Description

Mercari is a great moaty marketplace business that seems to be quite underappreciated - not just here on VIC (it is not even mentioned in a message once, let alone pitched as an idea), but by the broader investment community. A situation that is quite surprising given how much love and praise marketplace businesses generally get - especially so in the recent past.

Anyway, this is obviously very good news and we view it as the primary reason why this business is undervalued. Mercari is not a company/stock with a lot of controversy around it or with important pieces of the story that are very hard to understand. The company has also already shown anyone who cares to pay attention to it, how extremely profitable the business can be. Their most profitable quarter in the core business this year had an operating margin of greater than 40%. It is also not hard to see Mercari's future growth potential and yet the company is trading at an undemanding EV/ttm sales ratio of ~8 and 1 x ttm GMV or ~6 fwd sales and 0,7 x fwd GMV with ~30% continuing growth while already being FCF positive despite investments in adjacent business opportunities and in geographic expansion.

Let's shed some light on the opportunity

Mercari is a relatively young founder-led Japanese company focused on consumer-to-consumer e-commerce of used goods. Customers are served predominantly via Mercari's mobile app where both buyers and sellers facilitate their business activities. The company was founded in 2013 by Shintaro Yamada who still owns around 24% of the company today and has quickly become the undisputed category leader in Japan. Based on the latest published results, Mercari Japan has 17.5m MAUs and generated a GMV  of $6.5b (ttm) on its marketplace with no competitor coming anywhere near those numbers. By now Mercari gets over 1 million new listings a day with cumulatively listings of over 1,5 billion since the founding of the company.   

Besides its dominant core C2C marketplace business in Japan, Mercari also has a more nascent C2C business in the US and a payments business in Japan (both of which I will cover later). These businesses can be seen as kind of cherries on top. They offer a potentially large but uncertain payoff. However, the great thing about the situation is that if they don’t work out, we can still have a delicious cake which in itself more than justifies the current market price.

Some thoughts on Mercari Japan (JP)

Mercari JP quickly became far larger than any other competitor in its category in Japan. A glance on Google Trends drives this point home with Mercari shown in blue. Competitor Rakuma in red, Fril in yellow and Yahoo Auctions in green.  

Fril is effectively gone as a competitor after it merged with the Rakuten owned Rakuma in 2018. Yahoo Auctions is competing with Mercari but offers a poor value proposition for the core Mercari customer base. An auction-based selling system introduces friction and stress into a marketplace that is really only beneficial for sellers of rare/unique goods and collectables who want to maximise prices. That is not the job Mercari excels at and the reason the great majority of its users frequent it for. Mercari is primarily used by non-professional sellers who want to get a quick hassle-free sale of their used unwanted goods/possessions for what they consider to be fair but not necessarily the best prices. Buyers on the other hand are primarily looking for cheap alternatives to new goods. They are into the bargain hunt for economic or psychological reasons. Yahoo Auctions also offers a fixed priced C2C marketplace, but it is dwarfed by Mercari’s size. Rakuma tries to compete with Mercari more directly, but without much success despite zero fees for a long time and still much lower fees today with a 3,5% commission rate vs. Mercari’s 10% commission rate.

Mercari has a very good foothold in the Japanese digital online commerce and app space overall. The app primarily ranks among the top 5 shopping apps and is regularly one of the top 3 and at times hitting the top spot.

Mercari JP also enjoys very strong engagement numbers. The company shared some interesting statistics with the market around the time of their IPO (2018). Below are what I consider to be the two most interesting slides. Here is a link to the slide deck and here one to their recent Factbook deck. 

On average Mercari’s users spend over 5 hours per month on its app which is more than twice the amount of time vs. comps and best in class in e-commerce in Japan. The time spent on Mercaris app is even more impressive in the context of the Japanese entertainment and social app engagement.  

Mercari also has a strong DAU/MAU ratio of over 40% with users viewing over 23 goods a day - no wonder goods are quickly sold on Mercari. Lots of people are opening the app daily to see if there is something new to buy. The average user also spends over $30 a month. 

Mercari JP is very dominant in its category and we think it is reasonable to assume ongoing dominance. A used goods C2C marketplace business like Mercari’s, benefits tremendously from network effects given that both sides of the marketplace want maximum reach on the other side of the network. Once there is an established leader, the barriers to entry for competing businesses become very high - the new entrants are faced with a classic chicken & egg dilemma. On the seller side, the usually non-professional sellers have very low incentives to put in the effort to list their unique offers on a second/third platform with very little buyer traffic/liquidity. Especially if they experience decent liquidity/sell trough on the leading platform and the platform is not too greedy. This leads to no/low inventory on other competing marketplaces. Buyers on the hand won’t frequent the platform due to the low chances of finding something worth buying there, providing no liquidity for sellers. This dynamic offers the scaled leader a massive advantage over its competitors.

This dynamic on marketplaces is likely most pronounced if the sellers are non-professionals since professionals will put in a lot more effort to diversify their channels and potentially list their goods on smaller competing upcoming marketplaces. This leads us to the conclusion that Mercari with its focus on private sellers enjoys above-average network effects in the marketplace-land and high chances of continuing dominance.   

More on Mercari’s model

Mercari handles the shipping of all goods for its customers and takes the money in escrow to reduce fraud and to protect buyers and sellers from bad actors. Buyer and seller remain anonymous throughout the whole process, but there is of course a rating system in place. The business is shipping only (no meet-ups) and only Mercari knows the identity of two parties with no personal information (including addresses) shared. Once there is a sale, Mercari creates a QR code for the seller which can be shown at a shipping station that creates the shipping label from the code. There are around 80’000 places in Japan from where Mercari goods can be shipped.

A shipping-only model excludes larger goods like furniture or cars from the marketplace but comes with many advantages for reasonably priced and sized shippable goods. There is a lot less time and stress involved with shipping vs. meetups. You don’t get any no-shows, wasted meetings, last-minute haggles or dealings with strangers in uncomfortable places. Another benefit of shipping is that it increases the available inventory/liquidity due to much lower geographical constraints than with meet-ups.

The shipping model also ensures that the platform gets their commission on every transaction since parties can’t bypass it. Leading to superior monetization vs. an ad-based model. This is way more tricky for meet-up-based transactions, leaving the best option to monetize it with upfront listing fees and ad-based paid traffic generation tools with less user-friendly implications. The listing fee discourages people to list items (especially with low sell-through) and the platform's desire to make money with ads goes against the goal of building the best recommendation engine to curate the app experience for each individual buyer. Usually, listings are simply pushed to the back catalogue over time and the seller needs to pay to stay on top/relevant.    

Mercari has come up with lots of features to make it as easy as possible for both buyers and sellers to do business on its platform. Importantly Mercari has also discouraged power selling on its platform (for example by pushing sellers who offer the same item multiple times to the back catalogue) which immediately improves the selling experience of the average seller. The focus to enable average people to sell their unwanted stuff effortlessly seems very important to broaden the available inventory of (cheap) goods. 

Here are a few of the features Mercari offers its sellers:

1. Stress-free, cheap, nationwide, convenient, anonymous shipping.  

There are over 80’000 outlets from where goods can be shipped, with up to 50% cheaper pricing compared to standard postage fees. Of the 80’000 outlets that accept goods for shipping, over 40’000 are convenience shops. Last year Mercari entered into a partnership with shop owners, that they also offer packaging materials, to increase the convenience for sellers. Which means that at an increasing number of outlets, sellers can now show up only with their sold goods and their smartphone to get the job done. There are also 6000 post offices with dedicated Mercari areas that offer free packaging materials to sellers. Mercari plans to add an additional 5000 unmanned self service shipping locations in the next couple of years to increase the convenience further. Mercari also introduced a delivery service for bulky items where someone picks up the goods for the seller at additional costs. The latest new idea on the shipping front is a feature called “At-your-service-shipping” where the seller can immediately upon listing an item ship it to a warehouse where it is stored until it is sold. This service is certainly not for every occasion but comes in handy in situations where you want to make room/get rid of goods quickly (like when moving). 

2. Hassle-free, quick, mobile-first, AI-assisted listing of goods at no cost. 

The listing of an item can be done very quickly. It starts with hitting the list button in the app, that prompts you to take a photo. From there Mercari takes a lot of work off the seller's shoulders. They have developed an AI-based service that automatically fills in the details based on the photo/multiple photos you take of the item. There is a very high likelihood that the algorithm recognises the item and fills in all, or part of the listing name, product description, and product categories (including sub-categories), product condition. For a growing list of things like books, CDs, DVDs, some cosmetics, smartphones you can also list the item by barcode which automates even more of the work. Besides doing the work to specify the item properly you have to come up with a price for the product, which can be a bit of a challenge due to a lack of most of the necessary information to properly price your item. However, Mercari as the platform has that information and has developed a neat feature to help you solve the pricing question. The feature is called “will it sell” in its newest version. Again, with image recognition Mercari solves the question of what it is that you want to sell, it then takes all past sale prices of that particular item plus the currently listed ones and comes up with a suggested price plus a selling probability for you. Mercari also shows you price ranges of past and current similar items. The probability of the sale happening also takes the demand trends into account that Mercari observes and predicts. 

With cumulatively over 1,5 billion listed items on its marketplace, Mercari JP has already gained a lot of valuable data and is in a unique position to rapidly gather more valuable reselling data, that is not only useful for their own users but also for many manufacturers/brands. Mercari has a vision to share the data with them and to get an integration and/or compensation in return. The integration would mean that new sales information could be shared with Mercari. Which in turn could make reselling the item on Mercari later on a bliss. The integration would also enable Mercari to become a digital scorecard of personal possessions (at least in certain categories) and offer a sort of personal balance sheet with all the resell pricing data. Getting there is obviously a long stretch but some success in this area doesn’t seem unlikely given their strong position in Japan.

We think Mercari JP is in a position to double their user numbers over the next few years which provides the basis for at least a doubling of their GMV. We base this view mostly (but certainly not exclusively) on the company's belief to get to 35m MAUs in the next 3-5 years. The goal would translate into ~28% of the population using the platform on a monthly basis in some form (one glance on the app already puts you into the number). From the IPO presentation deck we know that a third of the MAU base buys something in a given month, and around half of the MAU base transacts at least once in the quarter. At their MAU goal that would mean ~9% and 14% of the population respectively. These numbers don't strike us as unreasonable given Mercaris high engagement and GMV mix that skews to relatively high purchase frequency goods like apparel. However to reach these goals the company will have to achieve a higher penetration in Japan’s older demographic. As becomes readily apparent by looking at the following chart. The positive side of that data is that the younger generations seem to be much more open towards buying used goods. 

Mercari started out with women apparel but quickly expanded to other categories. Today, apparel makes up ~40% (depending on the Q) of Mercaris GMV. Other popular categories are entertainment, toys, electronics, cosmetics and beauty followed by sports and leisure goods. There are also some bulky home goods (4%) or car and motorcycle parts or accessories (included in the 10-14% other) in the GMV mix. Two years ago, the japanese Ministry of Trade and Industry estimated the value of unwanted items at 7,6tn yen and the actual second hand market (offline and online) at 2,1tn yen (growing double digits). Importantly the estimate does not include automobiles and motorcycles. At 670bn yen on a ttm basis, Mercari quickly grew into this TAM, but we think is far from done with the best model to trade/get rid of unwanted goods. It has also developed a nice mouse trap to regularly lure users on its marketplace. Historically GMV growth was above user growth. We expect this trend to continue going forward and see GMV more than doubling with MAUs doubling.   

Another important trend we expect to continue for Mercari JP is gaining further operating leverage on the promotional/marketing costs. These costs consistently decreased over the years in percentage of revenue. The ratio went from 82% in FY2015 to 35% in FY2018 and 19% in the last FY2020. It is not hard to see more room for improvement here. Fortunately, there is further operating leverage to be gained beyond advertisement costs as the business continues to scale further. Therefore an operating margin of 50% doesn’t seem to be out of reach for Mercari JP. If they really pushed the profitability, more than 50% would probably work as well, but shouldn't be counted on. Mercari’s next midterm target is to achieve an operating margin above 40%.

Another margin lever worth discussing is the payment processing fee that can eat up to 15% of your revenue if your take rate is ~10% and payment is handled by a third-party payment processor (credit cards, competing wallets etc.). By convincing your users to use your own internal payment processor you have the opportunity to take this cost line down over time. Luckily Mercari is in a decent position to get their own payment service adapted by its users. 

Some thoughts on Merpay

Merpay is Mercari’s payment processing company. The service was launched in February 2019 and rapidly gained traction among Mercari users. By April 2019 1m users had already registered for the service. The number quickly doubled to 2m by June and per the last update in October, the service had already crossed 8m users. Merpay payments are accepted at 1,7m merchants in Japan and as of March 2020, the service crossed 20m monthly payments outside of Mercari’s marketplace. 

However, Merpay doesn’t want to go it all alone in the payment space. Payments is a game of scale and going against LinePay or PayPay is tough enough with a partner, given Mercari’s competitive positioning in payments. So, Mercari partnered up with NTT Docomo, Japan's largest mobile telco player. The two will integrate user accounts and share merchants. Docomo’s reward points from its d point club with 76m members also work on Mercaris Marketplace. The annual use of d points is around 200b yen. The partnership will keep the cash costs for merchant adoption down and the rewards program will help boost Mercari’s GMV. At least that is a goal of Mercari and likely a reasonable assumption with the right incentives.

Merpay recently launched their first product besides payment in the form of a buy now pay later program. There are certainly additional helpful features for users on the way but counting on Mercari to create a successful full fletched dominant wallet down the road is a stretch (we think). However, some success in driving down costs and boosting their own GMV with the service without burning a lot of money seem to be quite achievable. The developments on this front will be interesting to watch, just like it is to see what happens internationally.      

Some thoughts on Mercari US

Mercari launched in the US relatively quickly (less than 2 years) after the company had launched in Japan. The two businesses, however, developed quite differently. Up until more recently the US business seemed destined to fail among a more fierce competitive setup, and the not always well-understood differences between the countries. However, the situation flipped this year. Mercari’s more recently developed features, the gained awareness plus enough size lead to the business picking up quite some speed. Then the pandemic hit and pushed the business into hyper-growth mode. MAUs doubled to over 4m and growth in GMV in the last two quarters accelerated to +184% and +165% YoY to total GMV of 284m and 289m respectively. Cumulatively the app has been downloaded over 55m times and the platform sees over 350’000 new listings a day.

With an annual GMV of over 1,2b USD going forward, the US business is now on solid footing and we think very unlikely a long term money pit. The management team at the IPO believed they could get the US business to break even at a monthly GMV of 100m. A milestone that they have now hit. Recently, they have also implemented a price hike that brings Mercaris' take rate effectively to ~14% and more in line with peers. With the new take rate, the US business should do at least 150m in revenue going forward and help a lot in terms of profitability of this business unit. The strong recent US growth enabled Mercari also to turn profitable on a consolidated basis for the first time since going public.

The near term profitability in a business like this is generally not a big concern for us. As long as the money from the main cash cow is put to good use, we are fine. We had question marks. However, the worst case for the US business would now likely involve a sale of the business for an amount far above the invested money. A road we think the management team would take if needed. Luckily, it is likely not necessary to get rid of the business. 

and on its US competitors

There is a plethora of old and new comps, but Mercari is still quite unique in its position as a non-professional C2C general goods marketplace. Let's start with Poshmark, an important comp that is focused on apparel and almost entirely used by women only. The two companies are now practically neck to neck on a GMV level after Poshmark grew “only” +30% in 2020 to a ttm GMV of $1,3b per Q3. We are not big fans of Poshmark’s business model, for us there is too much unnecessary friction involved and going beyond apparel will be tough for them, at least that is what we think. Here is a useful link to understand the high efforts involved with the platform. 

Poshmark recently filed for IPO, which will be interesting to watch unfold. The initial price range puts the company's’ valuation around $3b (link), the company was valued at $1,25b sometime in 2019. The $3b are kind of crazy in comparison with Mercari, given that we think it is likely that Mercari will overtake Poshmark over time and that you get the whole company including the dominant Japanese business for an EV of less than $7b. I guess if Mercari would IPO again atm it would do so at least at twice its valuation. 

Besides Poshmark, Mercari also gathered momentum against other important competitors in the US, as the following two Google trend charts show. 

The Google trend charts obviously exclude Ebay, Fb Marketplace and Craigslist. Fb Marketplace is excluded because it is submerged in FBs main app and Ebay and Craigslist are excluded because looking at the other trends becomes meaningless if the two are included in the group. They are too dominant on the web vs. the others who are smaller and also primarily accessed via mobile apps.

Importantly, their search and overall dominance/size compared to the group doesn’t mean that they don't leave enough room for Mercari to build a decent US business. They left important gaps to fill for new comers. Ebay's Amazon envy has led it to become a suboptimal place for average people to sell their own stuff on their marketplace and for buyers to find those cheap unwanted goods. Ebay very clearly focuses on professional sellers and retailers and basically willfully neglects the market Mercari is focused on. Craigslist on the other hand just milks its old position super aggressively for as long as possible without spending anything on new features. Tellingly, their app usage already ranks far below peers even though they have such a strong position on the web. Nonetheless as a side note we find it kind of impressive that the company has achieved record revenue of over $1b with 90% net margins in 2018 - according to this article. Anyway, there is no real overlap with Mercari given Craigslist classified nature and verticals (primarily jobs followed by autos).

The following chart deck from JPM shows the impressive YoY growth that Mercari has achieved in the last year and provides usage numbers among a selected set of peers. 

Next on the list to mention are the other C2C marketplace competitors like TheRealReal, Tradesy, StockX and GOAT who are all focused on unwanted high value goods (luxury stuff, sneakers) that need to be authenticated for the C2C model to work. They as a group have a fine niche but very likely won't venture down towards the lower and general end of goods where most of Mercaris GMV comes from. They are in a position to reduce Mercari’s TAM but they are likely not a threat to replace Mercari as a general goods marketplace for used goods sold by average people like you and me.

TheRealReal is public, so it is easy to find information about it. Its GMV is ~$1b and more or less flat over the last 12 months, avg OAV is ~450$, the average take rate is 35% and the company is valued at ~$2b. StockX and GOAT are focused primarily on sneakers but are obviously about to expand to other pricey, fancy, rare stuff where the authentication model adds value. An authentication mechanism for a certain category/goods above a certain price point will likely be adopted by every successful marketplace where it makes sense. Mercari US launched one in the fall of 2019 for some goods and eBay recently launched a sneaker authentication program. 

For reference StockX was recently valued at $2,8b with a lifetime GMV of $2,5b (link). GOAT wasn’t funded too long ago either, with a price tag of $1,75b (link). Tradesy atm seems not likely to make it and hasn’t attracted new money since a while. Mercari US gained ground on all of them over the last two years. 

Finally, there is the remaining classifieds business group, OfferUp, LetGo and FB Marketplace. OfferUp swallowed LetGo in a merger last year. So the group is reduced down to two comps. As I already tried to point out at the beginning, the classified business (mostly meet-up based) is quite a different value proposition. The models are competing on the margins but one approach can’t replace the other, and there is little GMV overlap. The classified GMV is mostly bulky and impractical to ship and therefore also only available locally. On the other hand, over 90% of Mercaris GMV in the US is shipped across borders. We, therefore, think FB Marketplace is more of a threat to OfferUp’s business than to Mercari’s. Also, Mercari’s user base skews quite young vs. FB’s older user base. However, both platforms started to enable shipping and are not to be underestimated. We think the current user experience for shipped goods in both apps is less than optimal, but that can change. With shipping, there is also much more fraud and therefore more customer service involved that you as a platform can get right or screw up vs. running a classifieds operation. It remains to be seen how successful FB marketplace and OfferUp can be in combining both approaches. If it is done well there are obviously also advantages to be had.

Some final thoughts 

As already mentioned in the Mercari JP section we think GMV will more than double in the next 5 years. Given all the operating leverage inherent in the model along with the Merpay opportunity, we think that the operating margins will be at or above 50% at that point. Resulting in a growing earnings power of $0,5-0,6b that justifies an EV of $12,5-15b (a growing 4% yield in Japan) providing a 15% IRR from here. 

Depending on business execution, we believe Mercari US be worth anything from just a billion up to the current market cap in a few years. It would be a quite risky stand-alone bet to take, but we like the basically free option impeded in the Mercari mothership.

If the US goes well and needs less funding and attention Mercari will likely expand to other geographies creating more growth pillars down the road. I personally would love to see them trying their luck in more Asian countries. Maybe the resale markets are not ready in most ASEAN countries, but at least South Korea and Taiwan seem like worthy places for them to try their luck to become dominant.    

Catalyst

Mostly time and no catalyst but if pushed for one:

A growing awareness especially among US growth investors could increase the IRR quite a lot. A Catalyst could be the growing list of IPOs among Mercaris US peers 

If the business catches some of the market craziness that carries worse businesses like Jumia or Chewy, you name them to the sky, Mercari could easily double in little time.