Sectornomics: Technology

Is Etsy the next eBay, Amazon or not even close?

The era of Etsy trading as a public company began Thursday morning after the online craft mall's highly-anticipated IPO. That makes Etsy the latest hot technology IPO—but it's far from typical for a dot-com story.

If you passed on the IPO, should you now buy Etsy stock?

Source: Etsy

The question for investors is whether the company's market and business model provide enough room for the company to keep growing, and for shares to keep delivering, over time. Or to put it in high-growth terms: Is Etsy an "eBay of arts and crafts" or an " of arts and crafts" in the making, or is it a far cry from either?

New York-based Etsy last night priced its offering at the high end of its anticipated range, $16 per share, valuing the 10-year old company at $1.78 billion.

The company had $195.6 million in revenue last year, up 56 percent from 2013, but like many tech and Internet companies, it's not yet profitable based on generally accepted accounting principles (GAAP) for net income, losing $15.2 million last year, although it does make money before interest, taxes and non-cash charges. It did have positive operating cash flow of $12.1 million in 2014, down from $16.5 million a year before. Adjusted EBITDA was $23 million in 2014.

Read MoreEtsy prices IPO at $16 a share

Even if Etsy's stock moves higher on its first day of trading, that's no answer to the question of whether handmade crafts are enough of the nearly $1 trillion market for online retailing—and whether Etsy can sell them profitably enough—to make the company a long-run winner, said Renaissance Capital analyst Greg Leffert.

"They're not losing a huge amount," Leffert said. "They will also have lots of cash after the IPO," he added. Etsy raised an estimated $266 million in the deal.

"We would have liked to see them profitable, but where they are going seems to be very positive," said David Menlow, founder at in Green Brook, New Jersey.

Values vs. what Wall Street values

One of the biggest differences between Etsy and the usual dot-com narrative is it being a marketplace for artisans—most of them women, who sell handmade goods—so the company places an unusual emphasis on building up a culture in the Etsy community.

"To really understand Etsy you have to understand our values," CEO Chad Dickerson said in a video presentation for investors.

Read More6 ways to identify a good tech IPO and avoid future busts

It boasts that both its buyers and sellers are loyal and using Etsy more often each year: Nearly half the merchants who sold on Etsy in 2011 still do, and a third of 2011's customers are still buying, the company said. Merchants who have been selling on Etsy since then are now doing about five times their previous volume on average.

The company's biggest revenue stream is a 3.5 percent commission on goods sold on Etsy by its artisan vendors. Gross sales were $1.93 billion in 2014, up 43 percent. That drove $108.7 million in revenue from commissions and listing fees.

In the first quarter of 2015, there were 34 IPOs worth $5.4 billion, half of the 64 deals worth $10.6 billion in the first quarter of last year, according to Renaissance Capital. But IPOs are performing well. The Renaissance Capital IPO ETF (IPO) was up 10 percent this year, through Wednesday, and trading at an all-time high.

Etsy's other big basket of revenue—currently smaller but growing faster—comes from services it provides to merchants who sell on the site, including shipping labels and payment processing. That accounted for $82.5 million of sales last year, almost double 2013's $42.8 million.

That push into seller services highlights Etsy's growth challenge. The company plans to offer a wider array of services, in addition to expanding internationally, helping revenue continue to climb in future years, when merchandise sales growth levels off. But those services are much less profitable than the other part of the business and promise to keep Etsy's long-term profit margins before interest, taxes and non-cash expenses between 18 percent and 21 percent, which is lower than many e-commerce companies and less than half as profitable as eBay, the larger company Etsy most closely resembles.

The company's profitability declined last year on a cash-flow basis, but on purpose in a bid to accelerate growth, said Etsy CFO Kristina Salen in the investor presentation. The key question is whether the money was well spent.

Part of the the investment was spent more than doubling marketing to boost sales growth. Much of the rest went into product development, focused on the seller services. The result: Profit margins measured in EBITDA dipped to 11.8 percent of sales last year, from 13 percent the year before, as sales growth covered most of the extra spending but not all of it immediately.

"While [Etsy's growth with low marketing spending] is a strength, we also think it was a missed opportunity,'' Salen said.

Leffert said if Etsy's relative lack of profitability isn't as big a concern as with other tech IPOs, the company's margins place its story in a more negative light. While people may compare Etsy to eBay as far as the structure of the company, Leffert compared it to GrubHub, and unfavorably, in terms of margins generated on sales. "GrubHub has much higher margins with similar sales and a similar growth rate," he said.

Over time, Etsy thinks it will get more of that investment back in higher sales, and it will be able to scale back its spending as the company gets bigger. Long-term plans call for Etsy to trim marketing spending to 16 percent of revenue, from 20 percent last year, and product development spending will also moderate. That will let margins reach their long-term targets, Salen said.

Read MoreCan Etsy do good and make money at the same time?

The deal values Etsy at close to 9 times last year's $196 million in sales and roughly 7.5 times this year's sales, assuming a conservative assumption that it grows 20 percent, according to Renaissance Capital. That's less than what social media companies with wider profit margins attract, but twice as much as the more mature eBay, which, like Etsy, is a global platform for private sellers that also offers payment services and other extras.

Leffert said the valuation isn't overdone. "Their gross merchandise sales are still growing fast," he said, explaining that the company earned $23.1 million in earnings before interest, taxes and non-cash charges last year. "They have some room to grow, because it hasn't slowed down much yet,'' he said.'s Menlow thinks the valuation reflects a financial picture that won't develop for another two to three years. "That is evidently comfortable for many investors who don't think the deal is out of line,'' he said.