- Strong network effects make Upwork a buy and hold.
- Multiple levers to pull for substantial long term revenue growth.
- Severely under-monetized revenue model masks long-term growth opportunities.
- Disruptive business model vs traditional contract recruiters.
- Recent pullback is an excellent entry into a long term secular growth trend.
Upwork (NASDAQ:UPWK) operates the largest online global network that helps businesses find and work with freelancers and reduce inefficiencies inherent in the global market for sourcing talent for job openings.
In the event you live under a rock, there's a seismic shift going on with the way people work. Improvements in technology have enabled a massive talented global workforce in hundreds of industries to connect and work with companies ranging from small business owners to large global enterprises seamlessly online in a matter of minutes. This is disrupting massive industries and a large part of this work is being done on one platform: Upwork.
Upwork's business model makes it easy for businesses to find workers for open jobs, be it short term projects or longer term contract assignments. According to McKinsey “online talent platforms are increasingly connecting people to the right work opportunities and by 2025 they could make up $2.7 trillion in global GDP.”
Upwork believes that "the total global gross services' volume (or GSV) opportunity for our platform was approximately $560 billion in 2017". Meanwhile, in the 12 months ended June 30, 2018, the Upwork platform enabled $1.56 billion of GSV across 2.0 million projects between approximately 375,000 freelancers and 475,000 clients in over 180 countries. As a percentage of the total market, Upwork currently has a 0.3% market share. And if McKinsey is correct, this global opportunity could increase 5X over the 8 years from 2017 to 2025. The total addressable market is many multiples larger than Upwork's market share.
Upwork sits at the epicenter of a huge secular shift in the way people work and these are what we believe to be many inherent inefficiencies in the employment sector, as well as sector pain points and secular tailwinds all playing into what we think is going to turn Upwork into a long term multi-bagger investment:
(1) Trend toward on-demand work.
In her 2018 Internet Trends report, Mary Meeker discussed the secular tailwinds behind on-demand work and freelancing around the 22 minute mark in this video. Upwork already has millions of people seeking on-demand work and employers using on-demand work.
(2) Workers want and expect more flexibility
Also in her 2018 Internet Trends report, Meeker talked about the most desired non-monetary benefit for workers being flexibility:
(3) Technological change is accelerating and requires more agile workforces.
This article by Deloitte perfectly sums up the structural changes going on within employment and leads to a significant long term tailwind for a company like Upwork:
During the last decade of economic expansion, organizations have focused on finding the right talent to drive business growth. But with record-low unemployment rates and skills shortages in many technical areas, recruiting has gotten harder, leading to an escalating war of employment brands, recruitment marketing campaigns, and artificial intelligence AI-driven tools to deliver recruiting excellence. In 2019 and 2020, as the economy is likely to slow,1 we think a new approach is needed. Rather than automatically opening a job requisition when a manager needs a role filled, it’s time to think about how organizations can continuously “access talent” in varying ways: mobilizing internal resources, finding people in the alternative workforce, and strategically leveraging technology to augment sourcing and boost recruiting productivity.
(4) The boom in e-commerce and internet entrepreneurism via Shopify (SHOP) etc. feeds into demand for freelancers.
Shopify is closing in on 1,000,000 merchants on its platform. As more people sign up for Shopify and launch ecommerce businesses, this means more merchants looking for freelance / contract work for things like web design, logo design, graphic design, coding, packaging and product inserts, video development, photo editing, and dozens of other tasks to workers on Upwork's platform. This trend will continue to strengthen in our opinion as more and more people embrace selling online.
(5) The process of hiring someone is slow and costs companies significant money.
The average time it takes for a company to fill a job opening is now up to 31 days according to a study done by Deutsche Bank:
This interesting article at Builtin calculated the cost per day to a company to fill a vacancy. Their formula arrived at a $1,515.15 cost per day for a 30 person software company doing $10 Million in revenues to fill a job opening. The formula is as follows:
Another cost to consider if you choose to use a hiring agency to fill that job opening is the agency's cut: typically a hiring agency will charge 30 to 40% of the person's salary to place them at a company. For a $150,000 software engineer that comes to $45,000 to $60,000 in placement fees. Between the cost of vacancy and the placement fee, this software company could be looking at a total cost to fill one opening of $90,000 to $105,000. Alternatively, they could use Upwork to find a candidate and begin working with them within an hour.
(6) The interviewing process for workers is also filled with pain points.
This is what we consider to be a major selling point of Upwork: not having to go through the painstaking process of interviewing face to face with a recruiting firm and then with employers over a multi-day/week period only to find out that you're not an ideal candidate. Many people will give up trying after a few times.
The idea of creating a profile and uploading your skills and resume, taking skills and language proficiency tests, building out validated reviews from independent parties, uploading screen shots of prior work history and allowing companies to access all of this information online strikes us as light years ahead of the antiquated recruiting firm business model.
Take a look at the search process on Upwork for a company looking to fill a position for a mobile developer; it's efficient, streamlined and takes all of a minute or two...and the transparency is wonderful: candidates prior work history is all there along with validated reviews of prior work:
You can choose from filters including job success ratings (or reviews), amount earned over time by a candidate, the candidate's English proficiency, what their hourly rate is and more. Here is a look at what the search results show for a few filters we chose:
After finding a candidate that looks interesting you can look at his/her profile to see prior work history and a full list of reviews, see below:
Again, this entire process is far more transparent to the hiring company. And from the freelancers / contractors point of view, it's is a pain free process when compared with the alternative methods of finding freelance / contract work: typically, rounds of in-person interviews or screening interviews over the phone.
(6) The HR Industry has neglected technology and is ripe for disruption.
The largest players in contract recruiting are Robert Half (NYSE:RHI) and ManpowerGroup (MAN), which are worth $6 Billion and $5 Billion, respectively, and both have been slow to accept change. Larger employers are now more and more willing to integrate freelancers into their workforce and the online only model that Upwork employs is inherently faster, more streamlined.
Accenture recently talked about the "extended workforce":
And Deloitte in its 2019 Global Human Capital Trends survey talked at length about the alternative workforce as a means for sourcing. In their survey, they found that 87% of those global corporations surveyed expect the role of technology to increase in sourcing in the next 3 years:
The HR industry is ripe for disruption. In a recent article titled "HR, Time To Embrace The Freelance Revolution: Your Career Depends On It" by Jon Younger, author of "Agile Talent: How to Source and Manage Outside Talent" and member of the executive education faculties of the Ross School of Business, University of Michigan, he writes at length about how the HR industry isn't ready for change:
Strong Network Effects
We've written in the past about internet companies with strong network effects and how investing in companies that exhibit these traits often turn out to be huge winners.
In our article from 2012 we recommended 3 companies exhibiting strong network effects: Google (GOOG), Facebook (FB) and Zillow (ZG). Of the 3, Google clocks in as the underperformer at +260% returns since then. Zillow is up 511% and Facebook is up 687% since then.
We believe Upwork exhibits just as strong, if not stronger network effects vs those three companies. Upwork talks about network effects in page 7 of its IPO paperwork and we couldn't say it any better:
We believe our platform provides a strong value proposition for both sides of our marketplace and our scale creates powerful network effects that strengthen our competitive differentiation. Clients are attracted to our unique platform due to the availability of the more than 5,000 skills that freelancers offer in over 70 categories. In turn, as more clients use and post projects on our platform, we are able to attract more freelancers. As a result, we have been able to scale our business and our global community of users without the need for local physical presence and density.
According to Mary Meeker, the total number of freelancers on the Upwork platform is ~ 16 million. The sheer scale of this amount of freelancers on one platform makes it extremely valuable to the businesses on the platform as they have confidence the pool of freelancers is large enough that they can find the correct person to work with them on their projects. Additionally, we think the company has a lot of ways to sell services to its existing user base of freelancers that the market is under appreciating. For example, we believe the company could roll out a learning center (more on this below), an apps marketplace (again, more on this below, but down the road freelancers could potentially sell apps that they build on Upwork for their clients that are used for popular platforms like iTunes, Google Play, Shopify etc to other companies / potential clients on the Upwork platform whereby UPWK would take a cut of every sale and the freelancer would reap the benefit of their creation), or a variety of other features to help monetize its current user base on its platform, including a secure online enterprise collaboration tool that allows workers and enterprises to share files and collaborate online in a secure environment.
Underpricing Creates Opportunity Longer Term
In our opinion the company is severely underpricing its service in an effort to get more and more enterprises and freelancers on its platform to continue to build out network effects. This has the impact of subduing revenue growth in the near term, but we believe the company ultimately will exhibit all the hallmarks of network effects: the ability to increase pricing as the network becomes more and more valuable to all of its users.
As far as underpricing goes, consider that the company only charges businesses looking for a dedicated team of people at Upwork to help hire workers quickly $499 per month and then a small transaction fee of 3% after hiring is completed. See a screen shot of the company's website below:
A traditional recruiting agency, as mentioned above, charges between 30 and 40% of a candidates salary to place them with a company. The disparity between $499/mo + 3% and 30% to 40% is massive and there is room for Upwork to grow its fees substantially over time. To put this into numbers, the cost to hire someone at a company for a 4 week assignment with 40 hours a week for $50 per hour is $240 + $499 = $739 on Upwork. That same candidate through a traditional hiring agency at 30-40% fee would cost the company $2,400 to $3,200. The company would save between $1,661 and $2,461 using Upwork.
The Upwork online-only business model is a significant threat to companies like RHI and MAN who have high cost structures inherent in bricks and mortar infrastructure, where they have to staff thousands of employees and pay significant overhead costs for each of their locations.
To this end, UPWK recently revised its pricing to charge a little more to companies using its platform to hire freelancers and its now charging freelancers for each submission to a job opening above and beyond a limited amount of free job submissions they receive.
Last week, UPWK announced an initiative that strikes at the heart of RHI and MAN as well as Indian outsourcing giants Cognizant (CTSH) and InfoSys (INFY), two companies sporting $30B+ market caps. Both CTSH and INFY are global outsourcing agencies that help companies find teams of talented workers to perform work at far lower costs than in developed countries. See below:
Companies are moving away from agency of record relationships with traditional large consultancies or multinational firms. As a result, there has been a steady rise in boutique agencies that have emerged to support specialized project work. As this trend unfolds, companies struggle to engage and manage their agency portfolio in this fragmented landscape -- from finding quality agencies to support their project needs, to pricing transparency, to inconsistent service levels across team members. At the same time, boutique agency owners are challenged with gaining exposure to new potential clients outside of word-of-mouth referrals and their local networks.
Upwork’s newly enhanced agency experience removes the friction that exists with the traditional agency model, making it easier for businesses to find, hire and engage specialized boutique agencies on the platform with just a few clicks. New features include:
- Discovery Dashboard is a central hub comprised of the best resources to support a company’s large project needs. The Discovery Dashboard helps businesses scope their projects by providing insight into common use cases, top categories of work, project scoping and talent sourcing. The Discovery Dashboard also helps boutique agencies become more discoverable to potential clients who may want to engage them for their specialized skills and services.
- Curated Agency Listings allows businesses to drill deep into one category of work by browsing a curated list of pre-vetted agency profiles and project portfolios. Each pre-vetted agency has proven success working with businesses from SMBs to Fortune 100 companies. Upwork is offering three initial category pages, including 1) mobile, IT and web development, 2) marketing and 3) creative. The curated listings further enable agencies on the platform to showcase their services and project portfolios.
- Enhanced Agency Profiles helps companies evaluate and easily review agency services in one profile view where they can find pertinent agency information to inform their decision making. With enhanced agency profiles, agencies are empowered to better market their skills and capabilities. Agencies can easily build a robust profile to include key firm information (such as size and location), an overview of capabilities, minimum project size, featured clients and awards and certifications.
Other Opportunities: Upwork Learning
This post on Twitter is an interesting concept about how Upwork has an embedded freelancer workforce that is looking to enhance their skills so the idea of building out an online learning marketplace or perhaps partnering up with Lynda or LinkedIn (Lynda is owned by LinkedIn) seems to us like an obvious opportunity for the company. And it ties into rumors back in December about Microsoft (NASDAQ:MSFT) wanting to buy UPWK:
We don't place a ton of emphasis on this or buyout rumors but they make some sense here.
(1) In the near term, the market may place undue emphasis on near term growth rates being 16% or so. Guidance calls for growth of 16% in Q2 2018, 20% in Q3 and 22% in Q4 year on year. However, the current multiple of 5X sales for an online marketplace in a leadership position with strong network effects seems extremely low and prices in a lot of downside.
(2) Execution risks: inherent in any internet company are execution risks. If the company acts too slowly to take advantage of opportunities in the Enterprise space or if it doesn't capitalize on the shift to flexible workforces and leaves the door open to a competitor like Fiverr (FVRR), which is known more for its short term, low priced gigs, to capture market share in the higher priced freelance/contract work arrangements, then there's risk the company could underperform.
However, we think both risks are built into the stock price right now which is depressed.
Valuation is Reasonable
We believe the best part about Upwork right now is the stock has been left for dead. Growth only clocked in at 16% last quarter. The stock cratered from $24+ to $15.70 on 8/5/19. We believe this provides an excellent entry into what we think could be a 10-fold investment over the next 3-5 years. Recent guidance is for $301 Million in revenues for 2019, pegging the valuation at about 5 to 5.5x enterprise value to sales. Sales growth in the back half of 2019 should come in around 20-22% on a year on year comparison. For an online marketplace that is a leader in its category with an addressable market in the trillions, and with a SaaS component to it, this valuation is very reasonable.
A good comparison to use is eBay, another marketplace matching buyers and sellers. eBay has had 20 to 25% net margins for years. While UPWK is still very early in its growth phase, we believe that a good way to look at its valuation is to consider the "normalized" earnings power of its current revenue. We believe UPWK has the potential to generate 20-25% net margins over time.
Assuming a 20-25% growth rate for the next 5 years, UPWK could be doing $750 to $950M in revenues and $170 to $230M in net income. A reasonable multiple of 40X earnings (eBay used to trade at this multiple when it was a faster growing company) would peg this at close to $7 to $9 Billion market cap or 4-6X current levels. And we believe that a 20-25% growth rate may be too low given the multiple levers Upwork can pull to grow revenues. Additionally, we expect a tipping point to occur soon where it becomes commonplace for employers to utilize Upwork to complete the bulk of their work needs.
This is one of those rare instances when we would recommend buying weakness ahead of Q2 earnings due out on August 7th, 2019.
Upwork has a better business model than Cognizant (CTSH) and InfoSys (INFY). Both CTSH and INFY are global outsourcing agencies that help companies find teams of talented workers to perform work at far lower costs than in developed countries. They mainly source workers from India. But both lack transparency with regards to workers backgrounds, profiles and examples of work history that Upwork provides. And recruiting agencies like MAN and RHI have far higher cost structures and are far less scalable than UPWK in our opinion.
It's not often you find an online marketplace / SaaS company with a leadership position in an industry that has the potential to be worth trillions that is trading at only 5-6X revenues. Upwork doesn't have to dominate the global freelancing market to become a huge winner. Just a 1% market share of a $560 Billion current market is $5.6 Billion in GSV, or close to 4X Upwork's current annual GSV. We believe Upwork has multiple substantial levers to pull to grow tremendously over the coming years and that it should be a core position in any growth-focused investor.
This article was written by
Analyst’s Disclosure: I am/we are long UPWK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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