Adyen: Get On The Train Before It Leaves For Good (OTCMKTS:ADYEY)


Adyen (OTCPK:OTCPK:ADYEY) is a payments company attempting to untangle the Hydra that is the payments industry. Their strategy so far has been to turn the problem on its head—creating a seamless, global solution that integrates an array of critical functions into a single stack, making the merchant and customer experience as simple as possible.

The company’s disciplined path to growth has been inimitable, and while the numbers are already quite impressive, the more they scale, the faster the flywheel they’ve developed will continue to turn.

Let’s dive in.

Understanding Payments

When the Collison brothers were raising money to start Stripe, they were greeted with “this is … a solved problem. Aren’t there already ways to accept money on the internet?”. The truth is diametrically opposed, and for all the technological progress we’ve made as a species in recent years, payments is still an inefficient and immature market that has become increasingly fragmented over the years. Sending money should be as easy as sending a WhatsApp message, but reality stands in stark contrast.

Before diving deep into the Adyen thesis, it’s important to understand what the company does and how it fits into the exceedingly complex payments landscape.

Let’s take the following example that most people can relate to: say you want to buy a sandwich. Simple stuff, right? All you have to do is go to Subway, customize your order, pay for your combo and you’re out of there in more than 10 minutes (it’s called fast food for a reason, you know). The quickest part of this process is actually paying for your food, but there’s a lot going on behind the scenes in order to make that happen.

This backstage crew is comprised of six characters, who play the following roles in our example:

  • Account Holder: Your famished self yearning for a warm sandwich.
  • Merchant: The seller of warm sandwiches.
  • Acquirer: The merchant’s bank (also referred to as the “Merchant Bank”).
  • Card Network: The rails on which the flow of information travels, connecting the Acquirer and the Issuing Bank.
  • Issuing Bank: Your bank (the one that gave you that credit card).
  • Payment Processor: Usually companies that Acquirers contract to provide point-of-sale (“POS”) terminals and actual payment-processing capabilities. In this case, Citibank’s processing is executed by First Data (FISV).

The actual mechanics are as follows: you swipe your card on the Subway’s POS terminal, the information is sent to Citibank, who in turn needs to use Visa or Mastercard’s electronic network to get in touch with your personal bank (Chase) to see if you’re good for your $8.69 BBQ Chicken Footlong.

If Chase approves the credit check, it sends the information back through the Card Network to Citibank and Subway, relaying that the sale can go through. Since this particular transaction was on credit, you (the account holder) have 30 days to pay back your Issuing Bank (Chase). The process is the same for debit transactions, the difference being that the Issuing Bank is checking whether you have the necessary funds to buy that pricey sandwich, rather than scanning for signs of fraud. Consider that this process takes all of 3 seconds.

For more visual learners, the ensuing illustration shows how everything comes together.

(Source: Curious Capital)

For simplicity’s sake, we won’t go into all the details about how the transaction pie is distributed, but the overall lesson is that Chase is the bearer of risk in this chart, and thus takes the largest share out of everyone involved (2%). This makes intuitive sense because they’re liable for the actual money. As a result, Citibank pays an interchange fee to Chase to compensate for the credit risk. If we zoom out of this singular example, we can see that Issuing Banks are responsible for trillions of dollars being moved around and billions of transactions happening at the same time, further reinforcing their claim to such a large take rate coupled with credit card interest rates meant to incentivize people to pay on time.

We mentioned payment processors beforehand. While some banks do have processing capabilities, a majority opts to entrust this function to specialized companies such as First Data, NCR Corporation, and Global Payments, among others.

Adyen, conversely, does both.

(Source: Curious Capital)

Simplicity is the Ultimate Sophistication

Adyen has bundled together the full payments stack in an effort to solve the industry’s largest paint point: payment authorization. According to the company, 1 in 5 payments is declined worldwide. Having appreciated the risks involved, it is only natural for companies to err on the side of caution. However, the system’s implied friction is mostly harming merchants, since customers who can’t complete their purchases are deterred from ever trying again.

Essentially, the company is selling convenience, efficiency, and cost-optimization by performing an array of key operations (gateway, risk management, processing, and acquiring) on a sole platform and cutting out multiple third parties in the process.

(Source: Adyen)

The company targets large international merchants and has already amassed an impressive roster of clients that include Spotify (SPOT), Uber (UBER), Booking.com (BKNG), Microsoft (MSFT), and Nike (NKE), among others.

Rather than try to do too many things, ADYEY has been laser-focused on doing one thing really well. From its outset, it’s been very clear about its target market (large enterprises) and the paint points it’s trying to ameliorate.

Patrick Falk, Payments Product Owner at Spotify, says that “with Adyen’s risk management solution, we decreased chargebacks by 70%”. This translates into millions of dollars that companies can reap that they were previously missing out on. Adyen stands apart from the rest of its clunky competitors as a result of its vertical integration, providing a smoother experience across the crux of the payments stack.

As opposed to Square (SQ) and Shopify (SHOP), who target the entire scope of merchants, Adyen continues to focus on large enterprise customers. The name of the game is thus retention, as the universe of these types of clients dwarf in comparison to the overall business pie. Yet, since the company’s IPO in 2018, its volume-based churn has notably averaged less than 1%, highlighting ADYEY’s devotion to keeping its current suite of customers happy.

Ultimately, this results in four key benefits: global reach, unified commerce, centralized data, and ongoing innovation.

(Source: Adyen)

Adyen’s commitment to simplifying the complex has reaped dividends. By using a single code base and a distributed stateless architecture, the company has demonstrated an ability to grow at scale. For the first half of 2020, the company’s processed volume amounted to over €129 billion.

(Source: Adyen)

There’s also an implied alignment of interests between Adyen and its client base. In other words, the company has to continue evolving to accommodate its clients newfound needs, something that has been exemplified by the Adyen’s claim as a “future-proof partner” to its merchants. By offering a single contract, one integration for all countries and channels, a singular overview of payments, Adyen has further empowered its merchants to expand their global footprint without running into commerce-related headaches.

Regulation

Adyen has illustrated an uncanny ability to navigate regulatory hurdles that have previously served as a deterrent to new entrants. Where others saw a hindrance that fostered waves of acquisitions by large players rather than developing the technology themselves, Adyen identified an opportunity to stay nimble through its vertical composition.

The company already has regulatory licenses in Europe (banking) and the USA (money transmitter) and scheme licenses in Europe and APAC to act as an acquirer. In addition, its acquired licenses via BIN sponsorship in the US, Canada, and Brazil.

(Source: Adyen)

Investment Thesis

The last few months have seen an increase in digital adoption that was previously unforeseen. Companies have reached e-commerce targets that they anticipated for 2023 and beyond.

The payments industry has been no exception. Craig Vosburg, President of North America at Mastercard (MA), expressed the shift in consumer behavior at the Citi 2020 FinTech Conference:

One of the things in my experience that’s hardest to change in payments and introducing new things in payments is changing consumer behavior. Consumer behaviors tend to be fairly sticky, particularly when the things that they’re doing already work reasonably well.

What we’ve seen over the course of these last few months since the pandemic struck is a fairly dramatic change and a rapid change in consumer behavior that I think will have lasting impact on some structural issues in the payments industry.

Contactless cards had already risen in popularity in more developed economies, a trend that will certainly continue to compound as people have gained an increased awareness of hygiene and how germs can spread. Sweden was already well on its way to becoming the world’s first cashless society, with merely 1% of the country’s GDP circulating in cash. Cash has been dethroned, and while justified fears had emerged at the risk of potentially excluding a plethora of people from the economy, the need to go cashless will force central banks and governments to do so in a responsible manner. Pre-COVID projections estimated that cash would soon represent 1 in 10 of total payments (vs 6 in 10 a decade ago).

(Source: UK Finance, UK Payment Markets 2018)

Vosburg shared that the surveys the company conducts have underscored these new sorts of behaviors, with “70% of consumers saying they expect to continue or even increase their level of digital end e-commerce shopping”. According to ADYEY’s Q3 results, this holds up. In-store volumes within retail rebounded to pre-pandemic levels and were stable throughout the quarter, despite most merchants not yet operating at full capacity.

This all ties into secular tailwinds that are driving the shift in how consumers are purchasing, rather than what they’re buying. The digital proposition is inherently more attractive, not to mention more flexible. It is no surprise that the surge of Buy Now, Pay Later (BNPL) companies have had so much success.

Adyen has been at the forefront of innovation since inception. Almost out of necessity, management has demonstrated a prescience to identify trends both on the supply and demand side, with local insights into demographic shifts, and evolving consumer behavior. Its geographic expansion has been disciplined over its fourteen-year history, only just recently accelerating via the company’s entrance into Latin America’s biggest economies and into the Middle East by way of opening its Dubai office.

Over a three-year span (2015-2017), LatAm and APAC were the fastest growing regions, growing at annualized rates of over 130%. The company has been extremely successful in broadening its global footprint, as it has diversified its revenue across geographies. For instance, as of year-end 2019, North America, LatAm, APAC, and the Rest of the World, accounted for 35% of Net Revenue, as opposed to just 17% in 2015.

(Source: Adyen)

Whether its enabling merchants to expand their operations abroad or completing the switch from offline to online, Adyen provides a turnkey solution that empowers merchants to devote their time to actually running their businesses.

The company has been run profitably since 2011 (a rare feat for a FinTech company), is entirely equity-financed and has no long-term debt on its balance sheet.

Such is the extent to which Adyen has developed a streamlined payment process that one needs not look any further than eBay’s (NASDAQ:EBAY) definitive departure from PYPL. eBay announced the partnership by highlighting its intent on improving its customer experience, both for buyers and sellers. Before being spun out into its own entity, PYPL was eBay’s default processor following the company’s acquisition in 2002. As PYPL has been relegated to being merely one of the payment options on the virtual marketplace, Adyen will be receiving the bulk of the company’s volume as its default processor.

Ironically, Adyen recently announced a partnership with Affirm, spearheaded by Max Levchin, one of PYPL’s founders. Efforts like these underscore management’s shrewdness given these efforts instantly grant Adyen access thousands upon thousands of merchants who might be later labeled as either an enterprise or mid-market client.

Quantifying the Business

The company reports both gross and net revenue. Net revenue is what management has identified as a key performance indicator (“KPI”) as it is revenue net of interchange, scheme, and card network fees. In other words, net revenue is the company’s gross margin.

Scale is key for Adyen. So much so that management stresses that its take rate is not a driver of its business—the focus lies on “onboarding volume at scale”. Processed volume has increased 26% YoY, Net Revenue 25%, and EBITDA 24% YoY at a CAGR of 23.5%, 21.2%, and 21.6%, respectively.

(Source: Adyen)

Adyen’s LTM net revenue comes to $449 million on $3.45 billion in gross revenue, or 13% gross margins. Consider the following juxtaposition: Costco (NASDAQ:COST) has had historically low gross margins—13.2% LTM to be exact—because memberships are where it really makes its money. Yet, there’s an important difference in ADYEY and COST’s business models: tangible vs intangible goods. While COST has to buy inventory, store it, distribute it, display it and then sell it, ADYEY is simply moving digital money through its digital infrastructure. At scale, there’s little to no incremental capital involved.

This is further illustrated by ADYEY’s Net Property, Plant, and Equipment making up 5.16% of its revenue, while Costco’s is 3x larger at more than 15%.

Moreover, the company is able to generate monster cash flows due to its high margins, minimal CapEx requirements and low working capital needs. EBITDA margins for last quarter were at a staggering 60%. Additionally, free cash flow conversion stood at 95% for the quarter.

Valuation

The stock is up ~170% YTD. While some may argue that the stock is expensive, Adyen’s playing the long game. As they continue to scale, I fully expect them to monetize in a more meaningful way, especially in untapped markets where it’s only just venturing into.

Compared to its peers, Adyen (incredibly) does not appear to be an outlier. Shopify is an excellent example of a business that continues to delight investors as a result of its excellent management, continued growth, and consistent execution. ADYEY is cut from the same cloth, and as industry and global tailwinds continue to drive payments forward, the company is poised to consolidate its position as the leader in payments for enterprises.

Ticker Name NTM TEV/REV NTM TEV/EBITDA NTM P/E NTM MC/FCF
ADYEY Adyen N.V. 58.85x 102.91x 150.64x 116.56x
SHOP Shopify 30.39x 226.42x 253.87 213.56x
STNE StoneCo Ltd. 24.53x 43.71x 70.57x 55.58x
SQ Square, Inc. 6.79x 136.59x 178.51x 338.30x
PYPL PayPal Holdings, Inc. 9.06x 31.74x 45.33x 37.47x
FOUR Shift4 Payments, Inc. 3.04x 22.12x 128.79x 42.67x

(Source: Tikr)

SQ’s impressive quarters are cloaked by their increasing reliance on Bitcoin to boost their top line.

While not currently in its cheapest iteration, investors bestowed with the virtue of patience will be rewarded in the years to come—this is a winner that keeps winning.

Bear in mind that Adyen has also been run profitably for some time. This is a key difference that not too many high-flying stocks can advertise these days.

Risks

  • Competition: The payments industry has long been attractive for players bold enough to attempt to slay the dragon. As some of Adyen’s peers have gained expertise in their respective niches, the company could one day fall victim to its own deposition—much like eBay before it.
  • Card Networks: As we discussed, these companies act as tollbooths of commerce. Were Adyen’s relationship with these companies to significantly deterioriate or infringe upon their terms in any specific jurisdiction, Adyen could potentially lose access to entire geographies.
  • Concentration: Given Adyen’s target market, it is particularly prone to a few large clients producing significant portions of its revenue. As of year-end 2019, the company’s top 10 merchants accounted for 33% of revenue (vs 47% in 2018). Were these companies to shift their business elsewhere, Adyen processed volumes and net revenues would be significantly affected.
  • International Expansion: Over the years Adyen has successfully penetrated new markets, establishing partnerships with local players where it does not yet enjoy expertise. In entering historically-challenging markets, there’s no guarantee that Adyen’s expansion will prove fruitful.
  • Regulation: The company has long maintained its stance on embracing regulation. However, Adyen does run the risk of regulation cutting it out from successfuly operating in certain geographies or even being forced to divest some of its business.

Conclusion

Adyen’s meteoric rise is enough to make even the most seasoned investor that this particular ship has sailed. Nonetheless, we disagree. The company has been firing on all cylinders, while manifesting that its ambitions extend far beyond its current zenith.

After all, Adyen is dabbling in a $21 trillion market, so while there’s room for competition, and its single global platform has been a trailblazer for its specific niche, there’s a long way to go.

Management has stayed true to its long-term mindset, guiding to grow net revenue by achieving a CAGR between the mid-twenties and low-thirties. A bold statement, but one not worth making if you’re not extremely confident of being proven right.

Adyen outlined a very clear, specific vision since its founding. Their self-imposed constraints have been freeing, setting them on the path to solving payments once and for all. Their Kaizen-like approach has evolved the business over the years, expanding its offering while continuously improving along the way.

And they’re just getting started.

Thanks for reading.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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