From gimmicky beginnings (buy any service for just $5!) to a somewhat less gimmicky present, Fiverr is going to be on the markets soon. Investors should probably pass on this one, though. In this week's episode of Industry Focus: Tech, host Dylan Lewis and Motley Fool analyst Dan Kline look at one of the less appealing soon-to-be IPOs in the gig-economy space. Tune in to learn what's wrong with Fiverr as a long-term business, what the company is and isn't doing to fix those problems, why Fiverr's IPO motives are so uninspiring, and more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on June 7, 2019. 

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, June 7, and we're doing yet another IPO show. I'm your host, Dylan Lewis, and I'm joined on Skype by fool.com's Dan Kline. Dan, how are you doing? 

Dan Kline: I'm good! It is 88 degrees and cloudless here. I may literally burst into flames when I walk out of the office here. 

Lewis: It's a good thing you're indoors while we're taping. I wouldn't want any spontaneous combustion going on and having it recorded for our dear listeners.

Kline: I don't know, I think that might be just the kind of stuff we need to get our YouTube channel going.

Lewis: That might be the most listened to episode, were it to happen. I see Austin Morgan smiling behind the glass in agreement. Dan, it's pretty toasty here, too, in D.C. It's particularly toasty if we're talking about the tech IPO market. There have been some pretty big names that have gone public so far, or announced intentions to go public so far in 2019. There's one that may have slipped under the radar. It's a company that's been around for a little bit, but it's been a niche internet company. 

Kline: You mentioned before that this company, Fiverr, started as sort of a gimmick. And it was exactly that. When Fiverr launched, it was literally a dollar store. Everything costs $5. You want a logo -- $5. You want an opening for your podcast -- $5. It's branched out from that. And now the reality is, there's not very much on Fiverr that actually costs $5. But it is a very low-cost internet marketplace for services. If you want a very simple piece of video editing done, you might find someone who could do it for $20. If Dylan and I have an off-Broadway show we're working on and we wanted someone to do the logo for it, or make us business cards, you could get that for maybe $10, $20. And you pay for everything, every revision. It's a very regimented format, to, as I think of it, do very low-end work. 

Lewis: Dan, if we had an off-Broadway show, I think there'd be another five offs in front of that Broadway. I think it would be way off Broadway. I think we'd be on the sidewalk somewhere, trying to put a production together. But you're right. And you've used this service before. I have not. I remember poking around a couple of years ago, just because I thought it was so novel an idea. But you have used it for some of your side hustlers, right?

Kline: Yeah. I really don't think, unless you really search on Fiverr, you're going to use it for anything permanent. But let's pretend I'm proposing to you that, at Motley Fool, we go into a new type of content. And I'm really putting the pitch on. Maybe I'll spend $10 to get a graphic made for when I send my email to you. But there's no intent that that's going to be the graphic for the product when we launch it. Or, I own an '80s website. Maybe I launch a new section, and I want to do a placeholder to show the graphics person I use what I'm thinking. I might spend $10 on Fiverr. But it's very rare that you're going to use something real. Again, I'm sure there's some wonderful service providers on there; I've generally found its people grinding stuff out quickly, they're using a lot of templates, it's not great work, and it is kind of a model of, you get what you pay for. 

Lewis: Yeah, I was surprised, having kicked the tires a little bit before we did this show on what was there, to see so many people offering services at fairly high prices. They're clearly trying to legitimize this platform, and instead of it being something that's a quick and dirty $5 for a graphic, they're getting more pros on there, or trying to, where they're charging $100 or $150 for seemingly more professional work. But the idea here is, it's somewhere on the spectrum of Craigslist and Upwork. You're trying to get someone to handle creative work that you don't really want to do yourself. 

Kline: What Upwork has done -- we use Upwork, for full disclosure. It's our payment platform. That's how I get paid at Motley Fool as a contributor. But Upwork has a mix of, "Hey, I'll write 10,000 pieces of content for you for $500," and, "Hey, I'm a professional, I do this full-time, I'm living in the U.S. and I'm going to charge a normal U.S. freelance rate for this, not $2 an hour because I'm living in a country where that's maybe a better wage," or at least a livable, well, maybe not livable, but a decent side hustle, let's call it. So, you can see a little bit of Fiverr getting to that. And maybe, with the IPO, they'll use some of the proceeds to go there. But this is a company that had a niche, and it's given its providers more freedom in pricing, but it hasn't built out a pro side product. It's not really competing with Upwork for a Motley Fool, a company that's using hundreds of freelancers. There's room to grow here. But when you look at what they're doing now, they've been very conservative, they're not burning a ton of cash, but they are losing money. That's because their cost of customer acquisition is astronomical. 

Lewis: You look at the net income statement, losses grew from $19.3 million in 2017 to just about $36 million in 2018. About what you'd expect for a company going public. At the same time, we see revenue at the top line here growing 45% year over year. They have something. They have something that people are interested in and people are using. We need to dig into the numbers here on the core business metrics, though, Dan. 

Kline: They make their money, they take about a quarter of what you pay. If I'm paying $40 for logo, they get about $10. The problem is, they're spending more money to get new customers than they're retaining. Their repeat customer business is about 57%, up from 55% a year ago. The problem is, it's not an everyday platform. I use Fiverr occasionally as kind of a last idea solution. It's not like an Uber, where, OK, they're ingrained habit, and there's no other solution for it, so as they start to raise prices, people will use it. If Fiverr starts to raise prices, people might go to Upwork or freelancer.com, or Craigslist at the at the low end. So they're in an interesting dilemma. They might have some room to raise prices, but they have to figure out how to acquire people and get more word of mouth. And this isn't the kind of product you're bragging about. There's nothing cool about having someone do a mediocre business card for you for $10.

Lewis: If you want to put some numbers to those marketing costs, Dan, being a middleman online is a very good business. That plays out when you look at their books. Their gross profit margin is generally around 80%. But those losses, like you mentioned, the marketing spend is so high, it is 65% of revenue. That's because they are trying to bring people onto the platform to spend money. They need to keep those people and have them spend more down the road. 

Kline: Right. They are keeping people. Having a 57% retention rate for a service that really feels like a one-off is really good. The problem is, they're not getting me to go -- I have some other websites I work on, some side hustles. I'm going to employ someone, I'm going to make an arrangement. And hey, I'm going to have three pieces of content every week come from a Fiverr provider. I'm going to have graphics done every month by a Fiverr provider. That's something you tend to go to Upwork for, or freelancer.com. So, there is an ability to move into that space. But this has not been a company that's been plowing money into new platforms. I'd actually rather see their losses be a lot higher because they're developing new tools and new ways. Even right now, when you use it, it's a very regimented tool, in terms of, you're entitled to one revision, and then you can pay $10 for more. It doesn't offer a lot of flexibility for a creative process, and that's not great for a company that's largely selling creative things. 

Lewis: Yeah, when you're looking at companies that are operating as a network or software-as-a-service providers, you'd like to see strong network effects, and you'd really like to see that people are coming back all the time, because the business becomes very high-margin if you get those things working for you. Ideally, you get some enterprise clients in there that can help you out with that. 

Kline: I also think there's a lot more they can do in terms of cheap marketing. I can't tell you never, but I am pretty sure I don't often get a Fiverr email saying, "Hey, you used our service before. Here's some offers for you." Now, I've bought business cards from Vistaprint, and Vistaprint basically emails me three times a day. It wouldn't shock me if there was a guy outside holding a sign reminding me to use Vistaprint again. So it does feel like there's some low-hanging fruit that they're not going after. And yeah, they could grow with people. If you're catering to small businesses, you should find a way to offer them solutions as they become bigger businesses. And hey, maybe they don't need a full-time graphic designer, but maybe they need a quarter-time one, maybe they need other services. And it doesn't feel like Fiverr is doing any of that. It's really just a marketplace that sits there and you can go to it if you want to.

Lewis: Dan, I wouldn't be surprised if you started getting some more emails after this show. [laughs] You have to be careful what you wish for there. I do think talking a little bit about the competitive landscape here is important. You hear "gig economy," and there's been so much money dumped into gig economy, either private companies or stocks, now that a lot of them have gone public. They compete directly with Upwork. This is a company that I own, full disclosure. I'm an Upwork shareholder. But, freelancer.com is in the mix, too. This space is maybe a little bit more crowded than people realize. 

Kline: Yeah. More importantly, it's not only crowded, once you're using one of these solutions, there's not a huge incentive to go to another one if you're talking Upwork or Freelancer. If you're on Fiverr, there's limitations, there's stuff they can't do. So you might graduate to the other ones. They're not a complete platform. They have their customer base, and that's something that's very valuable, but they're not exploiting it as well as, say, Upwork does, which really makes it easy to bounce between being an employer and, I say employee, but, a gig worker. 

The other thing that they're really basing their business model on is this idea that we're moving into a gig economy. They've admitted that most of their customers are in English-speaking countries. Well, the reality is, Fiverr -- and to an extent, Upwork and freelance.com -- are a way for smaller U.S. companies to outsource work to countries where labor is cheaper. Maybe as a side hustle, they're getting the U.S. guy who's doing a $20 logo. But anyone I've worked with has been in countries where it's cheaper to live, where the average standard of wage is not as high. So I don't see this huge market where big-time U.S. graphic designers are going to go freelance and work on Fiverr. It doesn't make a lot of sense to me. 

Lewis: Yeah, I think you're right. I think it's a lot of people that are probably arbitraging, especially given that we're talking generally lower-cost projects than you might see on Upwork. And there are quite a few people using this service. I think they currently count roughly two million active buyers, those are customers, and about 250,000 sellers, people that are working --

Kline: Does that ratio seem crazy off to you?

Lewis: It does seem a little high, yeah. [laughs] It does seem a little high, now that I think about it. 

Kline: You're getting, what, eight $40 jobs a year? [laughs] It just doesn't seem to play out. Maybe there are power users. Maybe I'm not typical in only using it a few times a year. I'm sure there are people that are going to Fiverr 20 times a day because they own a bunch of businesses, or they need a bunch of cheap graphics. There's obviously channel expansion. That's something they cited a lot of times, too. They can grow into other areas. But, again, it's a limiting platform. If we need a theme song for our, as you said, off off off off Broadway show for the commercial, you can get that done on Fiverr. But if you don't like it, there's not much you can do about it. So, it's probably not the way you're going to go about it. Again, they say a $100 billion opportunity. Maybe, but it's still going to be at low prices, which makes it very hard to make money. 

Lewis: We've been a little bearish on this company so far. I do want to highlight a couple of things. The gross profit margin I mentioned before, that 80%, that says to me that once they -- if they ever -- work out their marketing expenses, there's probably a profitable business here. I mean, it hinges on them ultimately bringing those costs down and being able to scale their business a little bit better. But when you start off with something that has an 80% gross profit margin, the potential is there. 

I also think it's worth focusing on here, they have about $35 million in cash and equivalents, another $10 million in bank deposits, long-term debt is only $5 million, and the short-term debt and payables is only about $20 million. So this is not a super levered business that is looking at pay down debt. They have a net cash position, which you want to see. 

Kline: And an IPO helps your marketing. In many ways, this is a stunt IPO to get a lot of attention. It's not that they don't need the cash, but they haven't been a high cash burn, they probably could have raised money privately. If they get more eyeballs, and they figure out a little bit of development, some of this money has to go into having a payment platform like Upwork does, having more professional solutions that can be set it and forget it, but can also be a marketing tool. "Hey, I'm using Upwork once a month," or, "I'm using Fiverr once a month for this recurring freelance relationship. I wonder what else I can do while I'm tweaking that." So there's absolutely potential here. It's just been a very carefully run business, almost too careful. 

Lewis: I've been a little curious why they're going public, frankly. You look back at their funding rounds as a private company, they've raised a little over $100 million, but their last raise was in 2015. You look at a lot of the other private companies out there, they've been consistently raising money, whether it's once or twice a year, to fuel what's going on. You look over at the use of proceeds from the prospectus that we've been talking about, and they say the principal purpose of this offering is to obtain additional working capital and to create a public market for our ordinary shares. There's a little bit there, like, OK, we will raise some capital. But it kind of seems like this is a liquidity event to me, Dan.

Kline: [laughs] It's funny, I hadn't put those dots together. Then you said it on Slack. Yeah, there's a lot of people here probably who have their net worth tied up in this company. It's a good thing to let them get some of that money out. I'm fine with that. But I don't like that they're not saying, "We're going to invest heavily in the platform," or, "We're going to invest in building a better marketing platform so we can cut that cost in half, which would make us profitable." That is a little bit of a red flag. 

Lewis: Yeah. And, I look at this company, and I look at their biggest competitor, Upwork. Upwork's top line is about 3 to 4 times Fiverr's and it is a $1.6 billion company right now. You look at some of the valuation numbers that have been thrown out there -- we don't know exactly where Fiverr will be going public, we have to wait and see on that -- but I've seen numbers between $800 million and $1 billion. That seems a little rich for me based on the fundamentals of this business. 

Kline: It's very rich, and Upwork has enterprise customers. We're a fairly major customer. They have other people like us that are using it for very large operations. Fiverr doesn't have that. Now, on one hand, Fiverr's built out a community of very small-time users that are going to stay there. But I don't see them having the same value. 10 small customers does not equal one big customer. 

Lewis: Yeah. For me, this does not immediately seem like something that's investable. But there are the bones of something pretty interesting here. It's just a matter of whether management can make that happen. I would rather watch it happen for a couple of quarters, especially given that we don't even know the valuation yet, and then make that decision. 

Kline: Yeah. And look, I look at this and say, this would be a good business to work at. I believe in their future. I think the conservative model is going to get them to profit. In some ways, maybe 10 years from now, that's going to be a very valuable thing as some of these fast spenders make a mistake and burn out. But I'd like to see a little bit more aggression. Put some money into the platform. Put some money into lowering your costs. Don't crawl quite as much if you're going to have an IPO. 

Lewis: Dan and Austin, I'm curious, any working titles for that off off off off off Broadway production that we'll be putting out?

Kline: [laughs] Well, it's going to be based around mostly you human beatboxing. I haven't figured out my part of it. I'm probably just going to stand with signs with words on it. Austin, you got any ideas? 

Austin Morgan: I don't have any ideas, but I can tell you one thing. I'm not filming it for $20. 

Kline: No, you're in it! You're in the background slow cooking some meat for the after party. 

Lewis: There you go. My working title right now, and this is based on the way that Austin is dressed today, because it is a summer Friday, is the Hawaiian Shirt Monologues. We'll see if that sticks, but that's our working title for right now. 

Kline: [laughs] I'm not sure I could pull off a Hawaiian shirt, Dylan.

Lewis: Well, you never know! That could help on YouTube, too. Dan, thanks for hopping on today's show!

Kline: This was a silly one! I appreciate it!

Lewis: Listeners, that does it for this episode of Industry Focus! If you have any questions or you want to reach out and say hey, you can shoot us an email over at industryfocus@fool.com, or you can tweet us @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes, or, like I said, you can catch the videos from the podcast over on YouTube. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass today! For Dan Kline, I am Dylan Lewis. Thanks for listening and Fool on!