Deals

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

Etsy, the online marketplace for everything from wedding decorations to personalized baby onesies, could soon be listing itself for sale. 

Late Monday, TPG and Dragoneer Investment Group disclosed a combined 8 percent stake in Etsy and said they had offered to help the company figure out its strategic alternatives. On Tuesday, Etsy's shares jumped more than 23 percent as the Brooklyn-based company said it would "carefully consider" all options to improve shareholder value.

Downtrodden
Since its 2015 IPO, Etsy has rarely traded above its $16 offer price -- but Tuesday's jump sent the stock soaring past analysts' 12-month price target of $11.48
Source: Bloomberg

With Dragoneer in tow, TPG's private equity arm has taken a toehold stake in Etsy, which involves buying shares in undervalued public companies with a view to nudging management toward a buyout or, at the least, operational and other improvements. Kind of like an activist, but different.

Firms such as Apollo Global Management LLC and KKR & Co. have set aside cash within their multibillion-dollar buyout funds for this strategy. I've been skeptical about it, mainly because -- with the exception of some technology-focused firms -- most practitioners haven't been hugely successful in transitioning toehold stakes into deals of their own. Plus, undervalued public companies usually get pretty well picked-over by activists: 

Getting Crowded
Activists have staked out much of the ground among companies that fit as potential candidates for toehold stakes
Source: Activist Insight, Fitch Ratings

In the case of Etsy, Black-and-White Capital LP has already urged it to consider options including a sale and cutting "bloated" costs. And although this could be one situation where a toehold stake is an effective deal-sourcing tool, any buyout offer by TPG and Dragoneer could be trumped by other retailers.

There are some motivated strategic buyers out there -- though let's go ahead and shoot down any misplaced suspicion that Amazon.com Inc. could be one of them. It won't. As Gadfly has extensively written, Amazon isn't interested in the role of corporate savior. The same goes for Chinese market behemoth Alibaba Group Holding Ltd. and Facebook Inc. -- though it's tough to rule anything out, considering both have humongous cash piles. 

A likelier buyer is Wal-Mart Stores Inc., especially considering its recent track record of reaching into the bargain bin for downbeat e-commerce retailers as it tries to bolster its own online sales. Etsy would also fit into Walmart's growing marketplace strategy. But its $1.6 billion price tag is higher than most of Walmart's recent deals, including its $75 million purchase of Modcloth. (Still, it's much less than the $3.3 billion it shelled out for Jet.com.) 

Other potential suitors include arts-and-crafts specialty retailer Michaels Cos. and party-supplies store Party City Holdco Inc. Both could both benefit from adding a new online customer base to their primarily brick-and-mortar sales.

Decelerating
While it is slowing, Etsy's growth still outpaces that of most traditional retailers
Source: Bloomberg

Then there's the most logical buyer of all: online marketplace Ebay Inc., which needs an acquisition to turbocharge its sales. The company can afford to pay a 30 percent premium over Etsy's closng price Monday and still have a deal be accretive to its fiscal 2018 earnings, assuming at least $10 million in synergies, according to data compiled by Bloomberg.

Etsy itself would likely thrive with the additional resources of a larger organization. Monness, Crespi, Hardt & Co. Inc. analyst James Cakmak reckons that, in such a scenario, Etsy should be able to deliver an Ebitda margin of 40 percent or more.

Room to Improve
Etsy's margins aren't great, in part due to its sizable spending on marketing as well as research and development
Source: Bloomberg

At roughly 61 times its estimated fiscal 2018 earnings or 17.4 times its forward Ebitda, Etsy isn't cheap and financial buyers like TPG aren't known for paying top dollar. But unlike other corners of retail, Etsy is growing and has a fiercely loyal following. For a buyer in the industry, that may make it worth the price.  

--With assistance from Shelly Banjo.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. TPG profited from the purchase of a stake in Advent Software in 2013 but didn't push it forward into a deal of its own. The company was acquired by a strategic buyer, SS&C Technologies, in 2015.

  2. Etsy Studio -- its craft supplies market -- will likely be of the most interest to Michaels. 

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net