Investing in the Gig Economy

In this episode of Industry Focus: Tech, Dylan Lewis and Motley Fool contributor Brian Feroldi look at the gig economy and compare two of the top players in the space. They talk about what makes online platforms so appealing to companies and individuals and about the future of remote work. They also talk about these companies' finances, their operations, and their long-term growth opportunities. Brian also shares his insight on one of the hardest and most important things you can do as an investor.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Nov. 6, 2020.

Dylan Lewis: It's Friday, November 6th, and we're talking Upwork (UPWK -0.09%), Fiverr (FVRR 1.34%), and following up on a 2018 better buy question. I'm your host Dylan Lewis, and I'm joined by Fool.com's favorite feeble fabricator of farcical Foolish philosophies, Brian Feroldi. Brian, how are you doing?

Brian Feroldi: I'm doing fantastic, Dylan. Good to see you. Good to see that you're rocking a beard for the Big Lebowski party that you had; I love it.

Lewis: [laughs] You know, the beauty of facial hair is it grows back, and you can do pretty much anything you want with it. One of the pieces of advice my mom gave me early on was, do whatever you want with your hair when you're young, die it, cut it, do weird stuff, it'll grow back and it'll grow back the color it's supposed to be. And, you know, that's the joy of it. Same thing with your face, you could do whatever you want with it.

Feroldi: If you could teach the top of my head that trick, Dylan, that would be amazing. [laughs]

Lewis: [laughs] Well, you know, Brian, you can always slap a wig on, that's fine too, you know? So, I think creative control exists no matter whether it's natural or fake. [laughs]

Feroldi: That's right. I live vicariously through the hair on your head, Dylan. [laughs]

Lewis: [laughs] Hot start to today's show. I don't have a transition from that to what we're going to be talking about, so I'm just going to roll ahead; it's totally fine.

We are going to be checking in on some results from Upwork, talking about Fiverr, and just kind of generally talking about freelance, elance, gig work, whatever you want to call this industry, there are a lot of names out there, Brian.

Feroldi: This is a really interesting and exciting market. I mean, we've been talking about the gig economy on Industry Focus, for Geesh! A couple of years now, at least. And we have done deep dive episodes on both Upwork and Fiverr. I don't think we've done one that really compares the two, especially now where we've seen both of these companies have been public for a few years and we've seen some pretty different results from them.

Lewis: Yeah, and it's probably an oversight on our part that we didn't put these two together and instead we're kind of looking at them in isolation, because we have gotten to the point now where the two of them have existed long enough, we can really start to look on an apples-to-apples basis on these businesses. And this episode, just as a spoiler, there's going to be some mea culpas in here, [laughs] there are going to be some things that we've talked about in the past that simply didn't happen, and a lot of that's going to be on my part, and really, I think what's fascinating about this market is, we had a certain view of, kind of, how it was going to play out, going back over the last couple of years, and it has proven not to necessarily work out that way. So, we're going to unpack, basically, what we saw originally and, kind of, how that has changed over time.

But, really, I mean, the reason for this, Brian, is both companies reported earnings, we have a lot of excitement because Upwork is up, but year-to-date Fiverr has been a spectacular stock to own, so I could see how both of these companies are kind of on people's watchlist right now.

Feroldi: Yeah, and this is one where I think I got the moat wrong when we talked about Upwork on the show. When we initially talked about them when their S-1 came out, one thing that I said was this seems to me to be a natural network effect economy where employers want to hire from the place with the most freelancers, and freelancers want to be at the place with the most people that are hiring. That seemed to me to be an unassailable moat, and Upwork acquired its way to be the top-dog in the space. Upwork came together as a result of a merger between two companies called Elance and oDesk. And it is, by revenue, the larger company of these two. But one thing that always kind of irked me a little bit when Upwork was public, as they're top-dog, they're first-mover, this is a massive market opportunity, why aren't they growing faster? Turns out the answer is Fiverr.

Lewis: [laughs] Yeah. And I think we underestimated Fiverr a little bit. These are very similar businesses in terms of what you can get there. For the folks that are unfamiliar, you can go here and get talent that is skilled in pretty much anything. You know, if it's web development, if it's creative work, if you need someone who is a specialist in marketing, illustration, social media, SEO. It's basically a talent and, kind of, gig marketplace. And what we've seen generally, Brian, is marketplaces are a great place to invest because they connect people, they have those network effects that you talked about before, and they tend to be pretty high margin businesses. So, immediately we're interested in these companies, because they have the hallmarks of a lot of things that we've seen be successful so far.

Feroldi: Yeah, the financials of both these companies are really, really attractive and so is the market opportunity here. Fiverr recently put out some slides that basically said in the U.S. alone, they view their TAM [Total Addressable Market] at $115 billion, and that number is growing. When you add in the rest of the world, it's pretty darn clear that both Fiverr and Upwork just have a massive opportunity. What's also pretty exciting is that they believe, or Fiverr believes, I guess I should say, that the majority of freelance hiring still happens offline. I mean, they think less than 5% of freelancers are hired through online channels like Fiverr and Upwork. The traditional way of hiring freelancers is word-of-mouth and even today that is still the dominant away that freelancers are hired. If Fiverr and Upwork can take market share in that market, there's plenty of room for both of these companies to grow.

Lewis: If we rewind a little bit and kind of look at how we were originally looking at this marketplace, Brian, you said you kind of miss-viewed the network effects at play, and I'm guilty of that too, I thought Upwork being the bigger player, put them in a spot where it was going to be pretty easy for them to stave off competition. I think something that was kind of interesting too was that Upwork had this more polished offering, seemingly. It seemed like a better solution for enterprise. We use it that way at The Fool to manage a lot of our contractors and our relationships. And Fiverr kind of had this Dollar Store vibe to it. It was a little bit more amateurish, it didn't seem like you had freelancers that were as vetted. You know, the roots of this company are in people paying a couple bucks for odds-and-ends jobs, and they have basically taken what was kind of an internet oddity and made it into something that is a bona fide business.

If you look at the site now, if you look at the branding now, it's a very different company than it was, I think, even when we first looked at.

Feroldi: It really is. They have done a fantastic job of, you said, going from essentially a Dollar Store into a Target, shall we say. They have done a great job of swimming upstream and attracting more and more employers to hire using their platform. And they have some big-name companies behind them. Unilever is a customer, Facebook is a customer, and there are thousands upon thousands more. So, hats off to Fiverr, they have really done a good job of making their brand strong in the space.

Lewis: Yeah. So, our check-in was basically, looking at those originally, we thought Upwork was going to be a runway winner in the space. I was pretty doubtful of Fiverr's ability to really meaningfully grow and grab a significant part of that market given what seemed like strong network effects. That has not happened, Brian. [laughs] We've been categorically wrong about that.

Feroldi: But on the other hand, we're still right about Upwork being the bigger player here. If you look just at revenue, over the last year, Upwork has generated $338 million in revenue; that is more than twice the $163 million that Fiverr has generated over the same period. The trouble is, Fiverr is growing way faster than Upwork is. Fiverr, over the last year, has put up basically triple-digit revenue growth, although in the most recent quarter that dropped to only 88%; Upwork, by comparison, has been growing at a much slower pace in the teens. And more recently they uptick-ed recently to 24%. But if you look over any longer stretch of time, it's very clear that Fiverr's growth has outpaced Upwork and outpaced the market.

Lewis: And these were two businesses that were in a spot that they had pretty good tailwinds pushing them forward. I think even going back to 2019-2018, it was easy to read the writing on the wall and say that gig work, a less centralized work economy is kind of where we are moving. And people are more comfortable with some form of remote work, people are more comfortable with hiring out for really specific tasks than they probably were a couple of years ago. It's easier for them to do that thanks to these platforms. So, there was already a lot pushing these companies forward.

And then stay-at-home happened. And I think, you combine stay-at-home with a lot of people possibly losing jobs or looking to make extra money, the results for Fiverr, in particular, took off like crazy.

Feroldi: Yeah, they have done a fantastic job of capitalizing on the pandemic, essentially, Upwork has too, let's also throw that out there. Upwork's revenue growth has accelerated over the last couple of months. It's possible that could be due to a leadership change. Maybe 18 months ago, the CEO that we were touting when Upwork came public was replaced, and new management did come in and they seemed to have refocused the company and reaccelerated the revenue growth.

So, let's talk about that. Last quarter we saw Upwork grow its revenue 24% to $97 million, that was an acceleration from the 21% that it did the quarter before. The rest of the income statement here looks pretty good, as you teed up. This is a very attractive business model. 73% gross margins at Upwork, and they were actually able to produce an adjusted income of $5 million; that's impressive numbers.

Lewis: Yeah. And that 24% for what is, kind of, a nascent market might be a little underwhelming, particularly [laughs] when we get to the Fiverr part of the financial discussion. The reason that we see such a positive reaction and the fact the stock is up, I think, 40% or so after reporting earnings is, there were periods over the last four quarters or so where that year-over-year growth had dipped to 17%, 19%, 18%. And for a business that is so early on in the growth story, so much greenfield ahead of it, when they first started showing their financials, we were seeing year-over-year growth in the mid-20%s. For any deceleration there, that's kind of why the stock has languished for a while, people are going to start to get concerned.

It's particularly concerning because when you look over at their main competitor, Fiverr, the growth rates are outrageous.

Feroldi: Way higher, and they have been for a long time, but last quarter was definitely continuation of what we've seen out of Fiverr. Revenue growth was 88% to $42 million. During the quarter they grew their active buyer base by 37%. In the quarter alone they added on 310,000 new active buyers bringing their total to 3.1 million. They're expanding internationally, they're adding on new projects, but the thing that really has me excited about Fiverr is the gross margin here is 84%. 84% gross margin plus 88% revenue growth, boy! Is that something to get excited about.

Lewis: I think one of the natural questions when you look at these two companies, Brian, is, OK, we have Upwork at probably about twice the revenue run-rate of Fiverr, and Fiverr at about twice the valuation of Upwork. And that can seem a little bit hard to square for people.

Feroldi: It can be, but when you see that stark of a difference in growth rate, it clearly shows that Fiverr is taking market share in this market. That is something, the growth rate at Fiverr, if sustainable, clearly justifies a much higher valuation, not to mention the fact that it has a gross margin that's about 10% higher. So, the good news here is that neither of these businesses are really that big. I mean, Fiverr is a $6 billion company, Upwork is a $3 billion company, there's plenty of room for both [laughs] of these companies to continue to grow.

Lewis: Yeah. And we mentioned that both of these are businesses that benefit from people looking for other ways to make money, and stay-at-home, the remote work trends, there are a lot of different things pushing them forward. The pandemic in particular, though, is kind of a critical point for them. And when you look at the results from Upwork, we didn't see a massive uptick in the previous quarter; they're reporting their results through June 30, 2020. On the other hand, with Fiverr, they went from posting year-over-year growth in the 40%s prior to the pandemic to up into the 80%s. Their June 30th end quarter was 82%, we're seeing 88%. So, not only did they [laughs] basically double their growth rate, but then they accelerated growth on top of that. I think that's why a lot of people look at them as the leader in the space even though they're the smaller company.

Feroldi: And they're projecting 77% growth in the upcoming quarter, and a similar growth rate for the entire year. Again, Wall Street is excited by the fact that, one, this market is huge, and two, Fiverr is taking share away from the market leader. I wouldn't have guessed that that was possible two years ago, but Fiverr has clearly said otherwise. So, I completely understand why the valuation differences between these two companies are so stark.

Lewis: Yeah. And I think one other thing that's kind of interesting with the financials is, despite being a smaller business with less operating leverage, Fiverr has better margins. And that's another thing that seems a little anomalous given the size and scale of these businesses.

Feroldi: Yeah. And while Upwork was profitable last quarter, at least on an adjusted basis, Fiverr was not, but it was not profitable by just the slimmest of margins. This company's GAAP net loss was just $0.5 million; again, that was on $42 million in revenue. And on a free cash flow basis, Fiverr actually cranked out $5.6 million in free cash flow in the quarter. It's easy to do that when you have such ridiculous margins already and your business can scale so beautifully.

Lewis: I think it's natural -- you know, we talked through, kind of, where they are and why people are excited about them. For people to say, OK, well, we have these two businesses side-by-side, they operate in the same space, it seems like Upwork is finally, kind of, turned the ship around a little bit and is starting to show some of the growth that people are expecting. Is there one in particular that you're more interested in? And we mentioned before, Brian, that the valuation story is a little bit different for Fiverr, there's a little bit more growth baked into where that company is right now, but when you look at these two companies, do you say to yourself, OK, this is one investable business and one watchlist business or two investable companies in just, kind of, like a basket-style of approach to, you know, someone is going to win elancing, and I'm, kind of, comfortable putting money on both of them?

Feroldi: The good news is, even at these levels, I legitimately think there's room for both of these companies to 10X from here, and they still wouldn't be all that massive. I mean, again, combined, combined these companies market caps are just about $10 billion. Given the trends that we know are happening toward freelance work and just how much room there is for both of these companies to grow, I could easily see taking a basket approach here. However, if I was choosing, I would definitely go with Fiverr, and my money is where my mouth is on that one. I actually purchased shares of this stock last week.

And that's even with the very high valuation difference. I think Fiverr is trading at about 30X sales, Upwork trading at about 9.5X sales. The big difference there is the growth rate and the execution between the two, but yeah, if you want to buy both of these stocks to play it, I'd fully endorse that.

Lewis: Yeah, I own Upwork and we're going to [laughs] talk a little bit about some of the background with me owning Upwork in a second. These are two really good businesses. I don't own Fiverr. I don't think nearly as many things need to go right for Fiverr to continue growing and continue putting up good results. I don't think that they're going to be putting up the outrageous results that they have year-to-date for the rest of the time that they're a public-traded company, I think it would very hard, but a basket approach here makes a ton of sense if you're a believer in the gig economy and, kind of, the decentralized workforce.

I also think, Brian, that these are probably the two most interesting investable ideas in the gig economy space. For as interesting as the gig economy is, we've kind of pooh-poohed Uber and Lyft on the show and talked about how they're just hard businesses. I think what these offer is a lot of the true benefits that the gig economy purports to offer the workers, but also sustainable businesses that aren't squeezing those workers.

Feroldi: Yeah, and just from a margin profile, these two companies are just on different planets than companies like Uber and Lyft. And the jury is still out on Lyft and Uber, the big question that I have about both of those companies is that I think autonomous electric taxi networks are going to be here, I think that Tesla is going to get there first, but I could be wrong about that. But if so, even if that technology takes five or 10 years to get here, how does Uber and Lyft survive that? I don't know the answer to that, and I would not bet on either of those businesses based on that fact alone.

Compared to Upwork and Fiverr, I don't think there's anything out there that's going to disrupt them, in fact, I think both of them are the disruptors. So, I would much rather have my capital in Upwork and Fiverr than Uber of Lyft.

Lewis: It seems a lot easier. If we're talking gig economy investable ideas, I think one other one that could be up there, we don't really know what the full picture for it looks like yet, but Airbnb I think is also a name in this space that probably has a much more compelling business set up than some of the other names we've thrown out there. I don't know if the margins and everything are going to be quite as good as what we've seen with some of these elance companies, but that's one to, kind of, throw on your radar if you're interested in the space as well.

Feroldi: Yeah, I can't wait 'till they come public and we'll definitely do a deep dive on that S-1 once it drops on -- I think we're going to claim that as a tech company, right? [laughs]

Lewis: Oh, yeah, come on! It's a platform play, Brian. [laughs]

Feroldi: Get your hands off, Emily Flippen, we're claiming it on the technology show.

Lewis: [laughs] This is not consumer goods.

Feroldi: No, yeah, that is a company that could definitely be added to the gig economy, and I really look forward to diving in there. The trouble with that one is that they're going to be coming public at likely a tens of billions of dollars of valuation. So, how much growth there is left for public investors will remain to be seen. So, even when they do, I would probably still [laughs] bet on Fiverr and Upwork over Airbnb, but I still want to look at the numbers.

Lewis: So, Brian, as we close out the show, every time I think about my Upwork position, I mentioned I was a shareholder before, I think back to a show that you and I did in, I believe it was November of 2018, we were talking about Upwork and we were talking about DocuSign, and we talked about those two businesses, and as we wrapped up we each weighed in on which one we liked more. You went with DocuSign, you said that you liked the corporate culture, you thought it had better growth rates and you felt like it was better positioned in its industry, and I did not. [laughs] I took Upwork and wound up buying shares of Upwork. Basically believing, smaller business, little bit more room to grow and I liked, you know, what was in front of it in terms of greenfield.

Since that show, Brian, DocuSign is up about 500%, and Upwork is up about 76%. So, I think for listeners, just a quick reminder on who to listen to when we're talking on this show. [laughs]

Feroldi: In that case, I was right one time in a row, Dylan, so let's throw that out there. DocuSign has done absolutely everything right since that came out. They have executed beautifully. Their valuation has grown and rightfully so, and it's just a fantastic business. The good news here is, even if you went with the loser of those two, you're still up 76%, which is a return that crushes the market. So, one, you did better, but you still made money with the other. That's a pretty good outcome.

Lewis: And the beauty, going back to what we were saying about possibly just buying Fiverr and Upwork and, kind of, basketing these, is I own both DocuSign and Upwork, you gave me a compelling pitch on those businesses, and I was into it. I thought there's no reason not to put some money behind both of these ideas.

And the reason I wanted to call in this example, since it was related to Upwork, Brian, is that I think it can also be helpful to kind of walkthrough, we get this question all the time from listeners and viewers is, you know, how do you make decisions on when to add stocks you own. You have them in your portfolio, we talk all the time about getting that initial bitesize and then adding to the position as it proves that it deserves to have more of your portfolio and more of your allocation of your overall money.

Just to quickly walk listeners through how I handled this. I own way more DocuSign than I do Upwork at this point. Some of that is share price appreciation, but I bought both of them in December of 2018, had a small position, kind of, that initial third that I like to get on a stock. And then I basically said, prove to me that you deserve more. And over the ensuing six months, DocuSign did, the growth story continued, and I think shares are up about 40% when I added to it. Upwork didn't, and they for a long time hadn't. We've seen some really strong results recently from them. I think that this is kind of a psyche that people should have when it comes to these decisions of should I add more, when do I add more, all that.

Feroldi: One of the most challenging things for you to do as an investor is to buy something at one price and then buy that exact same thing at a higher price later, it is really difficult to say I could have bought DocuSign at $50, now I have to pay $200 for that same stock, but in many cases what you want to do is add after the stock has gone up a lot, after. Boy! Is that really challenging to do, and it goes against just every fiber of my [laughs] being to learn to do that, but I completely agree with you there.

One of the things that I always try and do whenever I make a purchase is take note of the company's valuation at the time. What's its price-to-sales ratio, what's its price-to-earnings ratio, what's its forward price-to-earnings ratio, what's its dividend yield? Whatever metrics are available to me at the time. And then with my next purchase, I try to buy at a better valuation than my first one, even if the share price is higher. You want to focus on the valuation, not the share price. Now, in some cases, you have to pay a higher valuation, but that's OK if the story changed for the better. So, if DocuSign's growth rate was 30% on my first purchase, and then it skyrocketed to 50%, that justifies a higher valuation, but it's really challenging to add to winners.

Lewis: What I like though, Brian, is in your investing philosophy, in your framework that you use, that's a box that has to be checked, has this company shown share price appreciation in the past, has this been a winning stock, and it's painful to make those additions. But you know, I walked through the DocuSign initial purchase, wound up buying again about 40% up six months later, both of those are multi-bagger positions at this point, and both of them are doing far better than my Upwork position, even though I paid more for that second slug.

Feroldi: Yeah, and that's a lesson that I had to learn the really, [laughs] really, really hard way. I mean, I think I've only purchased Netflix, for example, a handful of times and that split-adjusted ridiculously low prices, and they were recommended by, say, David Gardner many, many times afterwards, but I resisted buying more because the price was higher. Had I followed any of those follow-on recommendations, my portfolio would be worth more today. So, adding to winners is one of the hardest things that I ever had to learn, it's also one of the most important things you can possibly learn about investing.

Lewis: And, you know, to bring it to full circle, where we were originally talking about Fiverr and Upwork, I'm sure there are some people that [laughs] at some point in 2020 bought Fiverr and maybe had a very small position in Fiverr, and are looking at some incredible gains on that stock, because it has just been one of the best performers on the market year-to-date. It would be hard to look at that and say, do I really want to add more? But then you take that step back, Brian, like you were saying before, the valuation for that business, for as much as it's grown in 2020, is still not that big relative to the overall opportunity in front of it.

Feroldi: Focus on the market cap, I mean, that's what I'm trying to do. Yes, you could have bought Fiverr for $20 in January, now it's $180, even despite that tremendous growth in that short a period of time, this is still a $6 billion company. I could see it being a $60 billion company from today. So, in my opinion, even from today, there's 10X return potential over the next 10 years. But wow! Is it challenging to buy something for $180 that could've been bought for $20 just nine months ago.

Lewis: Well, Brian, I know if it does hit on that 10X potential you're talking about, there are going to be a lot of very happy Fools listening and watching the price go up. And so, we can only cross our fingers and hope. [laughs]

Feroldi: We can only cross our fingers and hope, Dylan, that's right.

Lewis: [laughs] Brian, thanks so much for joining me on today's episode.

Feroldi: Any time, Dylan, have a great weekend.

Lewis: You too. Listeners, that's going to do it for this episode of Industry Focus. If you have any questions or you want to reach out and say, "Hey!" shoot us an email at [email protected] or you can tweet us @MFIndustryFocus. Brian is @BrianFeroldi, I am @WilyLewis. If you're looking for more of our stuff, subscribe on iTunes, Stitcher, Spotify, wherever you get your podcasts, we are there.

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 Tim Sparks for all his work behind the glass today, and thank you for listening. Until next time, Fool on!