Etsy has come a long way since the early days when many of us were laughing to the point of tears with posts from the infamous and now-defunct Regretsy.com. There are still funny things to be found but it's a far more polished site now. Seriously though... the company is trying to take another step towards a far more commercial identity than they have ever had. At least one cautionary tale from Wired.com "How Etsy Alienated Its Crafters and Lost Its Soul" (Feb 2015) is worth a read but it's only one side of the story. To be fair as Etsy grows and evolves they will lose some early adopters while gaining new adherents.

Reflecting back on a presentation on Etsy we put together back in July of 2012 it turns out that the company was doing far less revenue than people thought back then. Some of the new consumer retailers we noted then have done well - Kickstarter, Quirky (now with GE) while others like Fab have disappeared. Back in 2012 Etsy was thought be doing $525M in sales and planning to "invest in marketing at 5% of net revenues." The Etsy "take rate" of 3.5% was thought to be low then versus the likes of eBay but apparently acts more as a ceiling than a floor for Etsy.

Etsy is positioned well in exploiting the growth in small-run manufacturing and thoughtful designs over simple mass-produced consumer goods. They are also able to monetize a family of technology services related to commerce - including payments, shipping, and advertising. See more in our sampling of ETSY IPO Roadshow Slides.

The company emphasizes the "relationship" model between buyers and sellers on the platform. It's as old as commerce itself however whether you consider patron of artists and the more modern use of individual designers in fashion and furnishings. This relationship model is evolving from the very early days of Etsy and is shifting to a more "branded" versus "personal" feel as the company combines design craft with small-run manufacturing.

Etsy has a strong brand identity that appears fairly defensible as long as they don't alienate their user-base, particularly the creators and sellers. For the seller they are offering small numbers of unique and often unusual items which don't fit at all into typical third-party seller marketplaces like Amazon and eBay. For buyers Etsy is more about discovery and specialty items typically found in small boutiques or is custom-made. If there are "growing pains" on the horizon this is probably where they will come from.

The business rests on a strong technology foundation (the CEO was the CTO of the company) and the management team and board of directors have the background, experience and professional networks to help Etsy grow and overcome the challenges that face high growth companies.

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Valuation of ETSY stock is tricky. The shares will benefit from the hype and the "hot deal" perception that a Goldman-Morgan Stanley cover brings to the market. Probably the best direct comparison is EBAY which trades at 3.7x revenue but their size and maturity make it far from ideal. The rest of the group of smaller companies are all over the map from 15x sales (Yelp and GrubHub) to 1-2x sales (Wayfair, Care.com, Blue Nile, Michaels). The proposed valuation of 5.5x projected 2015 sales for Etsy is reasonable but not demonstrably cheap, especially given the following concerns.

As much as I personally like Etsy and think they company can be a good investment there are some looming issues that are yellow flags:

1. The IPO itself is a major event and brings in a whole new facet of "community" in the form of investors who may in fact care much more about sales and profits then relationships, creating social god and long-term thinking.
2. Etsy has made a major shift from organic, word-of-mouth-driven growth to a more traditional method of spending heavily on marketing.  For example they doubled marketing spending from 17.9M in 2013 to 39.7M in 2014. As a percentage of revenue marketing went from 14% in 2013 to 20% in 2014.
3. Long-term financial goals call for gross margins to decline 10 points from the current 62% to 50-52% as a result of growth in revenue from new value-added services. Besides going in the wrong direction these revenues more typically boost rather than wilt gross margins. There is something wrong with that picture in our eyes.
4. The user population is still quite narrow. There are 1.4M active sellers and 19.8M active buyers on the platform today. The vast majority, over 80% are women. Although they don't talk about it much in the roadshow a large portion of the Etsy business is related to selling craft supplies (like a Michael's Stores) and Jewelry. Etsy is definitely diversified but even so the site has not shifted their demographic profile much in the past several years. For Etsy "active" means activity within a 12-month period.
5. Scale may be difficult. How large can the Etsy platform be and retain the hand-crafted and vintage sensibilities that sellers and buyers identify with? There's more to it than simple supply and demand. As the number of discrete items and customers grows it gets difficult to find and filter products. In the same way your local craft shop can't "scale up" and retain the same feel and identity. Etsy may be planning to use M&A to create more of a "federation of small platforms" but this carries risks as well and so far management hasn't said they would go in this direction. (Although they have made a couple of small acquisitions like Grand Street and A Little Market.)

Private and VC investors in Etsy have done very well up to this point but in many ways the tougher, more risky growth is what's ahead for the company and public market investors should be wary. Since this will be a "hot deal" traders will want to be in on the IPO and investors may want to take an initial position at that price.  We did do an IV for ETSY with fairly generous growth and valuation assumptions. It suggests a valuation at the $15 mid-point of the range for 2016.

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Deal Outline:

16.6M shares of which 13.3M are primary for a size of $249M at the $15 mid-point. Shares outstanding will be 111M for a pro-forma market capitalization of $1.66B.

There are just three banks (Goldman, Morgan Stanley and Allen) on the cover. They represent the top-tier to be sure but it would have been valuable to have two additional smaller banks in on the deal for coverage and after-market support.

Etsy had revenues of $195M in 2014 which were up 56% over 2013. We'd project 2015 revenues of just under $300M for a P/S ratio of 5.5x on the current year.