UPWK - Upwork: Resilient Performance And Positive Secular Trend

2023-09-27 11:14:04 ET

Summary

• Upwork's business model is resilient and sustainable, with potential for strong growth in the future.
• The company has achieved profitability after six quarters of negative adjusted EBITDA.
• UPWK's partnership with OpenAI positions it well in the competitive AI talent market.

Summary

I am recommending a buy rating for Upwork ( UPWK ), as I believe the trend for freelancing to be sustainable and will be a part of employers hiring strategies in the future. The recent quarter has shown that the UPWK business model is resilient despite a weak macro environment. Should the macro environment recover, I expect growth to be better than this. Importantly, the business has turned profitable after six quarters of negative adjusted EBITDA.

Business

UPWK operates a platform where freelancers can engage in the labor market by undertaking spontaneous projects listed by various parties. It stands as one of the world's most extensive work marketplaces, facilitating connections between businesses and independent professionals on a global scale. UPWK caters to a broad spectrum of clientele, spanning from solo entrepreneurs to large corporate entities. As of the second quarter of 2023, UPWK boasts a client base exceeding 800,000 and has facilitated a cumulative gross service volume that slightly surpasses the $1 billion mark. The company's resilience shines through in its track record, showcasing substantial growth in the total number of active clients, which has expanded from 524,000 to the present 822,000 over the past few years.

Financials / Valuation

Revenue for the most recent quarter came in at $168.6 million, exceeding the company's own projections of $161 million to $164 million, and adj EBITDA was $14.4 million, far exceeding management guidance of $0 to $2 million. The quarter performance was remarkable on both fronts. When extrapolated to an annual rate, 2Q23's revenue suggests a run rate of $674 million for UPWK, demonstrating the company's ability to sustain growth over time. The EBITDA performance was even more impressive, setting a new record for the year. Compared to the previous six quarters, this is a major turning point as UPWK continues its upward trajectory toward greater profitability.

Based on my view of the business, UPWK should be able to grow revenue by 9% in FY23 (annualized using 2Q23 revenue) and slowly improve its growth rate back to 15% in FY25. As UPWK has a large revenue base today, I expect the growth to be slower than its historical growth rate of 20+%. This 15% is also in line with industry growth . As such, I expect UPWK to continue trading at a premium to peers (such as Fiverr International, PageGroup, Adecco Group, Randstad, and Hays), as I expect it to grow faster. I also note that UPWK is on track to accelerate its EBITDA growth profile as its margin continues to expand. I see this as a catalyst that will further support the valuation premium. Valued at 1.9x forward revenue, I expect the stock to trade at $13.40, a 19% upside.

Comments

UPWK should continue to see resilience and sustainable growth, especially as the macroeconomic situation gradually turns for the better. Management noted in their most recent call that Enterprise business was following the same patterns seen in 1Q23, with customers remaining cautious due to macro uncertainty. I take this positively, as it suggests that the macro environment was stable through the months and did not deteriorate. Despite this, progress is still positive and on the upswing. In addition, SMBs' confidence in macroeconomic conditions has increased, indicating resilience in the marketplace business (which is a larger part of UPWK business). Notably, the trend of the labor market shifting towards freelancing continues, with businesses recognizing the importance of developing talent strategies centered around freelance professionals.

With regards to the enterprise business, I think the Open AI partnership opens up a promising new channel that can increase demand and supply for businesses seeking AI expertise and talent. In particular, UPWK's partnership with OpenAI should help the company gain ground in the competitive market for AI talent. Not only does UPWK benefit from being in a better position to fill the needs of AI-freelancer demand, but it also benefits from increased demand from OpenAI (as an employer), as OpenAI is using UPWK's platform to hire and manage employees for their own company. In my opinion, this is promising evidence that, once the macroeconomic environment improves, UPWK will be in a much better position to take advantage of enterprise demand for AI talents.

Finally, I'd like to say that I think generative AI is ultimately beneficial for UPWK. Since AI is still a relatively new field, I believe the number of qualified individuals who can assist with all stages (from planning to implementation to maintenance) of an AI function in an organization is small. Even if they do, they are likely to be concentrated in regions with more developed generative AI education and technology. As a result of these factors, the UPWK platform becomes more valuable because it provides more people with easy access to the AI specialists who can promote the widespread adoption of generative AI technology within their own companies. The latest call provided further evidence of rising demand, with management noting a 10-fold increase in generative AI-related posts and a 15-fold increase in corresponding searches compared to 4Q22.

“In fact, generative AI job posts on our platform were up more than 10X, while related searches were up more than 15X when comparing the second quarter of 2023 to the fourth quarter of 2022.”

In my opinion, UPWK is best understood over the long term, when the macro environment stabilizes. It's important to keep in mind that UPWK is targeting a massive TAM that's seeing a secular uptrend in the number of workers interested in adopting hybrid workforces, especially in emerging fields like artificial intelligence. Long-term growth should also be accompanied by improving profitability from here on (UPWK turned EBITDA profitable in 2Q23 with strength) as management focuses on optimizing cost structure, account salesforce, and marketing spend. Overall, I have high hopes for UPWK's future and am giving the stock a buy recommendation.

Throughout the quarter, we identified and implemented supplemental cost savings measures, including an additional reduction of brand marketing investments, de-prioritization of lower return on investment vendor expenses and consulting projects, and reassessment of hiring plans to focus on our most important strategic initiatives.

In the second quarter, we implemented changes to our sales team and strategy, generating improved productivity and increased revenue, while reducing staffing and expenses. Source: 2Q23 earnings

Risk & conclusion

The problem with hiring freelancers is that it is hard to provide quality assurance. As the platform gets larger, this problem scales exponentially. If the quality of freelancers on the platform deteriorates continuously, UPWK may be labeled with a bad reputation. In that situation, users might search for alternative platforms (like Fiverr).

In conclusion, I recommend a buy rating for UPWK based on the sustainable trend of freelancing in the job market and the company's demonstrated resilience. Despite a challenging macroeconomic environment, UPWK's business model has proven its durability. Should the macroeconomic situation improve, I anticipate even stronger growth prospects. Notably, UPWK has achieved profitability after six consecutive quarters of negative adjusted EBITDA. Additionally, the company's partnership with OpenAI enhances its competitiveness in the AI talent market.

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