Upwork (NASDAQ:UPWK), the operator of the largest online freelance marketplace in the world, recently went public. The company's stock skyrocketed about 30% on its first day of trading, which is a clear indication that Wall Street is excited about this business.
So are Upwork's shares a buy? Let's put the company through my detailed investment checklist to find out.
I'm a big fan of investing in companies that are in tip-top financial shape.
Here's an overview of Upwork's financials as they exist today:
- Balance sheet: Upwork raised $187 million during its IPO (before subtracting fees). Just over $95 million of that total went into the company's piggy bank, while another $78 million went into the pockets of shareholders who were looking for an exit. The deal raised the company's cash balance to just over $112 million, while its total debt was reduced to just $24 million.
- Profits: Upwork is currently operating at a small loss because of its choice to plow all of its profits back into the business in order to drive growth. The company set fire to $7 million through the first six months of 2018. However, the company actually generated about $8 million in free cash flow during the same time period.
- Margins: Upwork's gross margin was 67% over the first six months of 2018. However, the company's decision to reinvest at high rates caused both its operating margin and profit margin to be negative.
I like that Upwork has a cash-heavy balance sheet and that it's free cash flow positive. Its net loss is also small in the grand scheme of things.
Generally, I think that the company is in good financial shape.
Broadly speaking, there are four different types of competitive advantages.
I think it's safe to say that Upwork currently benefits from at least two of them:
- The network effect: Freelancers naturally want to sign on to the platform that posts the most jobs. Conversely, businesses want to look for talent in the place with the most freelancers. These facts create a classic network effect that naturally benefits the top dog. With more than 375,000 freelancers and 475,000 paying clients on the platform as of the middle of 2018, I think that this business has grown large enough to benefit from the network effect.
- High switching costs: Upwork boasts a client spending retention rate of 106%. This means that the company is doing a great job at retaining clients and convincing them to spend more on the platform over time.
When combined, I believe that these two factors provide Upwork with a decent moat.
You've likely heard the term "the gig economy" before. The idea is that there is a growing class of freelancers who are either looking for extra income on the side or have enough volume to make freelancing their full-time career. This is a megatrend that shows no signs of slowing down.
The increasing popularity of freelance work has enabled Upwork's key numbers to trend in the right direction for many years:
|Metric||2016||2017||Trailing 12 Months as of June 30, 2018|
|Gross service volume||$1.15 billion||$1.37 billion||$1.56 billion|
|Revenue||$164 million||$203 million||$229 million|
|Adjusted EBITDA||$1.3 million||$7.9 million||$0.3 million*|
These numbers are already impressive, but McKinsey Global Institute estimates that online talent platforms could eventually pull in $2.7 trillion in gross service volume by 2025. Even if that estimate is off by an order of magnitude, I think it's fair to say that the opportunity ahead of Upwork is truly massive.
I like to think about the interaction between a company and its customers from numerous angles when considering the company as an investment:
- Acquisition: Every day, about 10,000 freelancers and agencies sign on to Upwork's platform. While all of this customer acquisition is not free -- Upwork spent $36 million on sales and marketing in the first six months of 2018 -- I think that the company's spending rate to acquire new business is reasonable. I also wholeheartedly agree with the company's decision to build up a base of customers and freelancers as quickly as possible given the network effects discussed above.
- Dependence: Upwork's client spending retention rate of 106% makes it clear that customers are heavily dependent on the platform.
- Is revenue recurring? Yes. Businesses that hire freelancers tend to post new jobs after previous ones are completed.
- Pricing power: Upwork's competitive advantages should, in theory, give it pricing power over the long term. However, the company's gross margin actually declined by 100 basis points year over year between 2016 and 2017. I don't think that investors should read into the fall too much, since the business is still scaling, but this remains an area to watch.
5. Management and company culture
Upwork, as exists today, was formed when two online talent marketplaces called oDesk and Elance were merged in 2015.
Elance's co-founders, Beerud Sheth and Srinivas Anumolu, have since moved on and are no longer with the company.
Efstratios Karamanlakis was one of the co-founders of oDesk and currently serves as the Upwork's CTO. His other co-founder, Odysseas Tsatalos, left the company in 2015.
Stephane Kasriel serves as the company's CEO. Kasriel joined the company in April of 2014 and was promoted to the top chair in April of 2015. Kasriel owns 3.965 million shares of stock, which amounts to almost 4% of the company.
Collectively, all of the executive officers and directors at the company own more than 40% of shares outstanding. That's a lot of skin in the game.
On the flip side, the company's ratings on Glassdoor.com are only so-so. Its overall score is 3.6 out of 5, and only 62% of employees would recommend the company to a friend. CEO Kasriel gets on overall approval rating of 74%.
Upwork's headquarters is located in Mountain View, California, which is the heart of Silicon Valley. The company's so-so ratings on Glassdoor might make it hard for the company to recruit and retain top talent in the Bay area.
6. The stock
I love to buy stocks that have a history of creating value for their shareholders. Since Upwork has only been public for a few days, we don't have a lot of data to work with.
Having said that, I think that it's a good sign that shares popped on their first day of trading and that the stock currently trades above its IPO price.
I've learned the hard way that "sure thing" investments don't exist.
In an effort to minimize my chance of making the same mistakes twice, I like to check to make sure that the investment thesis doesn't have any glaring holes in it:
- Is it a penny stock? No. Shares currently trade for about $20 each, and the market cap is about $2 billion.
- Is there excess customer concentration? No. The largest customer accounted for only 2% of revenue. Upwork has thousands of paying customers.
- Does the industry face long-term headwinds? No. The market for freelancers is growing.
- Does the business rely on any outside forces for success? No. The company should be able to grow even if the economy takes a turn for the worse. In fact, you could argue that a downturn would benefit the company, since it would increase the pool of talent looking for freelance work.
- Is stock-based compensation excessive? Stock-based compensation expense was just $3.6 million through the first six months of 2018. That's tiny when compared to the company's revenue of $121 million over the same period. It's also small potatoes when compared to its market cap of $2 billion.
Upwork looks like a buy
Upwork's results weren't perfect, but I think there are a lot of reasons for investors to add this stock to their watchlists.
Having said that, I'm not a big fan of buying companies immediately after the IPO. That's why I'll green thumb Upwork in my CAPS page today and keep an eye on it for its first few quarters on the market. If all goes well with its first few quarterly reports, then I'll be happy to initiate a starter position -- even if it means paying a higher price.