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

Good morning, everybody. I'm Scott Devitt. I cover Internet, e-commerce at Stifel. Very happy to have Etsy's CEO, Josh Silverman, and CFO, Rachel Glaser, with us today. And it's been an interesting, I think, few years for e-commerce industry and I think maybe a good place to start, Josh, with you. If you look at -- not that our model is relevant in any way, but if you go back to before the pandemic, the -- relative to what we estimate the business in 2022, I think our revenue estimate is about 85% higher than what the '22 estimate was before the pandemic.

So if you read the news today, you think e-commerce as an industry was kind of ending in terms of all the things that are negatively impacting at the moment. But a good starting point would maybe where the business is, how the pandemic has kind of influenced and how you see the future from here?

Yes. So first, thanks for having us here. Do you want to do the safe harbor?

Yes. Just real quick with housekeeping. I just wanted to remind people that Etsy has a safe harbor on our Investor Relations website. You can find it there.

So we did an Investor Day in 2018, I think, where we set an aspiration that we thought Etsy could be greater than $10 billion of GMS in a 5-year time frame. And that was news to a lot of people, and there was a lot of skepticism around is the market really that big? And how big is the TAM? And we overnight exceeded that during the pandemic. Etsy was transformed by the pandemic. Again, it was a good business, growing nicely before the pandemic. But just to give some sense of scale, for guidance for this quarter, we said at the low end of guidance, Etsy would do $2.9 billion of GMS. In the same quarter, pre pandemic in 2019, Etsy did $1.1 billion of GMS. So the scale of Etsy is dramatically different than what it was before. And in some ways, we had a perfect storm of tailwinds in 2020, where people were on stay-at-home orders, they couldn't go outside. You can't spend on travel and dining. The government is putting massive amounts of stimulus into people's pockets. And even when you go and try to shop online, because of supply chain issues, everybody is out of stock. And so in 2020, millions of people turned to Etsy because they had to because they had no other choice. What we've seen since then, there's been a slow reopening in 2021. And as we all have observed since February of this year, a much more dramatic reopening. People are returning, millions of people are returning to Etsy time and time again because they want to, because they had a great experience on Etsy. And of course, they have vastly more choice than they did a year ago. They can travel, they can dine out and they can go to the mall again. And that makes a difference. And it's not at all shocking that they want to do some of that. And yet, they are returning to Etsy time and time again, and I think that's because Etsy stands for something different. We genuinely do something different. Everybody else is selling items with a SKU number. And if you're selling items with a SKU number, you're competing head-to-head with Amazon on their terms. You've got to find a way to sell it cheaper or ship it faster, and I wish you the best of luck. On Etsy, we have 15 categories that had over 1 million unique buyers in the past 12 months. You can find virtually anything on Etsy as long as it can be made by hand. You're not going to find iPhones on Etsy. But for the home, for fashion, jewelry, art, cooking, baking, gardening, toys, games, you imagine it, it's probably for sale on Etsy. And it's going to be something that was made for you that expresses your sense of style and that comes with a story. And what millions of people have discovered is that's actually pretty great. I can buy something that comes in a reasonable amount of time, is sold for a very fair price, and I feel really great about owning. And in a world maybe where people want to own fewer things, they'd like those things to mean more.

And you mentioned the additional customers that were added during the pandemic, and those customers continue to engage with the site as -- now that we're at this point in the cycle, with the reopening and the effects that it's having on goods they serve and services-based spending. Can you talk about the investments in the business that you're now doing from a user engagement, retention standpoint, you announced the purchase protection plan and other things to kind of continue the flywheel as we get through this period.

Absolutely. So first, I just want to highlight that we've gone through a very long period of time where there's been a sort of growth-at-all-costs notion in the market, Etsy has never been growth at all costs. We have always been focused on profitable growth and thinking about the investments that yield good returns and thinking about the marginal return on the next dollar. And actually, Rachel and I were reflecting that. Both of us, for better or worse, are old enough to have been around for -- this is our third big cycle. We were both in senior leadership positions during the tech crash of 2000 and have been around for a little bit. And so what you saw when business boomed during the pandemic was we didn't throw caution to the wind. We didn't hire like crazy. We didn't over -- margins exploded. People wondering could Etsy ever deliver more than a 30% margin, while we delivered well over 30% margins during 2020. We're not going to waste shareholder capital just to try to make our margins not look as good. But we also know that there is a very big opportunity out there that over time, I believe e-commerce is going to continue to grow, come and fits and starts, but e-commerce is going to be a lot bigger 5 and 10 years from now than it is today. And I believe there's going to be a lot fewer players. I think that you need to be a brand that's big enough for people to remember. You need to be able to get substantial organic traffic in order to be a viable player. And that means you need to stand for something really different and really meaningful, and you need to do it often enough. And Etsy is that. So in a world where things consolidate more and more around a few big players like Amazon, Etsy stands in sharp contrast to that, and I think we have ever more opportunity to win. So we are investing with discipline around that. With discipline, but where do we invest? First, marketing and mind share. This is a moment when we need to be front of mind, so people understand that Etsy is a viable alternative so often for them. We invest with discipline there, but I think this is a great time to be investing to make sure that we cement our brand awareness with people. And then in our customer experience, we have made great strides over the past 5 years, and there's still tremendous more to do. We were just meeting with some shareholders a minute ago, who were reflecting that it's still the case today that when 3 of them log in and do a search for an item, they all see the same search results, even though they're different genders and in different cities and all that, that's true. It's only been less than a year since we've had any personalization of our search capabilities at all. And the opportunity to bring you things that reflect your taste, your style, your stage of life, it's a huge opportunity for us to get even more relevant for you. And the state of the industry in terms of machine learning is allowing us to do that at scale in a way that we couldn't before. That's going to allow us to do more to inspire customers who come to Etsy. And about half of our traffic is people who are just window shopping. That's a privilege. That's pretty great. You don't go to Amazon just to window shop. You do come to Etsy for that. And our opportunity to show people things that they didn't even know that they might be interested in and have an engaging experiences, we think is great. Second, be more efficient. When you know what you want, you want to get in and get out. And in order to drive frequency, we know that the more efficient we can be, the more you feel confident that you can get in and get out, the more we're going to win those purchases. So getting search relevance to be good, getting the buying experience to be super streamlined. We've made progress, a ton of opportunity to still do better. And third and very importantly is trust. One of the things buyers tell us is I shop more often at Etsy, if I was really confident that the item is going to arrive on time; that if it didn't arrive, you'd have my back; that if it wasn't what I expected, you'd have my back. And the good news is our data suggests that our sellers do a phenomenal job at that. And so it's affordable for Etsy to provide that protection for both our sellers and our buyers and give people the confidence. And so we launched the purchase protection program. We feel great about it. It covers buyers and sellers when the item is lost in mail, arrives damaged. And so people know that they can shop with confidence on Etsy. Other things we're doing with shop with confidence, by the way, we've made dramatic improvements in making sure the item arrives on time. More marketplace, it doesn't come from our warehouse, so we have different levers than Amazon or Walmart or Target but we have those levers. And our sellers have made dramatic gains in making sure that they live to those promises. And as we do that, we really believe we're going to win more and more share of wallet.

And just real quick on the purchase protection. What -- we did a pricing increase, and we talked about we're not flowing through all of that incremental revenue to the bottom line. And the purchase protection is one of the things that we're reinvesting in which puts it back in the marketplace and benefit sellers and buyers.

Got it. Yes. That makes sense. And the industry, if I recall, gained like 5 to 6 percentage points of share immediately, right, in the pandemic when other options were shut down, et cetera. And it's looking as we head back towards trend line, like the industry. There's additional complexities now that are macroeconomic in nature, but maybe keeps 1/3 to half of that over time above the trend line. I think your commentary publicly has been something like you could keep 90% of the pandemic gains, and it's been quite a bit more transformational for your business. And so this question more relates to, I guess, that. And in addition to that, for Rachel, maybe, how you think through these factors that are impacting the economy at a micro level in the business with what's happening in terms of consumer wallets and shift to services and some of the commentary recently from Walmart and Target?

Yes. Internally, we look at a number of vectors. So one is reopening and what reopening -- how that impacts Etsy's business. Another one would be macroeconomic. So we're seeing huge inflationary gains from some e-commerce players because they might have more pricing power than Etsy does, or you're seeing grocery and gasoline mixed into their numbers. A 1/3 might be less related to inflation, the lower discretionary consumer spending. So we talked a lot about Q1 of 2021 getting a big tailwind from stimulus checks. And that's absence so we're looking at all of those vectors. The guidance we gave for Q2 at the low end of that guidance, it implies we keep 90% of the gains. And just to put that into context, that guidance, which was $2.9 billion at the low end is nearly 3x bigger than it was in Q2 of 2019, which is -- was $1.1 billion. So we are significantly larger than we ever were before. And what that means, as Josh often says, I don't want to steal your thunder, but when we're doing product development and we're spending on marketing, every gain we get there because we're so much larger is twice or 3x the yield than we were getting before. We have increased our headcount, but not 3x. We've increased our headcount something in the range of 25%. So we're getting a lot more bang for our buck, if you will.

And there is a cost impact on the business, I suppose, given what's happening with the labor markets. Obviously, you don't invest in inventory. So that's something that affects merchants. But is it something that influences how you think about pricing, take rates and things like that in the longer term to the extent that this doesn't change?

Yes. I mean first, we benefit from being a business that has very low fixed cost. We don't invest in inventory. We don't have warehouses. And so -- and our marketing is largely variable. We choose to invest in marketing when we see returns, and we can vary that lever quite a bit. So our main fixed cost is headcount. And we did not throw caution to the wind during the pandemic. We hired at a steady cadence. Our revenue grew 2.5x, and our headcount grew far, far less than that. Every product development squad -- because we have more than twice as much traffic on the site, as Rachel said, every new feature that we launch has twice the ROI. It did 2 years ago for the sheer fact that we have twice as much traffic. So the ROI of our engineering team increased dramatically during that time. And as we've said, we always invest with discipline. And so we have always been looking at what is the marginal return on our engineering effort. And most of our headcount, by the way, is product and engineering. And so what is the return on each new squad that we add. And we have been scaling that team, but we focus a lot on marginal return. And what I would say there is that we still think, over time, we've gained leverage, and we think it makes a lot of sense when we look at the gains we're making in things like search relevance and how that drops revenue, which drives margin, we feel great about the investments we've been making, but we continue to keep a careful eye on that. When you look at Etsy, our core, the core marketplace revenue per headcount, it's well over $1 million of revenue per headcount, which we know benchmarks very well versus all of our peers and only folks like Google and Facebook really put up numbers substantially bigger than that. Our headcount has also grown because of acquisitions. We bought Depop and Elo7. So when you look at our overall headcount growth, it's -- I don't want to say inflated, but it's informed by the fact that we've added 2 new subsidiaries that bring with them headcount. And those are earlier in their stage of development. And so revenue per headcount there is lower. They're in an investment phase. But overall, we pay a lot of attention to leverage and ROI in our headcount.

Okay. And there's a long history now of e-commerce and the development of the industry and the approach that eBay took in the earlier years in terms of infusing price without additional services, you definitely balance the two. It is a topic that does come up some time with investors. So curious where you think you are now in terms of that balance in terms of properly providing the incremental services, how much more room there could be to go on take rate inclusive of like advertising spend for merchants and just in terms of like mitigating that risk. I don't see a clear competitor out there doing what you do, but it isn't something that comes up in conversation.

So we just did a take rate increase. We raised our commission from 5% to 6.5%. A couple of things I'd point out about Etsy's structure. It is very, very aligned with seller interests. You pay $0.20 to list an item. All of the rest of the fees are success-based. So Etsy only gets revenue when you sell an item. And we know that our fees, we believe are very reasonable and benchmark very well the industry, and we believe there's a fair exchange of value. We just did this take rate increase. We did it based on what we think is fair. And so we think the exchange value is fair. A very small group of sellers had a petition and not very many -- out of 7 million sellers, very, very few of them signed that petition, and even fewer of them pause there shops for a week during that boycott. And so that small group of sellers was able to get a lot of attention from the press, but I think it's quite interesting that all it took as a seller was to click a button to say I agree that Etsy shouldn't raise its fees and 99.5% of the sellers chose not to do that. That didn't get a lot of press, but I think it's kind of interesting. So we think the exchange of value we're providing is fair. And we also commit when we do take rate increases to reinvest a meaningful portion of that back into the community. Not willy-nilly, but because we know that those investments are yielding real returns. So when we raise our take rate, the lifetime value of every customer goes up, of every buyer goes up, and that means we can invest deeper to acquire buyers. It's just mechanical. It's just mathematical, right? So by raising our take rate, we can invest more in marketing. We can invest in things like the purchase protection program, which is great for sellers, and for buyers. And we'll keep looking with a disciplined eye what investments make sense for the business and who should share which piece of those investments. So it's fair for shareholders and sellers and buyers.

Let me just add a couple of comments on take rate. So the take rate pricing that we just took was on that, what we call our transaction fee, that's a sort of a mandatory fee if you make a sale, you pay that transaction fee. We've only done that one other time before, that was in 2018. And we were just talking earlier in another meaning that if you go back in the history of eBay, another similar marketplace model, I think there was more of a history of taking take rate sort of more on a calendar basis rather than -- so we've been very -- and that, I think, caused a fair amount of seller exodus and thus the genesis of Etsy. So we're very conscious about that reinvestment, as Josh said. But there's other forms of bringing take rate up. For instance, we have expanded Etsy Payments to more countries. So that's how Etsy earns profit margin on our payments platform. We introduced Etsy Ads, which is a success fee-based ad product that if a sale is made on a PLA that we place, that seller pays an extra percentage for that specific transaction. Then again, they don't pay anything if we make the sale, but they don't, meaning somebody clicks on that listing but buy something else on Etsy. High ROI for the seller, really good return on investment for Etsy. So little by little, we've been able to bring take rate up in a way that is beneficial to the overall marketplace, not just to Etsy's bottom line.

Two other topics I want to make sure I hit on, acquisitions and then the ad business as well. But you have a very clear M&A strategy that you've made public, and there have been 3 deals, Reverb, Depop, Elo7. Talk a little bit about how the businesses fit in? And then also what's happened with valuations in the industry and the market in general, how that potentially affects deal flow?

Yes. So first, Etsy's mission is keeping commerce human, and we've acquired 3 other two-sided marketplaces that also are about keeping commerce human. Reverb is for musical instruments, Depop is re-commerce of fashion for Gen Z, and Elo7 is the Etsy of Brazil. And so in each of them, they share -- they are very well aligned with their mission. They're very aligned with our business model, which is these are inventory-light, capital-light, peer-to-peer two-sided marketplaces. We're not holding inventory. We're not sitting in the middle of a transaction. They're both -- they're all about the creative economy. And they have the same levers to manage growth and profitability over time. And so I believe that a two-sided marketplace at scale is lightning in a bottle. It happens very, very rarely. And when it happens, it can be a very, very valuable business. We have a significant amount of know-how in terms of how to run those businesses and how to unlock value. And we acquired Reverb and we're able to provide some very real value to improve the customer experience there and drive margins and growth in a way that we think demonstrated our ability to really add value. We've acquired Elo7 now as a foothold into Latin America, which we think is a really exciting market. It's a market where cross-border trade. Typically, if you look at businesses like Etsy's, what works in the U.S. and across Europe doesn't naturally work to Latin America as well as one global marketplace. I think eBay has succeeded in many markets, but hasn't succeeded in Latin America. Mercado Libre became the success -- survivor there. So we think getting a foothold of a brand that's fit for Latin America, we think, is very interesting. And then Depop in re-commerce, which we think is a very exciting space for the long term, which is the leading brand for Gen Z, which is a very large and growing demographic that we think is going to be the leading demographic. We laid out some very clear criteria for acquisitions. One is being able to get them at a fair price. Pricing has obviously changed a lot in the market. One of those is that we have the bandwidth to focus on it and do it well. And acquiring a company takes real bandwidth and real focus from management. And we are very thoughtful of that. And we are very focused on our core right now and really making sure that we drive growth in the businesses we've recently acquired and that we've got the bandwidth to focus on our core as well.

Okay. So is it fair to say despite the change in valuations, you're maybe less focused on inorganic at the moment?

I -- never say never, but we've always had -- we laid out some very clear criteria and there's a high bar for a business getting over those -- that criteria.

I would call this year a digestion year, but we're always looking forward. So it takes some time. We courted Depop for several years before we actually walked all the way to the alter with them. So we're constantly looking at things that might be interesting to our house of brands or to our seller -- to enable our sellers and help empower them. But this is what I would characterize it as a digestion year. With that said, we did say -- put in our last 10-Q that the Board authorized another $600 million of share repurchase. So we are still looking at use of capital and how to return that to shareholders in a way that is high return.

Okay. And so Rachel, you talked a little bit about the ad product and what it is. Could you just expand on that in terms of what Etsy does offer in the advertising form? And then Josh, how investors should think about the addressable market for advertising as a portion of the total business over time?

Sure. So just Etsy has an ad network of exactly 2 products. One is to advertise on Etsy and the other is to advertise off Etsy that we offer to our sellers. They're both success fee, but the -- on-Etsy advertising product is an optional thing that sellers can decide to allocate budget to and it gives them more prominence on a search result page. We've seen continued growth in that product because it benefits from improvements we make to our own search algorithms, which puts more and more relevant ads higher up on the page and so it gets higher click-through rate. And higher the click-through rate, the higher the return on ad spend for the sellers and they'll allocate more budget. And we've also managed the number of ads per page and balancing that with the offset of do we get lower click-through on nonsponsored ads that might convert better. So we're always managing and optimizing those pages. The second product is what we call off-site ads and Etsy has traditionally spent -- we spend until the last marginal dollar of spend is no longer profitable for performance marketing. So we've traditionally spent a lot of that performance marketing in the PLA channel. And now what happens is if those -- if the listing -- so a seller is benefiting from that spend that Etsy has and we've made it more cooperative now. So if the seller actually gets a sale from one of those PLAs, they'll pay a slightly higher transaction fee. And that ultimately amounts to about a 1% take rate increase, which is a virtuous flywheel that enables us to be able to spend deeper into the ROI curve because we've increased our lifetime value of that customer.

The only thing I'd add is on the on-site advertising program, all the gains we're making in search and search relevance apply to ads. So the headcount when we look at headcount growth, as an example, not long ago, we had 4 engineers working on the ads product. We have a lot more than that now, and it's been incredibly high ROI. Because picking the right ad for this given buyer at this given time in this given placement, it has -- unlocks huge yield. And we've seen really great gains in that. And that's a win-win-win. It's better for the buyer because you're seeing more relevant ads. It's better for the seller because it's driving sell-through at a good ROAS. And obviously, money drops to the bottom line for Etsy and Etsy shareholders. So that is an area where as fast as GMS has grown, adds have grown even faster, and a lot of that is just improvements in relevance and technology. There's still a lot more we can do to make ads even more relevant with millions and millions of ads available for any given search query. There's a huge opportunity there. But also in terms of how you present ads, where they go on the page, how big they are? Are they static or motion? There's tons of opportunity there. And then in terms of offsite ads, each seller is independently a blade of grass in the thunderstorm. And so when they go to Shopify and most of our big sellers do, they discover just how expensive it is to market. And that seller with only their data and only their brand has a very hard time gaining prominence in a place like Google, right? The Google search algorithm depends on how likely is a customer to click on your ad. And if they don't know your brand, they're less likely to click on your ad. And when they land on your website, they're less likely to buy because they don't trust you. So associating the small seller on Etsy with the Etsy brand allows them to get that click cheaper and to drive a higher conversion rate. And they only know that -- offsite ads only looks like a great deal when you open up your own shop and realize how fair our platform is. So we know we deliver great value. We focus on delivering great value. And when we know we're delivering great value, we have the conviction to charge a fair price for it and then see it through.

I do have one more, but there's only 2 minutes left. I just wanted to pause to see, does anybody have a question? Sure, go ahead.

Just to that last point. Can you quantify that a little bit for us?

It really depends seller to seller. It's really hard to say. But if you survey sellers on their own websites, the percentage of them that are spending less than, let's say, 20% of revenue on ads, I would suspect is pretty small, especially for small independent sellers. It won't be uncommon to see people spend 30% to 50% of revenue to try to drive traffic.

So the last question, the -- as we kind of exit the pandemic, investors are looking for like what's changed in the industry and who's actually really won, picked up something from what's happened, the unfortunate events of the pandemic that had such an effect on e-commerce, but what does that do for the next 5 years. Etsy ranks high, if not the highest in terms of the impact. I noted at the outset, our estimates for this very year, 85% higher than they were before the pandemic. I like to say that the company was kind of, in many ways, discovered because of the pandemic, and you've identified kind of the reasons why Azure being identified, consumers keep coming back. Is that a fair assessment? Or how should investors think about why Etsy is different as it exits?

Yes. I mean tens of thousands of brands pay to give free samples at different places. Half the world got a -- not half the world, many people in America and a few other places got a free sample of Etsy during the pandemic. And our sellers came through in flying colors. And so people got a chance to really try Etsy and discover how great it is. And now that they have vast amounts more choice, they're still choosing to come back to Etsy again and again to spend, and we think that, that is really a great pillar of strength for the future.

Very good. Josh and Rachel, thank you very much. I appreciate it.

Thank you, Scott.

Thank you.