Upwork's Q4 2021 Results: On Route to Building the World's Work Marketplace
While far from a perfect quarter, Upwork’s Q4 2021 results were solid. Nothing about this quarter has put a dent in their path to long-term value creation for shareholders.
Upwork (NASDAQ:UPWK) is the world’s largest marketplace connecting freelancers and remote workers with businesses who need specialised talent. Since their IPO in October 2018, Upwork has reported consistent 20%+ top-line growth driven by: (a) increasing digitisation of recruitment services, (b) the hiring of Hayden Brown as CEO who brings a clear vision for Upwork to evolve from a simple freelance marketplace that is more ad-hoc and transactional in nature to a recurring enterprise business focused on helping large enterprises manage their distributed workforce, and (c) mainstream acceptance of remote work following the COVID-19 pandemic.
However, despite substantial operational improvements since IPO, Upwork’s share price is only up 17% since their first day of trading and is down 52% in the past 12 months, resulting in a market cap of $3.16b USD. It is astonishing to me that the world’s largest marketplace for freelancers/remote workers has such a small market cap given the enormous total addressable market (TAM) of $1.3 trillion (based on Upwork estimates), but I guess that’s an indication of potential returns to come.
In this article, I dig into the good and bad of Upwork’s recent Q4 2021 results, which were met with a sharp 10% drop in share price (as seems to be the default response for all US companies this earnings season). Mr Market seems to be concerned about increased brand marketing spend, reducing take rates, and widening losses, but I think all of these are short-term concerns with little impact on Upwork’s long-term path to value creation for shareholders. I remain bullish on Upwork and added more shares at $25.35 on 12th February 2022 after first picking up shares back in November 2018.
The ‘Good’ of Upwork’s Q4 2021 Results
1) Continued strong growth in gross services volume and revenue
In 2021, Upwork reported gross services volume (GSV) of $3.5b (+41% YoY growth) and revenue of $503m (+35% YoY growth). As has become the norm since Hayden Brown became the CEO in January 2020, Upwork reported Q4 revenue of $136.9m, which was well ahead of their guidance released to the market of $130-132m.
If we take a step back and look at Upwork’s medium-term top-line growth, we can see that both GSV and revenue have grown consistently since Q1 2018, with a clear acceleration in growth rates during the COVID-19 pandemic. GSV has compounded at 28% per annum (pa) since Q1 2018 and 34% pa in the past two years since Q4 2019.
Revenue has compounded at 25% pa since Q1 2018 and 31% pa in the past two years since Q4 2019. Thus, 35% revenue growth in 2021 was above their historical average growth rate, benefiting from COVID-induced demand for remote workers.
2) A meaningful upgrade in medium-term revenue guidance
Around six months ago, Upwork put forth medium-term revenue guidance of $1b by 2025. In this latest quarter, Upwork upgraded this guidance and now expects to achieve $1b in revenue by 2024, which would represent a revenue compound annual growth rate (CAGR) of 25% over the next three years. This is a very bullish forecast and flies in the face of those who believed that Upwork was a ‘COVID stock’ and would return to mid-teen percentage growth rates once COVID-19 lockdown measures were wound down.
Consistent with this medium-term guidance, Upwork forecasted 23-25% revenue growth in 2022. Given their track record of beating internal guidance released to the market, I would expect Upwork to report 2022 revenue growth above 25%.
3) Strong growth in active clients and accelerating GSV per active client
The two core metrics that fuel GSV for Upwork are: (a) number of active clients and (b) spend per active client. As investors, we want to see both of these metrics trending higher, providing a powerful tailwind for Upwork to increase GSV and therefore revenues.
In Q4 2021, Upwork reported 771,000 active clients (+3% QoQ; +22% YoY), which is a solid headline number, but a slight deceleration from the prior two quarters on stronger comps. However, when we dig beneath the surface and look at larger clients, active client growth rates are much more impressive. The number of clients spending > $100,000 annually through Upwork grew 51% YoY while those spending > $1,000,000 annually grew at 61% YoY. Thus, Upwork is reporting solid growth in their overall client base, but seems to be finding excellent product-market fit with larger organisations.
After eight consecutive quarters of decelerating growth in GSV per active client, Upwork seems to have reversed this trend after reporting three consecutive quarters of accelerating GSV per client. Indeed, this 15% YoY increase in GSV per active client marks the highest reported growth rate since Q1 2019.
And Upwork does not expect this trend to reverse. In the Q4 conference call, CFO Jeff McCombs noted:
“We’re pleased that our average spend per client is up 15%. That being said, it’s still in the $4,000 range. We think there’s significant opportunity to continue increasing that for many years to come.”
4) Building out their product pipeline to service client needs
I have a lot of respect for CEO Hayden Brown. She rebuilt Upwork from a drudging marketplace focused solely on freelancers to one that is becoming the centralised platform for large enterprises to manage their distributed/remote workforce. See the following comment from Upwork’s Q4 shareholder letter:
“2022 is the year that Upwork takes the next steps in evolving from being the largest global freelance marketplace, as measured by GSV, to broadening our horizon as the world’s work marketplace. Our focus has evolved because the world has evolved. The old binary notions of “freelance” versus “full-time employee” work are being revisited in a world where remote work is rampant.”
Consistent with this strategic shift, Upwork has expanded their product pipeline over the past 12-24 months to better service their client needs and expand their TAM. Here’s a brief description of two of their newer product offerings:
Project Catalog allows freelancers to pre-package a task (e.g., design a business logo) and sell it to clients for a pre-determined price off the shelf (e.g., $50 USD). For those who are familiar with the Australian local services marketplace, Airtasker (ASX:ART), this is a similar concept to their ‘listings’ product. You can read my previous articles on Airtasker here and here. Project Catalog acts as a low-risk and low-friction onramp for businesses to become familiar and develop trust with Upwork before seeking other products, like their Talent Marketplace or enterprise solution.
In their Talent Scout product, Upwork acts as an intermediary connecting enterprises with specialised recruiters who are able to provide a list of pre-vetted talent to meet their unique business needs. In Q4, the average time taken to deliver a talent shortlist to clients decreased 30% QoQ, so Upwork appears to making significant progress at making Talent Scout a more compelling and efficient customer experience.
These above products all complement Upwork’s core Talent Marketplace product which is the traditional ‘post and hire’ model where businesses post a job/task that needs completing and then screens potential applicants for that job.
5) Continued traction with enterprise clients
Upwork’s enterprise product helps large enterprises manage their distributed workforce through recruiting, payroll, and onboarding solutions. As investors familiar with B2B SaaS business models will know, enterprise revenue tends to be more recurring in nature, and acts as a nice complement to the more ad-hoc and transactional nature of Upwork’s other products, such as Talent Marketplace or Project Catalog.
In 2021, Upwork reported enterprise revenue of $34.9m, which was up 73% from 2020. Based on this growing traction, Upwork management laid out ambitious medium-term guidance for enterprise revenue to reach $300m by 2025, which represents a revenue CAGR of > 70% over the next four years. Thus, while enterprise revenue only accounted for 7% of Upwork’s total revenue in 2021, it should become a much more meaningful contributor over the next few years.
If we assume that Upwork meets both their forecasts for $1b revenue by 2024 and for enterprise revenue to compound at a 70% CAGR over this same period, enterprise revenue should account for 17% of Upwork’s revenue in 2024. Given that enterprise revenue is more recurring and higher margin than non-enterprise revenue, a higher proportion of total revenue coming from enterprise revenue will be accretive to both gross and EBITDA margins.
6) Drop in share price means an attractive valuation for investors
Upwork shares are down 52% in the past 12 months despite accelerating top-line growth. As of 20th February 2022, Upwork trades at < 5x forward EV/sales and < 7x forward EV/gross profit, which is at the lower end of their historical valuation range.
This seems an attractive valuation for long-term investors. Upwork compounded revenues at 25% pa from 2018-2021 and is expected to continue to report similar growth rates until 2024. Since 2018, gross margins have expanded from 67% to 73%. Adjusted EBITDA margins have also increased from 1% in 2018 to 4% in 2021, despite significant increases in marketing spend and research and development to build out new products.
Upwork’s most direct valuation comparable is Fiverr International (NYSE:FVRR) which is down a whopping 75% in the past 12 months. Similar to Upwork, Fiverr reported outstanding 2021 results with revenues increasing 57% to $298m, gross margins of 83%, and adjusted EBITDA margins of 8%. However, 2022 guidance for revenue growth of 25-27% (on par with Upwork) and flat adjusted EBITDA margins sent some investors running for the hills. As of 20th February 2022, Fiverr trades at < 7x forward EV/sales and around 8x forward EV/gross profit.
Market Concerns about Upwork’s Q4 2021 Results
1) Increased brand marketing spend
In Q4 2021, Upwork spent $17m on brand marketing, which was up from $8m in the prior quarter. I know Upwork isn’t a household name with the same level of recognition as renowned D2C brands like Tesla (NASDAQ:TSLA), Apple (NASDAQ:APPL), or Chipotle Mexican Grill (NYSE:CMG), but I was surprised to learn that Upwork’s unaided brand awareness is less than 10%. The fact that Upwork has achieved so much success to date with such poor brand awareness is a testament to the secular tailwinds driving adoption of remote work.
“Our unaided brand awareness amongst our target clients is in the single-digits. And we imagine how much bigger our business can be if we are able to double or triple that awareness.” (Hayden Brown, CEO)
As such, Upwork is going to be ramping up their brand marketing spend in 2022 to around $80m, up from $47m in 2021. To oversee this increase in brand marketing spend, Upwork hired Melissa Waters as their new Chief Marketing Officer in January 2022. Melissa is an accomplished executive with prior experience as the Global VP of Marketing at Instagram (NASDAQ:FB), as well as executive marketing roles at other D2C companies like Hims and Hers (NYSE:HIMS) and Lyft (NASDAQ:LYFT).
While it takes time to reap the benefits of brand marketing, Upwork mentioned in their Q4 shareholder letter that they are “pleased by the early signals that we are seeing”. While Mr Market seems to be selling down all unprofitable companies reporting increased operating expenses in 2022 (ironic given that Mr Market rewarded these companies throughout 2020 and most of 2021), I am comfortable with Upwork’s increased brand marketing investments in 2022, given their low brand awareness.
I am also comforted by the fact that Upwork seems to be taking a very data-driven approach to their brand marketing:
“We are absolutely taking a test and learn approach. We want to understand what works best across reach and frequency by geo, by channel, all of those different intersections. And as we get those learnings, we’re going to move the dollars to the areas that are performing well, and move them away from the areas where we’re not getting the target performance.” (Jeff McCombs, CFO)
2) Another quarter of reduced take rate
Upwork reported another successive quarter of reduced take rate, dropping to 14.0% (down from 14.2% in Q3 2021 and 14.6% in Q4 2020). While a declining take rate is not a good sign for a marketplace business, it is important to understand the context behind this drop. Take rate is inversely correlated with GSV per active client; as large clients spend more through Upwork, their service fee decreases, which results in a lower take rate for Upwork.
Upwork explained this phenomenon in their Q4 shareholder letter:
“More higher-value relationships being built on Upwork and higher spend per client results in a larger percentage of business activity on the platform being priced at the lower rates of our tiered service fee structure.”
However, all hope is not lost. Upwork expects to reverse this trend and increase take rate in 2022 as non-core marketplace products become greater contributors to overall revenue. See the below excerpt from Upwork’s Q4 shareholder letter:
“Enterprise, Project Catalog, and Talent Scout have take rates that are higher than those of the rest of our business. If these offerings continue to grow faster than the rest of our business, they will provide a positive impact on take rate over time.”
Given their forecast for 70%+ CAGR in enterprise revenue and the initial success of Project Catalog, I am confident that management can meet their guidance and expand take rate in 2022.
3) Widening net income and adjusted EBITDA losses
On a GAAP basis, Upwork is not profitable and never has been for more than a single quarter since IPO. In Q4 2021, Upwork reported a GAAP net loss of -22.6m (vs. net income of 0.9m in Q4 2020). Total GAAP net loss for 2021 was -56.2m, which expanded from -22.9m in 2020, due to increased investments across all areas of the P&L.
In line with their guidance, Upwork also reported their first quarter of negative adjusted EBITDA since Q2 2020 with adjusted EBITDA of -3.3m. However, the thing that seemed to concern investors was that Upwork expects adjusted EBITDA to be breakeven in 2022 due to increased investments in “brand marketing, performance marketing, and sales”. This comes after reporting $19.1m adjusted EBITDA (4% margin) in 2021. Management also expects stock-based compensation to increase from $54m in 2021 to more than $80m in 2022. In this market climate, companies guiding for widening losses and increasing stock-based compensation are being met with complete and utter disdain from investors, leading to some sharp drops in share price.
While widening losses can be frustrating in the short-term, Upwork laid out a clear path to achieving 30-35% adjusted EBITDA margins at scale and has a net cash position of > $120m, enough to withstand another 12-24 months of losses before needing to tap the capital markets. However, it is possible that Upwork announces another capital raising in the next 12 months, although I imagine this would be met with a lukewarm reception from investors in the current climate.
Gross margins can expand to > 80% through an increased contribution from enterprise revenue and other products like Project Catalog. Research and development, and general and administrative costs have been either flat or trending down since 2018 towards Upwork’s long-term target, despite continued investments in building out their product pipeline.
The trend for increased sales and marketing spend is the main concern I have about Upwork and I expect this 2022 number to be > 35% of revenues, which is unsustainable in the long-term. I expect that if Upwork is able to increase unaided brand awareness to their 20-30% target, sales and marketing costs should trend down towards their 20-25% long-term target.
I urge investors to also keep track of Upwork’s stock-based compensation. While stock-based compensation can be helpful to attract talent and reduce cash burn, excessive shareholder dilution is not something I like to see as an investor.
Conclusion
While far from a perfect quarter, Upwork’s Q4 2021 results were solid. Revenue was well ahead of guidance while adjusted EBITDA losses were in line with guidance. Nothing about this quarter has made me doubt whether Upwork will be a long-term winner. However, investors will need to exercise patience when evaluating the success of their brand marketing campaigns and to endure the share price volatility associated with being an owner of unprofitable technology stocks in the current climate.
As mentioned earlier in the article, I bought more Upwork shares after their recent sell-off post-earnings release at a purchase price of $25.35 and will continue to purchase more shares over the coming quarters if the following conditions are met:
Upwork continues to exceed their revenue guidance.
Take rate begins to rise or at least remains flat on a QoQ basis.
YoY enterprise revenue growth is above 60% (and ideally above 70%).
Upwork reports accelerated growth in active clients and/or quantitative metrics indicating increases in brand awareness from their investments in brand marketing.
Best,
Jordan