Description

Pair Trade: Short: Fiverr International Ltd. (NYSE: FVRR); Long Upwork Inc. (NYSE: UPWK)

Summary

Despite Fiverr equity having declined ~80% on an LTM basis, we believe the business is at a critical inflection point that will cause the stock to decline a further 30-70% over the next 6-12 months (see FVRR Valuation table below for valuation view). If you are like us and constructive on the long-term potential of the outsourced remote work space broadly, we recommend the pair trade of long UPWK and short FVRR to better isolate the SG&A investment dynamic that is central to our investment view. 

While FVRR bulls point to a large TAM creating top line significant growth runway, take rate expansion opportunity, and operating leverage potential, bears have pointed out the large gaps between FVRR take rate and UPWK take rate. The story has become largely focused on future top-line for both Bulls/Bears, but we think both sides are missing key differences in likely medium term margin structures. 

While the take rate inflection is a very real concern, we believe the market continues to misunderstand Fiverr’s future SG&A needs in an assumed steady-state scenario. As the Company builds out “Fiverr Business,” significant investments in SG&A will be required – we believe this dynamic is not being incorporated into Street models. As a result, consensus has incorrectly extrapolated out the current SG&A leverage onto LT targets for FVRR without taking into consideration the implied efficiency required by the Fiverr team. Conversely, UPWK has already taken the pain of investing in a fully deployed sales force and we believe margins will inflect up over the next 36 months.

While valuation looks similar on both EV/Revenue and EV/GP, this perspective misses what is really going on under the hood. Investors should be focused on incremental drop through the bottom line - we believe the story is really about SG&A leverage over the medium term. We see this as timely due to heightened investor interest in understanding true margin structures and 

Because there have been quite a few write-ups of FVRR and UPWK, we will not revisit the details of the business and market backdrop. Instead, we will highlight specifically where we think we have a variant perception.

For more detailed background on the two businesses, we highlight recent write-ups on Fiverr by swag95 (on 4/17/22) and nathanj (9/27/19) and Upwork write-ups by SanQuinn (on 3/11/22) and Bluefisher (on 5/14/21). In the appendix, we included high-level summary snippets from our internal 2019 investment memo.

Happy to dive deeper in the comments.

Variant View

We expect Fiverr management to significantly guide-up required SG&A investment in the business over the next 6-12 months. This will be driven primarily by management’s push to move up-market with the Fiverr Business platform. 

In the upside case for FVRR, the incremental Spend/Buyer for new Active Buyers is going to need to be >$900 to get to our bull case. We don’t believe management will be able to source these active buyers for the required incremental SG&A street/bulls are projecting. They have pointed to the Q4 investor letter, where FVRR management called out how their biggest spenders were the fastest growing segment. However, that is on an extremely small base and is relatively insignificant to the bottom line as shown by moderate growth in Spend/Buyer over the LTM.

As we reverse engineer the bull case for FVRR, we are skeptical of the implied CAC to get to their LT target. UPWK has shown the necessary CAC for larger accounts to be many multiples of what is being underwritten. 

Our expectations are that FVRR will realize they are not acquiring the right customers with what to date has proven to be highly efficient marketing platform, and instead will have to build out a sales force, similar to Upwork. If this is the case, we believe FVRR’s CAC will either grow precipitously, or FVRR will back off their top-line growth targets. We believe they will have a choice between top-line growth, or margin preservation.

While the immediate push-back we receive boils down to a view that the customer mix is very different between UPWK and FVRR, we would point out that the customer mix of FVRR has not changed meaningfully since becoming public. This highlights the dependence of their growth on highly efficient marketing spend. Unfortunately, that cannot be the path forward if they want to target >$900 Spend/Buyer. UPWK has already made significant mistakes in their growth journey and have realized the complexity of bringing on larger accounts. This comes down to execution. It is very difficult to extrapolate out SaaS economics without recognizing the execution risk. This is especially highlighted as we evaluate the required customer acquisition strategy for a large customer and the differences vs. customer acquisition of gig buyers.

Source: Refinitiv; Internal Estimates

Valuation

On Fiverr’s current 2024 street estimates, at a 25x EV/EBITDA multiple, the stock should be roughly flat at ~$58/sh. However, we see the Street estimates as too aggressive given our view on the required SG&A investment to achieve the future-state growth guided by management. 

Our base case assumes FVRR hit their targeted Active Buyer number of 6.4M, but Spend/Buyer doesn’t quite double. We still assume the take rate at 30%, but expect the CAC begins to step up as S&M efficiency declines due to the impact on the cost base of a dedicated sales force to support the Fiverr Business product.

In the bull case, we assume FVRR hit’s their targets while in the bear case, we see Spend/Buyer growth in-line with their historical performance, while S&M steps up to drive the active buyer growth. We think there is a greater than 50/50 risk that instead of achieving Take Rate expansion to 30%, their Take Rate begins to converge with UPWK and margins decline more precipitously. 

Source: Internal Estimates

On UPWK, we believe the cost base is now in a place where the business can start to show meaningful operating leverage. The bet on growth is now primarily a bet on management’s execution. Incremental S&M is focused on the enterprise segment and developing the internal capabilities to support sticky customers over the long term. We believe CEO Hayden Brown has good ideas, and understands the critical levers in the business well enough to deliver. It is worth noting that Hayden is incentivized with a significant piece of equity if the share price can get to and remain >$60/sh.

On the long-term-target unit economics, we believe you can buy UPWK at ~10x EV/EBITDA which we see as an appealing call-option on the growth of remote work.

While the FVRR short idea could be taken entirely in isolation, there is potential upside to pairing it with UPWK as the marketplace continues to accelerate in a post-COVID world. 

Source: Internal Estimates

Risks

• FVRR demonstrating product/market fit with Fiverr Business at low CAC levels

• FVRR management remaining patient on top-line growth and focusing on operating leverage despite a top-line slow-down

• FVRR winning the battle in organic marketing

• UPWK management not being aligned with shareholders and beginning to pursue low ROIC projects to drive their 20% top-line targets

• UPWK SBC accelerating and material dilution on a per share basis for existing shareholders

Appendix: Snippets from our internal 2019 UPWK investment memo

Upwork, the largest online marketplace for freelancers, has the potential to appreciate more than 10x over the next decade. The need for flexible talent at lower prices has never been greater. The opportunity to transform how companies think about their workforce is large and underestimated. Upwork’s value proposition is uniquely positioned to facilitate this increasing secular trend. The company is in the early innings of entering a new stage of incremental growth, where they have identified their core market, established product-market fit and will begin recognizing significant operating leverage as they transition to a core enterprise service business. They benefit from having the economic characteristics of a SAAS business, with the network effects of a marketplace. In our opinion, Upwork intentionally under-earns relative to the value created for customers, exhibiting robustness in the economic value of the model, and masking the true long-term profitability of the business. Management understands the levers of value creation and are beginning to execute. 

Several reasons have led to this compelling opportunity at an attractive valuation: (1) difficulty for investors in understanding the product-market fit of the business, (2) slower than expected migration of F500 companies to mobilize their workforce, (3) under-appreciation of the scale economies shared model of the business, (4) executional misses plus distraction from the previous CEO and (5) significant forced selling of the early-stage VC investors over the last year. 

Upwork is the leading marketplace for connecting highly-skilled talent (freelancers) with businesses across the globe in a growing ~$1 trillion industry of remote work, agency projects and staffing. Each year, Upwork facilitates over 2 million projects across 180 countries in more than 70 categories generating $2.1 billion of Gross Sales Volume (GSV). Upwork’s platform reduces friction for businesses through connecting talent with outstanding projects and enables freelancers to easily assess how they can productively utilize their skills in a global workplace. The business takes a tolling fee from transactions on the platform that consists primarily of a percentage of GSV and enterprise subscription fees. 

At its core, Upwork is incentivized to be at the center of enterprise customer’s talent needs to reduce the struggle that businesses have in retaining highly-skilled talent at attractive rates, while increasing productivity per dollar spent. In our opinion, the global marketplace is moving rapidly towards commoditizing high-skill talent and viewing it as a variable labor expense. Freelancing and remote work will accelerate large companies’ ability to have higher discretion over their labor spend with increased output. 

Upwork is positioning itself as a toll-booth in a growing online-talent industry that is under-penetrated by existing solutions. In both a top-down and bottom’s up valuation, we believe Upwork to be significantly discounted to it’s true earnings potential

1. The opportunity to transform how companies think about talent is large and underestimated

There is a large, underpenetrated opportunity in deploying remote work solutions to both SMB’s and enterprise customers globally. Currently, the primary solutions to find and recruit flexible talent, or freelancers, are through traditional staffing agencies, word-of-mouth, local knowledge, job-board postings or and online marketplaces. Upwork estimates this market size to be $560 billion globally. We believe the true market size of flexible talent over time can be greater than ~$1 trillion through adding both (i) agency projects and (ii) staffing adjacencies. Historically, Agencies (both creative and other) have had significant scale advantages over smaller, less established firms. This scale has been disrupted by the rise of ecommerce and digital advertising solutions, creating a path for smaller, niche solutions that are customized to an end-market. The internet created a long tail in boutique agency work and opportunities for independent creatives. Upwork was finding that their freelancer platform created the perfect breeding-ground for creatives and engineers to collaborate on larger and more complex projects (Footnote 1). This is on-top of the existing agencies that used the platform to supplement their existing work pipeline. Recently they unveiled an “Agency” product to enable independent freelancers to collaborate and, as a result, opening the door to higher quality-of-work efforts delivered through the marketplace at significant cost-savings, for customers, to established agencies. As a result of the vast number of freelancers that have used Upwork, they also expect to benefit from natural temp-to-hire opportunities that evolve over time. 

The online freelancer market can be broken into three specific sub-markets, the low-end gig market, the SMB market for contract work and the enterprise marketplace that entails large contract workforce strategies (i.e. Genpact). To detail them further, (i) the lower-end, high volume marketplace of small, “gig” related projects that can average from $5-$150/project and are short duration; (ii) SMB projects typically go for $150-$1000/project that can last as short as a few days to as long as a few weeks and generally include basic, “high-skill” transfer that an SMB cannot afford to employ full time. Think computer programming or digital marketer; (iii) the largest marketplace is going to be the enterprise marketplace, where you have F500 teams who utilize contractors, or have a procurement team bidding on contract rates. Options for these types of contracts include either long-term fixed contracts (i.e. Genpact), where F500’s are in long-term agreements, or can fit inside a variable cost structure where an HR team would work with a staffing option. 

Freelancing perception is shifting from being viewed as the lower-end sub-market, to a comprehensive talent solution to reduce the fixed cost structure of a business. Particularly in large enterprise businesses that desire greater control over the cost structure. We see Upwork as being perfectly positioned to provide that solution. 

2. Upwork is in the early innings of true product-market fit

We were encouraged by the FY19 earnings call, where newly appointed CEO Hayden Brown specifically clarified the strategy of the business as (i) attracting bigger enterprise clients, (ii) higher spend per client (iii) more unique, complex engagements between freelancers and client. This clearly summarizes where the business is moving and the product-market fit that can be achieved through the platform. 

Source: Internal research; Upwork filings

1. Brian Kinion, Upwork CFO, described this phenomenon at the Deutsche Bank Conference on 9/10/19 saying, “The freelancers will start as an individual freelancer, and then they'll build a business, right? And they'll start to say, "Look, I'm getting more complex projects as a result of working as a freelancer, but I can't do it all." Or I need something -- A, B, C and D, and I only know how to do A, but I'll go get somebody who can do B, C and D. And then they'll build this team, and they'll start to deliver. And they just start to build an agency business as a result of that. So, it's been a successful journey for those people. And we spent some time building some product features for them to able to do that.”

Catalyst

• FVRR Mgmt guiding down operating leverage as incremental SG&A investment required
• FVRR take-rate compression
• UPWK acceleration in enterprise and normalization of SG&A to get true sense of margin structure