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Upwork: A New Inflection Point

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Upwork: A New Inflection Point

May 15, 2020
Seeking Alpha
By Gary Alexander

Upwork shares have doubled since late March, owing to a rise in users and site traffic since the coronavirus began.

Rising unemployment has led many out-of-work job seekers to turn online.

Upwork isn't simply a freelance company; it has brand-name hiring partnerships with companies like Glassdoor.

Revenue growth has accelerated in the wake of the coronavirus, and Upwork's CEO notes that its site saw record visits in April.

Since I last wrote on remote job marketplace Upwork (UPWK) in late March, shares have more than doubled. Back when the market was at its nadir, investors were worried that Upwork's small market cap and niche appeal would render it too weak to survive the pandemic, and investors sold off Upwork like they did many other small-cap stocks. Yet the coronavirus has proven to be a blessing in disguise for Upwork, with the company recording huge volumes of traffic to its site and generating revenue acceleration. In my view, the vastly changed macroeconomic landscape - one that has confined many office workers to their homes, and left many more unfortunate workers without jobs and needing to resort to freelance work to pay the bills - has completely rewritten Upwork's growth trajectory.

Since Upwork's earnings report in early May, the shares have risen more than 50%, and though Upwork is now up year-to-date, the stock is still about 35% below all-time highs near $18 notched shortly after Upwork's IPO in late 2018. It's a good time for investors, in my view, to examine the momentum trade and review the bullish case for Upwork.

My earlier thesis that Upwork would benefit from increased site traffic throughout the pandemic (for which I used Google Trends search data at the time) has largely been confirmed by CEO Hayden Brown's appearance on CNBC this week. In the interview, Brown emphasized that some of the world's biggest employers have turned to Upwork during this critical time, saying:

Companies like Microsoft (NASDAQ:MSFT) come to us looking for talent that they can't find locally that we can supply through our platform, because we've got millions of workers all over the world who are skilled at remote work and are ready to get started."

As a further illustration of how Upwork has integrated itself into mainstream employers and isn't just a freelance site, other marquee corporate partners aside from Microsoft include General Electric (GE), GoDaddy (GDDY), and Automattic, the parent behind the Wordpress blog site. Upwork also partners with a wide slew of smaller businesses as well, and has been focused on remote work for twenty years. Since the coronavirus began, Brown noted that Upwork has been offering consulting to its various corporate customers on how to hire and maintain remote workforces, transforming its role and relationship to employers in the hiring market.

There's a lot to like about Upwork at this juncture - aside from its most recent traffic/revenue trends, Upwork also has strong cash balances and a consistent margin improvements and a low-cost business model that allows for impressive scalability. Plus there's the recent slew of insider buys since March that I detailed in my prior article. And despite the recent rally, Upwork is still cheap. At current share prices near $14, Upwork has a market cap of just $1.60 billion. After netting out the company's $145.3 million of cash and minor $31.3 million of debt on the balance sheet, its enterprise value is $1.49 billion.

For FY20, meanwhile, Wall Street analysts have a consensus revenue target of $336.0 million for Upwork, or +12% y/y (per Yahoo Finance). Considering Upwork's first-quarter 2020 revenue showed acceleration to 21% y/y growth, a 12% y/y growth rate for the full year is likely conservative especially when all signs point to the coronavirus being a tailwind for Upwork's growth. Regardless, even if we simply take this consensus revenue forecast, Upwork trades at a modest 4.4x EV/FY20 revenue. That's substantially below most other companies projected to grow in the ~20% range this year (a high single-digits multiple is more common among ~20% growth comps), especially when we consider the fact that Upwork is perfectly suited to the remote-work environment and is also generating gross margin expansion and free cash flow growth.

Stay long here and ride the upward momentum.

Let's now dig into Upwork's latest quarterly results in greater detail. The earnings summary is shown below:

Source: Upwork Q1 earnings release

Upwork's revenue grew 21% y/y to $83.2 million this quarter, substantially beating Wall Street's forecast of $80.0 million (+17% y/y), and perhaps even more impressively yet, seeing two points of acceleration in revenue growth versus Q4's 19% y/y growth rate - in a quarter when most companies have reported slowing growth.

For Upwork, of course, the coronavirus has been the exact opposite - a tailwind. Per CEO Brown's prepared remarks (key points highlighted) on the Q1 earnings call:

In early to mid-April, we began to surpass pre-crisis levels on numerous client activity metrics and momentum has continued to build. In the last week, for example, we broke our own records by a significant margin on leading indicators such as client registrations and new job posts. While it's still early in these trends, we are optimistic that these leading indicators of future spend will translate, as they typically do, into GSV and revenue. These signals indicate companies have shifted from the triage phase in March to a transition phase in April, as they are now focused on getting work done in new ways as they navigate the opportunities and constraints this crisis has created."

We have to acknowledge that there are still some risks on the horizon, however. Upwork does maintain a meaningful portion of its revenues from small and mid-sized employers, who have in recent times cut back on overall hiring and workforces in an attempt to preserve cash. Upwork has noted that these SMB clients' spend has decreased since March - although clearly, record-setting trends in visitors and job postings have been more than enough to offset higher churn from SMBs.

It's also useful to note that Upwork now has a plan to sustain >20% y/y revenue growth "in the years to come." Companies typically err on the conservative side when giving long-range targets, so the fact that Wall Street consensus only calls for 12% y/y growth this year and 14% y/y in FY21 leaves plenty of room for upside surprises.

Capitalizing on greater economies of scale, Upwork has also increased its gross profit margins this quarter too - up three points to 72% this quarter. This largely is a reflection of the fact that Upwork's "take rate" - or the percentage that it makes from a hiring transaction conducted on its platform - is up 80bps to 14.9% this quarter, from 14.1% in the prior-year Q1, driven by an increase in pricing and the rollout of paid client subscription plans.

Figure 2. Upwork gross margin trends

Upwork's focus on growth to capture market share during a time when the global workforce is focused on remote-work, however, has pushed the company into spending more on sales and marketing. Sales and marketing costs on a pro forma basis (that is, excluding stock comp) rose 50% y/y to $29.8 million, which also drove Upwork's pro forma operating margins down to -3%, versus breakeven in the year-ago quarter. Still, however, investors should be willing to sacrifice a few points of margin in the near-term to accelerate revenue growth and take full advantage of Upwork's recent surge in traffic. To offset some of this increase in marketing, Upwork has also cut travel & entertainment expenses (naturally, like most other companies with sales teams that are now grounded) and slowed down hiring and vendor spend.

In spite of slightly deteriorating operating margins, however, Upwork has still been able to deliver cash flow improvements. Q1 operating cash flows were virtually breakeven at -$1.7 million, versus a -$29.4 million cash burn in last year's Q1. Note, however, that on a full-year basis Upwork has been cash flow positive in each of the last two years; this OCF improvement in kicking off Q1 points to cash flow expansion in the year ahead. And with roughly $130 million in net cash on Upwork's balance sheet, we have no concerns on this company's ability to maintain a sufficient liquidity cushion.

Figure 3. Upwork cash flow trends

Key takeaways

Prior to the coronavirus, most investors regarded Upwork as a rather insignificant company filling an obscure niche for freelance workers. Now, however, remote work has moved into the mainstream - both for freelancers and large corporate employers. Upwork has seen encouraging trends, reporting acceleration in revenue on top of record-setting job postings and site traffic, and has a plan to sustain >20% y/y revenue growth over the next few years. Sitting at a valuation of just under 5x forward revenues despite its positive exposure to the pandemic and remote-work trends, I believe Upwork still has plenty of room to rise higher.

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