Summary
- Shares of Upwork, already up nearly 30% this year, face substantial macro headwinds this year.
- The company has relied on enterprise growth to fuel its expansion, and sales cycles are elongating due to recessionary fears.
- Companies are slashing discretionary projects and delaying unnecessary expenses, which will hurt contract-based marketplaces like Upwork.
- Though cheap, Upwork may continue to suffer due to revenue deceleration and a recent slip in profits.
We've enjoyed the sharp rally in tech stocks since the start of the year, but we should all be careful to avoid the mentality that a rising tide lifts all boats. Stock selection remains utterly critical in this period, and we should be mindful to prune our portfolios for names that have run out of rebound juice.
Upwork ( UPWK ) is a stock I have recently changed my tune on. This remote/gig-based work marketplace has long been a great value stock, but in the wake of sharp macro headwinds this year, I think the stock's ~30% rebound since the start of January is already generous:
Though the longer-term outlook is still sound, Upwork will struggle under the weight of this year's recession
I have divested of my position in Upwork and am shifting to a neutral tone on the stock. I now view the company as a mixed bag of positives and negatives.
On the positive end for Upwork:
- Backdrop for freelancers has never been more optimal, and remote work will continue its upward trend. Upwork notes that 10 million Americans are currently considering leaving their jobs while half of "Generation Z" is also choosing to start off their careers as independent freelancers. Remote work also continues to be a dominant force in the workplace, with many large companies implementing hybrid policies while some abandon office requirements entirely.
- Enterprise push. Before the pandemic, Upwork was largely a "retail" site. Gig seekers would use the site to find small, one-time jobs. But more and more, Upwork is evolving into an enterprise platform. Companies as large as Microsoft (NASDAQ: MSFT ) have used the platform to drive their contract hires
The other big positive for Upwork is its valuation, which has plummeted dramatically since the prior summer. At current share prices just under $15, Upwork trades at a market cap of $1.81 billion. After we net off the $675.8 million of cash and $563.5 million of debt on the company's most recent balance sheet, Upwork's resulting enterprise value is $1.80 billion.
For the upcoming fiscal year FY23, meanwhile, Wall Street analysts have a consensus revenue target of $722.5 million for Upwork, representing 17% y/y growth. I think this target is aggressive, considering Upwork guided Q4 to a 15-17% y/y growth rate and hiring headwinds are likely to persist throughout 2023. Nevertheless, taking consensus at face value, Upwork trades at just 2.5x EV/FY23 revenue.
I'm afraid Upwork is now a value trap, however. I am incredibly concerned that in light of current macro conditions, many companies are zooming into opex and making rapid-fire decisions on which projects and priorities can be delayed or cut entirely. Upwork's contract-based jobs are highly likely to be axed.
At the same time, the company recently invested tremendous amounts into building up its sales team, particularly in the enterprise space. It has not yet announced any layoffs, but performance is likely to slip in the wake of tightening macro conditions - hurting overall profitability.
The bottom line here: I think there is more risk than opportunity for Upwork this year. Looking ahead longer term, I do continue to see secular tailwinds toward remote/contract-based work that Upwork, with its solid branding and enterprise presence, should be able to capitalize on. But with a healthy rebound already since the start of 2023, I'd take your profits here and run - there will be a chance later on this year, in my view, to pick up shares of Upwork at even lower prices.
Headwinds have already factored into recent results
Upwork will next report results on February 15 (where the company has guided to a deceleration of 15-17% y/y revenue growth, from Q3 results of 24% y/y growth) - but I don't think we need to wait until then to see how the current macro environment is impacting the company.
Upwork's biggest recent efforts have been around building up its enterprise sales team, which has driven a substantial chunk of the company's growth. And while enterprise is still growing tremendously for Upwork (up 41% y/y in Q3), sharp deceleration is starting to kick in. As shown below, enterprise revenue was virtually flat sequentially between Q2 and Q3:
Meanwhile, new enterprise client adds in Q3 clocked in at just 25, the lowest net-add count since the start of 2021 (and this is not even to mention the fact that Upwork invested dramatically into building out its enterprise sales team in 2022).
CEO Hayden Brown commented on the shift in marketplace dynamics on the Q3 earnings call :
To be sure, as we expected since our second quarter earnings, our customers are not fully immune to that uncertainty, evidenced by the softness we continue to see in some metrics. Nonetheless, revenue impact in the third quarter from these conditions was in-line with our previously shared expectations. We have seen the softer client acquisition and retention trends that we observed in the second quarter stabilized in the third quarter, with the softness continuing to be more pronounced in Europe and with small and medium sized businesses.
Our enterprise Land team also saw elongated sales cycles due to the macroeconomic outlook for a handful of accounts. This plus some operational Growing Pains resulted in fewer enterprise clients find in the third quarter than targeted. We are remedying the operational growing pains and believe the enterprise opportunity remains as attractive as ever for Upwork."
In my view, as companies continue to belt-tighten in 2023 in anticipation of continued softness in customer demand, Upwork will continue to see its marketplace business impacted.
There's one saving grace here: the company does continue to boost its take rates, up to a record 15.4% in Q3, 40bps higher sequentially and a 120bps improvement year-over-year, which will help soften the blow to revenue growth.
Still, Upwork does have holes in its profitability. In Q3, adjusted EBITDA swung to -$2.9 million, down from a profit of $8.2 million in the year-ago quarter. Q4 guidance points to adjusted EBITDA of -$1 million to -$3 million as well.
Losses here are driven by the company's expansion in its sales force. On a pro forma basis, sales and marketing expenses grew 44% y/y to $60.1 million, representing 38% of revenue - up from a 33% share in the year-ago Q3. In my view, this profit compression will be another big overhang on Upwork stock that will prevent it from rallying much higher.
Key takeaways
Already up nearly 30% this year, I see a great opportunity for investors to take profits (or cut losses, depending on when your entry point was) in Upwork. The going will only get rougher for the company as enterprises curtail their spending in expectation of a harsh macro reality in 2023.
For further details see:
Upwork: Stepping On The Brake Pedals In Light Of Macro Headwinds