Upwork: Disciplined Cost Reduction, Platform Improvements - Buy

seekingalpha11-22

I'm initiating Upwork with a buy, as I'm convinced by management's surgical approach to reducing costs while boosting profitability next year.The way I see it, Upwork has three things that'll work in ...

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Noctiluxx/E+ via Getty Images Upwork (NASDAQ:UPWK) reported its 3QFY24 earnings results and outlook this month, shooting the stock up ~12% in response. I’ve been a fan of the company for a while and am now initiating the stock with a buy. Management commentary and relatively conservative outlook this quarter lead me to believe Upwork is better positioned to outperform next year as it improves its profitability with high free cash flow and cost reductions, scales its reach with partnerships and membership programs, and continues enhancements to its platform with focused AI integrations.   YChartA cut of the pay - short context Upwork is an online marketplace where people can hire or be hired as freelancers for a wide range of tasks and projects. Its business model has four main income streams. Upwork’s major revenue source is transaction fees; for every payment made from client to freelancer, Upwork gets a cut of the pay. Connects are bought by freelancers and work as currency, enabling them to apply for projects. For an extra job post fee, clients can also boost the urgency and visibility of their projects. And, for those who want some extra perks, subscription plans are available for freelancers and clients alike, the most recent addition being the Business Plus plan, which should bring in more revenue and a host of new clients. The platform also offers Managed Services, where clients can have their projects handled (hiring, management, and quality control) for a more hands-off hiring and management process. All in all, Upwork offers a 360-degree service connecting clients and freelancers and is doing well to turn a profit on it, and its third-quarter results prove that. Despite macro headwinds weighing on Gross Services Volume (GSV), down 3.1% year-over-year and almost 1% quarter-over-quarter to $998 million in Q3, the company has continued in its two-year streak of beating estimates. For the quarter, Upwork reported revenue of $193.78 million, exceeding consensus by $9.78 million and growing 10% year-over-year. It also hit a record net income of $27.8 million this quarter, up 25% quarter-over-quarter and 70% year-over-year. To top it off, the company raised guidance for FY24 and is giving us a show of confidence with a second $100 million share repurchase program this year. So, what makes Upwork worth the buy? Three factors drive my buy call: improving profitability, scaling reach, and enhancing the platform. Improving profitability To start off, Upwork’s financials are looking good. Alongside their record net income, FCF for this quarter came in at $98 million, a 193% rise from last quarter’s $33.5 million. This big jump in FCF was helped by the weekly billing schedule, but even excluding this fortunate timing, FCF would still have seen double-digit growth year-over-year with $52 million (a 58% increase year-over-year). I expect this to carry into next year as management focuses on cost reduction more seriously under the banner of their $60 million cost savings initiative. Just this October, management shaved another 21% off its workforce and is guiding for a decline in expenses for the next quarter. This follows last year’s layoffs, during which Upwork cut 15% of its workforce. I also think the cost reduction doesn’t mean management is no longer investing but rather that they’re being more strategic about prioritization and efficiency. What’s more, there is a clear focus on margin expansion, with the goal of raising adjusted EBITDA margin to 35% in the next five years. Here’s how progress is looking so far: adjusted EBITDA margin guidance for Q4 is 22% (up 5% year-over-year and flat sequentially), and management expects a few points of EBITDA margin improvement in 2025. Scaling Reach In terms of reach, Upwork is capturing a wider customer base in two ways that make me excited about the stock: Their recent partnerships with Lettuce and Ocoya allow them to scale their reach beyond the company’s platform by showcasing Upwork’s talent to their partners’ clients. This is great because 1. it presents Upwork’s freelancers to clients in a more packaged way, and 2. it focuses on delivering work on an outcome basis rather than an hourly basis. I think these partnerships reflect that management is prioritizing the quality of the work done through or on the platform over the quantity of it. However, I’m keeping in mind that management is still experimenting with these partnerships, and they were careful not to get ahead of themselves in projecting the success of this initiative. If testing goes well, though, this borrowing model has the potential to expose them to thousands of new clients in these third-party ecosystems. An exciting new addition to Upwork’s platform, launched on October 16th, is the Business Plus membership program. While the platform already boasts a successful Enterprise membership option, Business Plus adds another entry point to the platform with more affordable pricing and a smoother buying plan, allowing them to extend their reach to many more businesses within their target audience. As management put it on the earnings call, “Business Plus further closes the gap between our current Marketplace and Enterprise offerings. We are already achieving solid traction via Business Plus, with hundreds of clients organically enrolling in the new plan since its launch.” Even better, since it’s a more self-serve type of service than Enterprise, Business Plus also reduces cost of acquisition and cost of service. Platform enhancements – surgically enhancing their ecosystem As for platform enhancements, I’m seeing a lot of attention placed on optimizing Upwork’s already-existing features, prioritizing their users, and raising the quality of their offerings, which I expect will translate to better top-line growth. I’ll cover their AI acquisition and general system improvements. Upwork has been successfully accelerating its AI strategy primarily through acquisitions, namely Headroom in 2021 and Objective AI in the upcoming months – all working alongside and improving their own AI, Uma. This is a good indicator that they are focusing funds and channeling investment on AI, which is optimizing search-and-match functionalities between clients and freelancers, helping clients manage projects and hire more easily, and assisting freelancers in tasks such as writing, coding, drafting proposals, and much more. The numbers are speaking for themselves so far: GSV is up 36% year-over-year from AI-related work, freelancers doing AI-related work are out-earning those doing non-AI-related work by 41%, and job post creation is now 73% faster with the help of the Uma-enabled job post generator. Together with investments in AI, management seems to be placing all their focus on “surgically enhancing the entire [Upwork] ecosystem.” Management predicts “more measured take rate expansion” as they no longer optimize for it, focusing their attention instead on up-leveling their existing features. For now, the key driver of take rates will be the services available for freelancers to promote their offerings: boosted profiles, boosted proposals, connect purchases, and the Freelancer Plus membership. For those of you who don’t know, the take rate is the percentage that Upwork takes from a transaction (aka their transaction fees). GSV remains a point of concern, but not for long As I mentioned in the earnings recap, GSV is declining quarter-over-quarter and year-over-year. The gross services volume, or GSV, is an important success marker for Upwork, representing the dollar value transacted through the platform. It’s mainly composed of client spend – the amount spent on both marketplace offerings and managed services offerings – as well as additional fees for value-added services. That number has been declining year-over-year; in this highly uncertain economic climate, price points are dropping, and businesses are cutting spending and self-sourcing their projects. This fall in GSV is not necessarily all-bad, though. Considering Upwork’s strategic focus on higher-quality clients and freelancers, a declining GSV in the short term could be signifying fewer, larger contracts (lower take rate) rather than more frequent quick-turnaround jobs that pay less. This falls in line with Upwork’s general emphasis on keeping high-quality standards and encouraging relationship-building between clients and freelancers. Valuation: Upwork has a market cap of $2 billion and an enterprise value of $1.77 billion. The stock price has fluctuated between a 52-week-low of $8.42 and a 52-week-high of $17.79. The market sentiment is positive on the stock, and over 18% of Street Analysts give the stock a strong buy, over 54% give it a buy, and the rest are a hold, according to data from Refinitiv. The price targets for Upwork have also been revised up with the median price target going from $14 in August, September and October to $18 this month, November. The mean saw a similar although not identical trend, going from $14.09 in August and September to $13.91 in October before going up to $17.64. What’s Next?  A big part of why I’m optimistic about Upwork is my belief that the stock has a lot of unrealized potential, particularly given management’s conservative guidance for Q4. Upwork’s guidance is between $178 million and $183 million on revenue, with a $180.5 million midpoint slightly missing on consensus of $181.17 million and between $0.24 and $0.26 on EPS, with the high point in line with consensus. For FY24, management is also more or less in line with estimates, forecasting revenue of $756 million to $761 million and an EPS of $1.00 to $1.02 versus consensus of $759 million and $1.02, respectively. Though they’re guiding cautiously, these strategic shifts in focus towards optimizing their platform and offerings – while still minding their budget and maintaining a clear objective for margin expansion – bodes well for Upwork in Q4 of 2024 and in FY25.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"1","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2485047401"}