Upwork: Don't Expect Too Much From This Bull Run As Valuation Stretches Higher (Rating Downgrade)

seekingalpha04:41

Upwork's stock has surged to YTD highs after improving Q3 trends and raising its outlook, but I'm downgrading to neutral as its valuation multiples have rebounded.The stock isn't expensive yet at ~12x...

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Wall Street is expecting the company to slow to ~3% growth in FY25.   Morsa Images/DigitalVision via Getty Images The sharp rally in the stock market has breathed new life into stocks that previously were in the penalty box. Upwork (NASDAQ:UPWK), the freelance marketplace site, has been a major beneficiary after plunging post-Q2. After reducing its guidance substantially for the year in Q2, the company saw better trends in Q3 and raised its outlook again (though not as high as it was previously). The good mood from investors, however, has fueled Upwork's rally to YTD highs, providing a much-needed upward multiples correction from when Upwork was trading at deep bargain-basement levels. But the core question we have to ask ourselves now is: does Upwork really have enough fundamental fuel to keep its rally going? Data by YChartsI last wrote a bullish note on Upwork in August, when the stock was still trading just above $9 per share. At the time, I had argued that the company's selloff was overdone and that Upwork's value multiples were bound for a correction. Since then, I've enjoyed a ~70% gain on my position: but I'm not holding out much hope for a substantial continuation of Upwork's recent run. As such, I'm downgrading Upwork back down to a neutral stance. Valuation checkup against latest guidance My rating cut and decision to trim my position on Upwork is a call primarily based on valuation, so we'll start there. At current share prices near $16, Upwork trades at a market cap of $2.14 billion. After we net off the $601.2 million of cash and $357.5 million of debt on Upwork's balance sheet, the company's resulting enterprise value is $1.90 billion. For the current year (FY24), Upwork has raised its revenue guidance to $756-$761 million (+10% y/y growth) and $155-$159 million in adjusted EBITDA (21% midpoint margin), from a prior viewpoint of $735-$745 million in revenue (+7% y/y growth) and $140-$150 million in adjusted EBITDA (this outlook, meanwhile, was sharply dropped from Upwork's original guidance of 12-13% top line growth in FY24).   Upwork outlook (Upwork Q3 earnings deck)Meanwhile, for next fiscal year (FY25), Wall Street analysts are expecting Upwork to generate $779.3 million in revenue (+3% y/y). We note that Upwork recently announced a layoff of ~15% of its headcount that is expected to save $60 million in annual operating costs (more on this in the next section). If we give Upwork full credit for achieving these savings next year, it would translate to ~8 points of adjusted EBITDA margin expansion, and adjusted EBITDA has the potential to swing to ~29% next year (or $226 million in adjusted EBITDA, +44% y/y). This puts Upwork's valuation multiples at:   Revenue: 2.5x EV/FY24 revenue, 2.4x EV/FY25 revenue  Adjusted EBITDA: 12.1x EV/FY24 adjusted EBITDA, 8.4x EV/FY25 adjusted EBITDA  A balanced bull and bear case considering Upwork's current multiples Upwork isn't exactly expensive; in fact, if the company truly is able to deliver its promised savings next year without meaningfully increasing hiring, a single-digit adjusted EBITDA multiple looks cheap against the broader market. That being said, I'm concerned on several fundamental points:   Will spend slow down in a tough macro environment? Despite Upwork's enterprise push, the company still generates plenty of business from SMB customers which may trim their spend if U.S. macro conditions continue to tighten.  How long will Upwork be able to stave off the threat of AI? I continue to view AI as an existential threat for Upwork. Despite the company now citing double-digit growth in AI-related tasks such as model training and AI software integration, in the long run I believe automation will rob Upwork of many of its basic functions (jobs such as copyediting, language translation, or website and logo design).  These risks, meanwhile, are still balanced against a number of positives that support the bull case for the company:   Rising take rates and monetization - The company has not only boosted its pricing but it's also focused on tertiary revenue opportunities such as signing up high-volume freelancers for a premium subscription product and offering Boosted Listings and Boosted Proposals to increase their visibility, for free.  Active client growth - Despite pricing increases, Upwork has continued to gain active clients, which indicates that the Upwork marketplace is also gaining market share versus rival Fiverr.  All in all, I see a rather balanced bull and bear case for Upwork at current share prices. I'm content to lock in gains on my position and trim my holdings until I'm able to reinvest into this stock at a better price. Q3 download Let's now go through Upwork's latest quarterly results in greater detail. The Q3 earnings summary is shown below:   Upwork Q3 results (Upwork Q3 earnings deck)Upwork grew revenue at 10% y/y to $193.8 million, beating Wall Street's expectations of $184.0 million (+5% y/y) by a large five-point margin, showcasing the fact that Upwork's guidance cut in Q2 was quite conservative. The company continued to grow its take rates, up 230bps y/y to 19.4% - which the company cited as being driven by higher attach rates on ads, as well as the company's higher pricing.   Upwork marketplace metrics (Upwork Q3 earnings deck)We do note, however, that the company lost 13k clients sequentially versus Q2. The company is both focusing on enterprise customers while also reducing its own personnel - and the way to solve for those two goals is to adopt a lighter-touch service model for its smaller customers. Per CEO Hayden Brown's comments on the Q3 earnings call:  In Enterprise, we used learnings from the last few quarters to sharpen our strategy. We've positioned a leaner, more effective sales and support team against our largest, highest-ROI clients, immediately improving profitability in this business unit while still enabling our smaller Enterprise clients to succeed with a lighter-touch approach. The launch of Upwork Business Plus on October 16 lets us serve larger clients with a plan that meets their needs by being more fully-featured than our Marketplace offering, but with a higher take rate. At the same time, acquisition costs and cost to serve are significantly lower than with our Enterprise offering.\"  For now, higher contribution from enterprise customers is still fueling Upwork's double-digit growth. However, we can't ignore the looming risk of AI and these same enterprise customers preferring to design AI automation models rather than hire freelancers to address low-hanging tasks. On the expense side, as previously mentioned, the company cut 15% of its workforce in October and expects $60 million in annual run rate savings, while also announcing a new $100 million buyback program (worth roughly ~5% of the company's latest market cap).   Upwork layoffs (Upwork Q3 earnings deck)Even before any benefits from Upwork's layoffs kick in, the company boosted its adjusted EBITDA margins in Q3 to 22%, up four points y/y. Key takeaways Though the pace of Upwork's deceleration may not be as slow as originally feared, the Street clearly thinks that Upwork is headed to mid/low single digit growth territory next year, and the company is also seeming to brace for lower growth as it shrinks its workforce.  In my view, Upwork can certainly continue to deliver gains in a slower-growth environment by expanding its adjusted EBITDA: but with the sharp rise in the stock over the past few months and the rebound in its valuation multiples, I'd rather take chips off the table and wait to re-enter at a better price.","kind":"highlight","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/2486050803"}