Great. I guess from that standpoint how do you think about different focus areas for product improvement, customer experience? What are sort of the key areas in those and that they are looking forward to in 2020?

Yes. I mean we believe we have 4 -- we a have right to win, which is composed of 4 pillars. One is our sellers' unique collection of items. So again, 2.3 million sellers selling over 60 million unique items, there's no place in the world that offers anything close to that. The second pillar is search and discovery, the third is human connection and the fourth is trust and reliability. And if I go through each of those one at a time briefly, there's over 60 million things on Etsy, and they don't map to a catalog. So our search and discovery challenge is unique. There are other people that are very good at search. Google is very good at search. Amazon is really good at product search. We don't need to beat Google at search. We don't need to beat Amazon at product search. We just need to be exceptionally good at search and discovery in this incredibly long tail of super unique items. And just to dimensionalize that for all of you, if we take a product on Etsy, coasters, if you do a search for coasters, you'll get about 200,000 results on Etsy. So if you just want to visualize that for a minute, sit in the middle of the University of Michigan football stadium, the largest stadium in America, and look around, and every single seat will have 2 sets of coasters. That's how many coasters there are for sale on Etsy. The challenge for our team is how do we pick the 30 that are the best for you and should go on the first page of search results. That's a very unique challenge that would have been impossible even 10 years ago, but with the benefits of machine learning it's becoming more and more possible. And we need to be the best in the world at that very specific type of challenge. The second opportunity is human connection. One -- the thing that is most unique and special about Etsy is that you're buying from the person that actually made the product. And the ability to customize it, to personalize it for you is really important. But if you talk to anyone who's ever bought on Etsy, most often the first thing they will mention is the handwritten note that they got from the seller. And again, in a world that's feeling more commoditized, more anonymous, more distant, the idea that you can form a real connection with a maker is really important. And so how do we allow that sense of humanity to really come through on the site, that sense of connection to really come through on the site? Because it is really different. It is what sets us apart. And the last pillar is trust. If you're buying a can of Coca-Cola, you know what that can of Coca-Cola is, and you can buy it from any of the 1,000 places, and you don't really care. But again, everything on Etsy is made by someone you haven't met before, and it doesn't come with a brand. So our job is to create a brand around Etsy that stands for trust and reliability and then lend that brand to each of these 2.7 million makers so that they can collectively benefit. And our ability to create standards around things like shipping price and return policies that lift up the whole collective, whole is important and powerful. So any one of those things I just talked about, 2.3 million or 2.7 million sellers selling millions of items, you can imagine a world where items become available in more places. But is search and discovery going to be where we do it? Or is someone else going to be able to deliver a really human experience? And are they going to be able to deliver the kind of trust that our particular sellers need? We think no one else is positioned to do that collection of activities as well as we do. And we think it's those collection of activities together that are necessary and important to lift up our sellers. So we think we've got a really unique and powerful market opportunity that's very different than where everyone else is going. And to pause on that just for a second, there's a lot of people out there who think there's going to be 2 million places to buy things online. I don't think that's true. And if you look at all the web enablers out there that will help you to create a presence online and buy traffic online and facilitate, you're effectively betting that there will be hundreds of thousands or millions of different places to buy things online. I think that's exceptionally unlikely. I think it's much more likely that there's only a very few places to buy things online. There's going to be Amazon, and there's maybe 1 or 2 people who can compete with them on price or speed of shipping. And then there's going to be a very few other people who stand for something super different than Amazon. And I think we're incredibly well positioned to win in that space and with a very defensible set of rights to win.

Great. So last week, you reported your fourth quarter earnings, your 2020 outlook and within that you announced the change to the Etsy ads product and the introduction of a new program called Offsite Ads. Obviously, there's been a lot of investor questions about -- explain to us what's changed, what was the impetus for the change and sort of the thinking behind that decision.

I'll start. So Etsy has had a couple of ways to offer sellers a chance to market themselves and their listings. One way is a product we formally called Promoted Listings, which are -- they can advertise themselves on Etsy's website. And then there's another product that we called Offsite Ads, that was a way for them to market themselves off of Etsy primarily through Google Shopping. And in August, we announced that we were merging those 2 things, and we were going to help them simplify by taking their budget and being able to optimize across one of those 2 ways. And we believe that, that was a way that was going to help get more scale for them and also for us to be more efficient with their marketing dollar, being able to use the unutilized portion of that budget from the on-site ads across to the offsite ads. We had some good success with that launch. We -- sellers, for the most part, did not churn out of the program. They maintained and grew their budgets, but we've found that it was difficult to scale it. We had said at the time it would take the better part of 2020 to be able to get all of the sellers that we -- the large important sellers that we needed into the program for us to really get to the scale that Etsy had been spending on its own PLA program. And so we found another way to do it. We found a way that we think is a lot more efficient, both for the sellers and for us. And we announced on our last call that we were breaking the 2 products back apart, and we are giving -- we are going to be giving them back the control on their on-site ads to be able to set their budget there and set their minimum bids. And then on the offsite program, we're only -- we're going to spend on their behalf. They do not put any money upfront, and they will only be charged -- it's really a cost per sale model, they will only be charged when there's a successful transaction from one of the PLA ads that we bought. So we have sellers that are large and important, that are over $10,000 in sales on Etsy that will be eligible for a discounted fee, but they're going to be required to be in the program; and then sellers that are under $10,000 can opt out at any time if they choose to, and their fee is 15%. Effectively, that's a take rate increase across the Etsy marketplace. A take rate increase implies that we now have increased the lifetime value. We can actually now spend more at the same or better ROI.

Okay. Great. And so I think the overarching goal is that this allows Etsy to spend more of your own marketing dollars on top-of-funnel, which will hopefully drive more traffic, more buyers. I guess, where should we expect marketing as a percentage of revenue to sort of trend over the medium term?

So what Lauren is referring to is that what -- Etsy also spends a fair bit of budget on upper funnel marketing. So we do -- primarily in television. And that's a place where you -- Etsy as a brand can uniquely increase consumer awareness of the Etsy brand and drive traffic to the Etsy site. We sometimes refer to as a tap on the shoulder. Our -- right now our creative ads are reminding people why Etsy, when Etsy. We think we've gotten some really good return on that spend. But no individual seller can market up the funnel like that for the Etsy brand. We feel that their spend is much more relevant and appropriate, lower in the funnel when we're driving traffic directly to their listing. And so what happens now is that because we'll be earning incremental revenue from the same budget that we had been spending previously, we're able to reinvest that money either in more performance marketing because, as I said a few moments ago, LTV has increased, so we can spend more and still get the same ROI or we can spend that in other parts of the funnel and more upper funnel marketing or we could drop it to the bottom line. So the mix will shift. Right now we expect the mix of Etsy's total spend to shift as sellers kind of take -- step into our shoes on what we had been spending on PLA. We have not been -- it will be somewhat dynamic. We haven't been crystal clear on exactly how that mix will change.

And if I can add, we did a fee increase, call it, gosh, 1.5, 2 years ago now, I think, how long has it been, where we took the commission from 3.5% to 5%. And what we told sellers is we're reinvesting that back into the business because we believe that the market opportunity is absolutely enormous. And during that time, the growth rate of Etsy has accelerated very, very significantly. So 2.5 years ago, 3 years ago, when Rachel and I joined, GMS on the platform was growing about 11%, and we had about 11% profit margins. If you look today, we guided this year that revenue will grow 27% to 30%, and we will do it at a 21% to 22% EBITDA margin. So yes, we reinvested significantly back into the program. About 80% of all the incremental money we raised, we put back into the business, and it's yielded terrific results. And if you look at Etsy growing revenue 27% to 30% at a 21% to 22% margin, that's -- if you've heard of rule of 50, companies at the midpoint -- or rule of 40, companies at the midpoint, that's like around a rule of 50, like, we think that's pretty good. So we have always been focused on top and bottom line and making sure we get the balance of those 2 right. What I would say is if we can spend $1 at a good ROI, we want to do that because we're a growth company. So we're super disciplined. We really are rigorous looking at the return on each dollar we spend. But I think it's fantastic when we see opportunities to go invest that drive growth and take profitable growth, and so we're excited. So we said this year is, yes, this results in a take rate increase; yes, we're reinvesting a meaningful portion of that back into the business, particularly in marketing and in product. So we'd expect marketing to stay roughly constant as a percent of revenue, but we're driving really great growth as a result, and we feel great about that.

Great. I think I've told you, I think I'm in your top 1% of buyers. I actually can say I bought 19 things in the past 12 months. So -- but the vast majority of buyers are still -- I think 50% are still only purchasing once a year on Etsy. So maybe talk about the 1 to 2 key initiatives that you've had to sort of drive that frequency over the next 12 to 24 months.

Yes. So we've said for a long time, about 60% of buyers buy once a year. By the way, I suspect if you look at almost any e-commerce site, that's probably true of almost anyone. I'd say, in fact, the point of difference for Etsy is that they buy reliably every single year. So as opposed to being sort of one and done, we see a lot of someone who came on Mother's Day, who comes every year for Mother's Day. And that person may not realize that we're also great for furnishing your homes or getting dressed for the party or buying jewelry or all the different categories. So there are so many use cases which Etsy is relevant, and many people who come in for just one use case don't realize all the others. What I feel great about is we don't need to invent any new use cases. We already have tens and hundreds of thousands of customers who love us for each of their discrete use cases. When you add them all up, it's enormous. We've got to do a better job of stringing them together. Where we've seen the most gain, and we have seen meaningful gains, so GMS per active buyer has grown every quarter for 8 quarters. On a 2-year stack, it's up 6%. Right now we publish our cohort curves. In our most recent 10-K, you'll see the cohorts are strong and actually improving. So we feel really good about the progress we've made on frequency. We think there's a lot more opportunity. Where we've made the most gain is actually in the 40% that were buying occasionally, getting them to buy more often. And what we hear from them is that they love Etsy. They just don't know when to think of Etsy. So we go to a customer and we say to them, "Hey, why haven't you shopped on Etsy more often?" They say, "What do you mean? I love Etsy. I'm on Etsy all the time." And you're like, "No, you're not. You haven't been in a year." And they're like, "Really? I guess I just didn't think of it." And that's where we think top-of-funnel is so valuable for us. So if you look at the television ads we've just recently started running, they're not designed to tell you what Etsy is. They're designed to remind you of all the use cases that are relevant for Etsy. So you'll see lots of different really great merchandise across a range of purchase occasions that you can relate to, that are the taps on the shoulder to remind you of all the different relevant purchase occasions.

And just one other little thought I would add to that is that we started to talk more about the -- it's now 41.4% of buyers coming to or more times a year rather than looking at the other way because that number took a little inflection in the last quarter. I mean every quarter, it's been increasing, but in the last quarter it had a nice little step-up and that really is showing you the benefit of the product and marketing efforts we've made to drive frequency.

Okay. Great. You mentioned that last week you guided to 2020 EBIT margin of 21% to -- EBITDA margin of 21% to 22%. Last year, you laid out a path to 30%-plus. Maybe talk about the key drivers. I know there's a lot of moving pieces, but the key drivers that will bridge us to that 30% margin.

Well -- so just to orient everybody, we gave long-term targets at our Investor Day, which was last March. So it's been almost exactly 1 year since we gave those targets. And what we said was GMS would grow on average over time, over a 5-year time period, from 16% to 20%, so that's a CAGR. And we've just finished the first year, we did 20%, but we've been doing about 20% a quarter for 3 quarters in a row now. And we said revenue would grow slightly faster. Revenue has grown significantly faster. And then we said at a point in time, which we said was about 2023, that's the 5-year mark, we thought that margins could be 30% or higher. So first of all, we don't plan on updating our long-term guidance annually, but those are the numbers that we said last March. And we think there's some investing we need to do. So the other 2 numbers are our CAGR, this one is a point in time and that there's some investing we need to do to get to the 30%. So I think we're investing for growth, we're investing for scale. Some of the things in the last call that we said -- I don't actually -- I feel like it would bore you all to death if I started telling you all the puts and takes about what makes margin plus or minus, but the things we're investing significantly in our products plus engineering and our marketing investments. And we invest with an ROI lens. So we want to have conviction that there's going to be a positive ROI with the investments we make, but we don't necessarily say that, that ROI has to come in the very next quarter. And so some of the things that might have a longer-term payback would be things like upper funnel marketing, which we have a lot of conviction that it's positive ROI spend, but that has a longer payback period. And things like our investment in Google Cloud we've talked a lot about in the past calls we think are actually making our engineering teams more effective as they are able to develop much more sophisticated algorithms that actually are producing higher GMS, but that's not going to be immediate payback either. Those are longer-term investments, and we're willing to stay the course. So there's nothing in what we've done that prevents us from thinking that, that 30% margin is out of the question, but we're not necessarily tracking to it quarter-by-quarter as one might want us to.

And the additional color I'd add is, the reason that we laid out a 5-year target 1 year ago is because people kept asking, what does this thing look like at scale? How big is the opportunity? And what will the margin structure look like at scale? And in particular, they kept asking, is there any reason that these margins can't look like every other marketplace? And we wanted to say, no, there's no reason it can't. The margin structure of Etsy -- Etsy is a 2-sided marketplace and marketplaces get better when they get bigger. And so our margin structure should look like other marketplaces over time, and we think 30% or better by 2023 is perfectly reasonable as a point in time. We also said GMS would grow 16% to 20%. It grew 20.4% in the first year, and we said revenue would grow slightly faster than 16% to 20%. It grew 30% last year. And we just guided to 27% to 30%, again, on top of that in 2020. So we're seeing tremendous opportunities to grow this business and to do it profitably. And by the way, we're going to maintain the margins we did last year while growing revenue really, really significantly. So what that says to me is we're seeing opportunities to invest to grow, and we're excited about that. Again, one thing we love about our model is, should growth slow, and I'm not saying it will, but should it slow, we don't have 10-year leases, we're not building factories, we're not building warehouses and logistics supply companies. Our spend is largely discretionary. And so when and if we don't see the returns we want from the investments, it's pretty easy to pull back and get higher margins.

Great. I'll ask one more and then we can open up for audience Q&A. In August of last year, you announced the acquisition of Reverb, which I think, as you described, is the Etsy for musical instruments. Maybe talk a little bit about what that business can look like long term in terms of the take rate, EBITDA margin and what excited you most about it.

Yes. So Reverb is a 2-sided marketplace for musical instruments. And it's primarily used musical instruments. It's primarily professional musicians or small dealers that sell and buy on Reverb. And the founder of the company, a wonderful entrepreneur named David Kalt called me December of 2018 and said, "Hey, I've built this great business. It's doing great, but it's bigger than I like to run. And I don't trust eBay to run it, and I don't trust Amazon to run it, and I don't trust Alibaba to run it, and I don't want to raise another round of equity and then have a boss. So you're the only company I would trust to take care of this marketplace." And when we looked at it, it's a 2-sided marketplace that looks a lot like Etsy, and it's about supporting creators. Etsy supports artists, Reverb supports musicians, so it felt very strategically aligned. And we felt that the playbook we've been executing on Etsy can make sense on Reverb as well. So opportunistically, we said let's give it a shot. Let's take a look. So we paid $275 million for the business. It had about $650 million or so of GMS. So we felt like we paid a fair price, not in an auction, to buy this company and to test the idea that we can apply our playbook to Reverb and to see that business grow and grow profitably in the way that Etsy has as well. And so we're beginning to execute that playbook now. So we've taken a senior engineering leader from Etsy, and we've put that person at Reverb, and we're really looking now at how do we do a lot fewer things on product that we believe are very, very likely to drive growth. How do we instrument really deep measurement in marketings that we know with every single dollar we spend, are we getting a good return on that dollar. And as we look at investing and growing and accelerating growth in the platform through really focused product and marketing investments, we make sure that we get a fair exchange of value as we demonstrate that we can grow. To your question of how big can it be, one of the things that I think is really interesting about the used market is there's historically been so much friction in used that the market is -- there's a huge opportunity to disrupt and grow the market. Musicians on Reverb really are wanting the vintage 1992, whatever, but they can't afford it. And the way to fund it is to sell the guitar that they currently own. And that kind of buy-sell activity happens all the time on Reverb, and we love that about the business. We think there's a huge opportunity for that to grow the market as a whole.

Okay. Great. Any questions in the audience?

Do you see this Reverb acquisition as a one-off? Or is this an opportunity to roll out other interesting smaller marketplaces by vertical? That's Chrono24 for watches or StockX for sneakers and then so on and so on.

Yes, I'd say it's a test. We like to test things before we go heavy into them. So this one was opportunistic, and we're testing 2 things: one, can we truly add value to the playbook transfer, but probably, more importantly, can we do it without distracting the core marketplace at Etsy because we believe that the opportunity at Etsy is enormous, and the team working on core Etsy is very busy. And so can we add a lot of value to another marketplace without distracting the core. We've just hired a wonderful new CEO, David Mandelbrot, for Reverb. He's terrific, and I think he's going to do a great job. And we're testing both parts of those. So I wouldn't expect Etsy to go do a bunch more until we've proven to ourselves both parts of that thesis.

But I'd just add that in our -- I think we have a slide in our investor presentation from last year's Investor Day that talks about a couple of different rationales for M&A as one of the uses of capital, and adjacent marketplaces was one, but another might be geography. So a year ago, we did a transaction with DaWanda, which was the Etsy in Germany. So we put Etsy Germany and DaWanda together, and that was quite additive to the overall buy side and sell side of GMS for us. And then a few years before that, we did a technology acquisition, a company called Blackbird, which is actually right here in San Francisco. That really sort of catapulted our machine learning capability, so that was an IP technology type of acquisition. So there's other rationale, adjacent marketplace is one of them.

Over the past year or so, you've been talking a lot about free shipping initiatives in that space. Can you kind of talk about how that's going? How much more do you see left in that initiative? And what the opportunity is there?

Yes. So one of the pillars I talked about for Etsy is that it's to be trusted. And for many years now, the shipping cost on Etsy has far exceeded what buyers' expectations are. And so buyers would rate the shipping cost on Etsy as high or even exorbitant a high percentage of the time. And in a world where people are used to having shipping baked into the item price, it's a cost of goods sold that stood out more and more as a top 3 detractor for our buyers. And so in the third quarter of last year, we took some bold -- we've been taking actions to educate our sellers. And in the third quarter, we took some bolder actions to educate our sellers to get them to bake shipping cost into the item price like all of the other cost of goods sold that they deal with. And I'm asthmatic, and it's not a good time to be an asthmatic with all the fear in the world. But -- so we've seen huge progress in the back half of last year. So in the beginning of 2019, about 23% of items showed as available to ship for free. And by the time we exited the year, 76% of item views were items that were available to ship for free. 50% of packages that arrived in the fourth quarter arrived with free shipping. That's more than double what that number would have looked like just 2 years ago. So customers are now experiencing free shipping on Etsy. And we think we've made tremendous progress on the supply side in getting sellers to adopt that. Now what we've got to do is, we've got to get buyer awareness to catch up. Now that it's true, we've got to shape perceptions. So in February, when we surveyed buyers, only 12% of people who buy on Etsy were aware of the fact that you can find free shipping on Etsy, 12%. So we'll start to really see the gains as buyers become more aware of it, and that's something that I think we're going to see steady incremental progress in the months and the years to come. Thank you.

All right. Well, we really appreciate your time. Thank you so much.

Thank you. Thanks very much for the conference.

Thank you.