Description

Overview: 

We believe Upwork equity is an attractive medium and long term investment from today's levels. As a result of the rotation out of COVID beneficiaries and high growth technology companies, as well as the tragic humanitarian crisis in Ukraine, investors today can buy the largest freelancing marketplace in terms of GSV at 5x trailing marketplace revenue, an attractive value for a high-quality two-sided marketplace business with strong underlying secular growth trends and a 20-25% revenue growth CAGR.

While Peter Lynch said never buy a stock based on how much it has fallen, I would be remiss not to point out that UPWK shares are down over 70% off of their 52 week high and have declined 43% YTD. Month to date in March, UPWK shares are down roughly 20% MTD as the company withdrew its Q122 and FY22 guidance due to the Russian invasion of Ukraine which I will discuss below.  

Upwork has been written up three times previously on VIC, once each year from 2019 through 2021, at $14, $17, and $38 respectively. Please refer to the latest write up by Bluefisher as it offers helpful background information that I will not repeat as the focus of this write up is on the current dislocations. I will point out however, that UPWK trades at a lower multiple now than it did at any of these past write ups and I believe the medium and long term growth prospects are just as good today even from today’s higher level of revenue than they were at the time of past write-ups. 

Dislocation: Impact from Russian Invasion of Ukraine: 

As I write this it feels callous to discuss the investment implications of an ongoing human tragedy.

While Upwork has “nearly” no client-side exposure to the region, Ukraine was a talent rich area for freelancing. Ukrainian freelancer activity levels dropped meaningfully following the Russian invasion on February 24th and on March 7th Upwork announced they will proactively suspend all business operations in Russia and Belarus in the coming months and management suspended their first quarter and full year 2022 financial guidance. 

While Upwork has almost no clients in the affected countries, freelancers in these countries were responsible for doing work that accounted for ~10% of Upwork's FY 2021 revenue, with Ukraine comprising 6% of revenue and Russia and Belarus contributing 4% combined. 

For Upwork, I believe the impact of the war is short term in nature as opposed to long term. I believe that because Upwork is not a “supply constrained” marketplace, ie there are many more freelancers than clients and supply is not a constraint on marketplace activity typically, that client spending will be re-allocated over time to new freelancers in unimpacted regions over time.

Unlike competitor Fiverr where typical project size is in the hundreds of dollars and very episodic and fast turn by nature the impact of a freelancer workforce disruption is theoretically a lot less because projects turnover very quickly and new demand can thus be allocated to available freelancers seamlessly. 

However, Upwork freelancers are often on long term ongoing projects so the velocity of projects that drives gross services volume (GSV) is lower and the freelancer/client relationships are stickier so the financial impact on Upwork is likely larger than Fiverr in the short run. Because of the longer-term nature of Upwork’s freelancer/client relationships this freelancer workforce loss is short term disruptive because it’s not frictionless for the client to transition work from one freelancer to another; it involves posting, interviewing, hiring and onboarding and its possible that not all clients will replace freelancers they lose one for one. However, I think it is likely that a significant majority of the work being done will be re-allocated to freelancers in new regions over time. 

My hypothesis is partially based on my experience as a customer of Upwork. Luckily none of our firm’s freelancers have been impacted. However, at least at my firm, the work that we have done on Upwork needs to be done and if we lose freelancers, we have a process to replace them. 

As a result, while some fraction of this 10% of revenue generation may be permanently lost, in my opinion most of it will be re-allocated in the coming quarters as the demand for talent remains despite the events taking place in Ukraine. 

While it is seemingly unlikely, it is still not impossible that there is some form of negotiated resolution of Russia's invasion that could reopen the region for freelancing activity. It is also possible that some of the Ukrainian freelancers will either leave Ukraine or resume some form of activity from within Ukraine but I do not count on any of these things happening. 

Dislocation: Status as COVID Beneficiary: 

Prior to COVID, freelancing was shifting from offline to online marketplaces, driving growth for Upwork and peer Fiverr prior to 2020. However, Covid increased companies’ awareness and willingness to engage in remote work which previously had been a barrier to larger scale adoption of freelancers who are typically remote. As a result Upwork's growth accellerated particularly in 2021 with growth peaking in Q2'2021 at ~42%.

While COVIDs benefit to some companies like Peloton may have been truly 1x in nature, because only so many people will want to spend exorbitantly on an exercise bike and once those bikes are bought it's hard to grow, in the case of Upwork, I believe that even as companies migrate their workforces back into the office post covid, the learnings and cultural willingness to work in hybrid remote environments will remain. 

While admittedly growth levels were decelerating for Upwork even prior to the Ukrainian impact due to lapping of COVID benefits, Mgmt was projecting 2022 revenue growth of >25% and on their Q1’22 conference call in early February prior to the geopolitical events, they actually accelerated their timeline to reach their $1B revenue goal established at their analyst day in 2020 from 2025 back to 2024 which implied a 25% revenue CAGR through 2024. So sure it was decelerating from 2021’s peak higher than trend growth, but growth was stabilizing back at roughly Upwork’s pre-Covid growth rate, not dipping way below like many pure COVID beneficiaries have seen.  

Valuation: 

Revenue multiples are clearly out of style these days. At the risk of sounding valuation insensitive, 5x TTM Marketplace revenue seems attractive to me for a business that was expected to have a 25% three year revenue CAGR with expanding margins. 

Closest comp FVRR which I surmise is less impacted by the Ukrainian crisis, but which was expected to carry a similar 3 YR growth CAGR prior to the Ukrainian crisis at least, trades at 7.5x TTM revenue. To FVRR's credit they do have a positive EBITDA margin versus Upwork’s break even EBITDA margin, but Upwork has a significantly lower take rate due to the longer term nature of their freelance contracts and as a result I think they just need more scale to attain their target margins. 

At Upwork’s June 2021 analyst day, management outlined a path to 30-35% EBITDA margins in 2025 at $1B in revenue scale. 

Management recently brought that revenue target forward to 2024, but I will assume this occurs in 2025 given that the 2022 guide was withdrawn due to the Ukraine situation. If management is able to hit their guidance you are paying 7.5x 2025 EBITDA. Sure there is a lot of execution risk and that is a long way away so maybe that doesnt exactly get the traditional value guys excited. Maybe management doesnt quite get there on the margin side and you are paying more, but either way I think there is a long growth runway here so I think today’s valuation can produce an attractive IRR even if margins dont reach 30% in 2025.  

Risks: 

Takes longer than expected for customers to shift spend outside of Ukraine/Russia and revenue is permanently lost. 

If Linkedin were to really gain traction that might pose a risk given they have the means to create network effects. That said, Microsoft has been a frenemy for a while now and I think it's more likely that Microsoft buys Upwork than successfully outcompetes them; however this is a thesis risk worth monitoring. 

Continued high inflation further impacts valuations for growth technology stocks valued at multiples of revenue. 

Conclusion: 

Despite short term headwinds, I am optimistic about the sustainability of UPWK’s growth and believe the business is on a path to becoming structurally profitable, generating over $1B in annual revenue with gross margins in the mid 70% range and highly attractive EBITDA margins within the next 3-4. 

Some concluding bullet points we view UPWK as an attractive investment:

• UPWK is a high quality business that has a strong competitive position due to the network effect of being a two sided marketplace, a strong secular growth tailwind and high gross margins and the potential for high EBITDA and free cash flow margins in the future. 

• Freelancing and remote work are trends that will continue to see adoption by new businesses and existing businesses will increase their spend toward freelancers.

• UPWK is embarking on a strategy focused on enterprise clients which we believe will be accretive to revenue growth and profitability. 

• Current valuation is undemanding on an absolute basis and relative basis when compared to peer Fiverr (FVRR). 

Disclaimer: 

This write-up contains certain opinions of the author as of the date written. Before investing, do your own work. The author or his employer may or may not hold positions in the Security noted in this article. These parties may trade at any time, without notification to this community, and will not disclose this information to this community. The author and his employer disclaim any liability for investment losses that you may incur under any circumstances.

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