Let's Go Bottom Fishing With an Activist-Pressured, Low-Priced Stock
We're betting that pressure can enhance the appeal of this already reasonably valued small-cap name. Here's the play.
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Today, we are lining up a covered call trade idea around a low-priced stock that has been under a lot of pressure lately: Upwork UPWK.
Who the heck is Upwork, you say?
This San Francisco-based small-cap company provides and operates a platform that enables the entire freelance work process, including communication, engagement and secure payment processing.
The company's shares have lost approximately a third of their value so far in 2024. This is certainly understandable given the clear deterioration in the labor market throughout the summer.
However, at current trading levels, the stock offers a solid value in what is increasingly becoming an overbought market. Indeed, the shares have become compelling enough that an activist investor, Engine Capital, has recently accumulated a 3.5% stake in Upwork. The new investor is pushing for board changes as the company has underperformed its closest peer Fiverr FVRR.
Engine Capital notes that Upwork has roughly $140 million in net cash, and combined with expected free cash flow over the next three years, it has $575 million of capital that could be more efficiently deployed. The company's current market cap is around $1.2 billion, to put that in perspective.
UPWK currently trades for just over $10 a share. Last quarter, the company used almost the entire $33.5 million of free cash flow generated during Q2 to buy back stock.
Upwork is seeing considerable headwinds in its services business, but the company is nicely profitable. It made $0.52 per share on $689 million of revenue in 2023. The company is expected to earn just north of $0.90 a share in 2024 on sales of $740 million. Currently, the analyst firm consensus has Upwork making $1.07 a share in 2025 on revenue growth of 6%.
Upwork beat bottom-line expectations with its second-quarter numbers when it posted results on August 7. Revenue grew more than 14% on a year-over-year basis, which was in line to the consensus. Management did lower 2024 guidance, primarily because of the challenges its small business clients are currently facing. The company is seeing a huge pickup in AI-related work (up 67% year over year), although that is off a small base.
I am hopeful Engine Capital is successful in spurring meaningful changes at Upwork. I would much prefer the company use its free cash flow to pay down outstanding long-term debt than buy back shares. Upwork certainly has the cash to do so.
The stock is trading at its lowest price-to-sales ratio in the past five years. And analyst firms have largely maintained their faith in Upwork despite the recently lowered full-year guidance for 2024. Seven firms, including Goldman Sachs GS and BTIG, have reissued Buy ratings on the stock since second-quarter results hit the wires. Price targets proffered range from $13 to $20 a share.
Activist pressure is welcomed, but even without it, we believe the shares look more than reasonably valued. A covered call trade provides some additional downside protection and should generate a solid return.
Option Strategy
This is how one can initiate a holding in UPWK with a covered call order. As a reminder, covered call orders involve buying an equity and simultaneously selling just-out-of-the-money call strikes against the new position.
Using the April $10 call strikes, fashion a covered call order with a net debit in the $8.35 to $8.45 a share range (net stock price - option premium).
This strategy provides downside protection of around 17% with upside potential of 19% even if this stock falls a bit from here over the next seven months.
At the time of publication, Jensen was long UPWK.
