Description

I am long Adyen NV (ticker ADYEN NA).  It is sensible to address the elephant in the room immediately.  This is a recently-listed company with a stock price that is up more than 150% from the IPO price, and a headline LTM P/E multiple of 140x. It is covered by over 20 sell-side analysts.  On the surface, does not sound very promising.

However, in my view, Adyen’s current price (~ €625 per share; market cap of approx. €18 billion) is too cheap relative to the long-term FCF-generating power of the business.  That power rests on a high quality business model, capable (founder-led) management executing well, and exposure to some of the fastest-growing areas in global payments. Adyen is attacking a massive global market with an approach which I believe is superior to that of its competition.  My DCF produces a fair value north of €1,000 per share (60%+ upside). Over the long-term, I expect an investment in Adyen to deliver a decent money multiple and a reasonable IRR.

Introduction and public history

Adyen is a global payments company based in Amsterdam and traded on the Amsterdam stock exchange.  It was founded in 2006 by experienced Dutch fintech entrepreneurs Pieter van der Does and Arnout Schuijff, along with a small team of co-founders after they sold their prior payments business Bibit to RBS for $100 million in 2004.  RBS’s payments business was since sold to PE under the name Worldpay in 2009 for £2 billion, taken public in 2015 at a market cap of £5 billion, and then merged with Vantiv in 2018, with that combined business currently trading at a market cap of $30 billion.  Around the time of Worldpay’s IPO, van der Does stated that Bibit is essentially at ‘at the heart’ of Worldpay.

After selling Bibit, in 2006 van der Does and Schuijff recruited a small team of ex-colleagues from Bibit/RBS with a goal of launching a start-up and building a new, end-to-end payments platform from scratch using cutting-edge software, free of the technical debt that comes from having to rely on disparate, often decades-old infrastructure of the banks. They named their new venture Adyen (Surinamese for “starting over again”).  By 2009, the team has finished building out the core of Adyen’s technical platform and landed its first large global merchant, Groupon. In 2011, Adyen raised its first external financing round from Index Ventures (quoted at < $50 million in Crunchbase) and in 2012, Adyen received a pan-European acquiring license and accelerated global expansion (opening offices in the US and other European cities). Adyen was also already solidly profitable around 2012/2013.   In 2014-2015 Adyen raised $250+ million through 2 financing rounds led by the Singaporean sovereign wealth fund, ICONIQ (Mark Zuckerberg’s family office), General Atlantic, Felicis Ventures and Index, reaching unicorn status. The company continued to rapidly expand, adding risk management products, a POS product, gaining acquiring licenses in various territories (with Brazil and Singapore ending up being particularly important for Adyen’s growth on new continents). In 2017, Adyen’s annual processed transaction volumes (TPV) exceeded $100 billion for the first time.  Gradually, Adyen’s client list grew to include high-profile logos like Uber, Facebook, Netflix, Spotify and Booking.

Adyen went public in June 2018.  This was a purely secondary offering.  No new shares were issued as the company had already been profitable and FCF +ve for many years.  The IPO was priced at €240/sh, valuing the company at €7 billion; 13.7% of the existing share count was sold in the IPO.  van der Does and Schuijff respectively sold 12% and 30% of their stock in the IPO. Their remaining combined stake is around 10% of the company, and other insiders & employees currently own another ~15%.  The price action on the first day was peculiar, as the stock closed above €500/sh (up more than 100%). In the months after the IPO, the stock peaked at €738 (in September 2018, just before the start of the recent market turbulence), and then dropped as low as €411 around Christmas (close to lock-up expiry).  The stock is now around €625.

Adyen reports semi-annually; 2H / FYE Dec 2018 results were released last month and came in well-above sell-side expectations across the board (as has the inaugural report from 1H 2018 in August 2018), but the management is consistently conservative and thus far has refused to provide any material guidance beyond the medium-term goals issued at IPO (“55% long-term EBITDA margins; mid-20% to low-30% net revenue CAGR over the medium term; capex / net revenue of 5%”).  

I count 22 sell-side analysts that cover the stock; there are 7 ‘buy’ recommendations, 10 ‘hold’s and 5 ‘sell’s. From what I can see, these analysts appear to be Europe-generalists, often also covering the closest European ‘comp’ Wirecard (WDI GY; 70%+ ‘buy’-rated by broadly these same analysts) as well as other Euro companies with questionable relevance to Adyen e.g.  industrials such as ASML & Infineon and Euro software & IT service companies such as Atos, Capgemini, SAP and Sage.

Business overview

Adyen enables merchants to accept and process electronic payments via online, POS and mobile channels.  89% of Adyen’s processed volume (TPV) is online/ecommerce, and 11% is point of sale (POS). Adyen’s internally developed, in-house ‘single platform’ serves as the online gateway, merchant acquirer and processor throughout.   The figures below express the typical electronic payments value chain as well as Adyen’s role:

This integrated platform gives Adyen some structural advantages, which Adyen expresses via: 1) Demonstrating incremental margins that are far in excess of what is currently being achieved by incumbent competitors; 2) Electing to attack the market via a volume-based tiered pricing approach which is attractive and transparent for clients. For instance, Adyen’s gross and net take rates of 100 bps and 22 bps compare favorably vs Wirecard at 139bps gross and 80 bps net, and Worldpay at 100 bps gross and 30 bps net in ecommerce; the numbers for the likes of PayPal and Square are even higher (though their products are not as comparable).  Adyen’s advantage allows it to be public about its take rates, whereas peers tend to be somewhat cagey and only disclose it periodically in various forums; 3) Speed of innovation, with Adyen’s feature cycle reportedly measured in days and weeks rather than months. Adyen was proud of the fact that it was the first to roll out a compliant PSD2-specific payments product in Europe recently. Adyen also refuses to implement customer-specific customization and if a customer in a specific vertical requests a new feature, Adyen rolls it out to all the clients in that vertical. 4) Adyen’s choice to initially expand by primarily targeting very large merchants who are not only high-volume and global but also very demanding technically (settlement times; fraud false-positives; data analysis), resulting in Adyen becoming a fairly global business over a very short period of time relative to how long it took for competition to expand globally (some, such as Square or PayPal’s Braintree, are far less internationally diversified than Adyen), and also a lot more e-commerce focused (i.e. contrast with Square’s primary focus POS and SMEs).

Adyen’s key financial metrics are profiled below:

There is some additional nuance to the above numbers which is important and broadly positive:

• The majority of the incremental TPV in FY2018 is from merchants who were already existing clients as of Dec 2017, demonstrating the ongoing rapid growth in the respective underlying ecommerce businesses of Adyen’s top customers (i.e. the likes of Uber, AirBnB, Netflix and Spotify) as well as the rhythm of Adyen’s evolving relationship with new clients. When Adyen wins a new client, if that client is sizable, usually Adyen initially only starts off with a portion of that client’s business and Adyen’s share rises over time.  For instance, Deutsche believes that Adyen’s share of its top 10 clients’ TPV was 51% in 2017 and that this has potential to increase to 70% over time. To me, that does not sound crazy. For instance, Spotify disclosed in its IPO F-1 that Adyen powers 70% of Spotify’s payment processing;

• 70% of TPV in FY2018 is ‘full-stack;’ (i.e. where Adyen does both the acquiring and the processing), up from 60% in FY2017.  This strengthens the ‘single platform’ argument of the business, and most of the TPV that is not full-stack relates to Adyen’s airline clients (where Adyen only offers the gateway);

• In H2 2018, Adyen’s incremental EBITDA margins vs the prior year period were 75%, and incremental EBIT margins were 73%.  These growth rates (both in TPV and in net revenue) as well as these margins (both absolute and incremental) are considerably higher than those of almost any relatively global publicly-listed payments business that I can think of, with the clear exception of the card networks (whose absolute margins look even better when I use the gross revenue number as the denominator instead of the net revenue number, and whose moats are arguably the deepest in all of payments).  

In terms of net revenue split by type of activity, ~44% is from settlement fees (charged as % of TPV, and representing the fees Adyen takes when it acts as the merchant acquirer to underwrite the settlement risk), ~37% is from processing fees (charged as €0.10 per transaction), and the remaining ~20% is from ‘other services’ (mainly FX fees).  Adyen also generates some gross revenue from sale of goods (mainly POS terminals manufactured by Verifone but running Adyen software), but these generate negative net revenue. Overall, the ‘other services’ segment is growing the fastest (90%+ yoy), followed by settlement fees (58% yoy) and processing fees (33% yoy).

In terms of net revenue split by geography, the major regions are 65% Europe (growing 46% yoy), 14% North America (growing 93% yoy), 10% APAC (growing 120% yoy), and 9% is LatAm (growing 25% yoy; unclear why LatAm is growing more slowly than the other regions, but perhaps this has to do with competition).  In some cases, it is the geographic expansion of Adyen’s marquee customers which helps drive Adyen’s own geographic expansion. For example, Uber uses Adyen in more countries (50+) than the countries where it uses Braintree (e.g. US and UK), which was Uber’s first payment processor.

Adyen segments its business into 3 groups, and these groups sometimes overlap: Enterprise (large, often global merchants, with monthly TPV in excess of €1 million), Unified Commerce (omnichannel clients with a significant POS component to Adyen’s relationship), and Mid-Market (medium-sized merchants with monthly TPVs below €1 million).  Enterprise accounts for 97%+ of Adyen’s TPV and Unified Commerce accounts for 11% of Adyen’s TPV (and growing the fastest, with 85% yoy TPV growth); the Mid-Market segment is still relatively nascent, at only €4 billion of TPV in FY2018 (less than 3% of Adyen’s total TPV). In the Enterprise segment, Adyen’s client list is impressive and includes Uber, Spotify, Netflix, Booking, Facebook, Nike, L’Oreal, H&M, Domino’s, Sephora, Etsy, Groupon, Farfetch, LinkedIn / Microsoft, AirBnB, Adidas, Match.com, Transferwise, Yelp, Vodafone, KLM, Cathay Pacific, EasyJet, and Delivery Hero.  Top 10 customers currently account for roughly a third of Adyen’s total net revenue. Over the past 4 years, churn rate was less than 1% of TPV annually and on the most recent earnings call last month, CEO Peter van der Does matter-of-factly said “we do not lose customers to anyone”. In prior interviews, van der Does stated that new wins tend to be defections from incumbents such as Worldpay.

Adyen’s Unified Commerce / omnichannel capabilities are also getting some traction, corroborated by its wins of demanding logos such as Nike and H&M as well as faster-than-average POS TPV growth.  Overall, the lines between Unified Commerce and Mid-Market segments of Adyen are sometimes blurry, as management quoted Bugaboo (an omnichannel brand of pushchairs) as a good example of what Adyen considers a Mid-Market client.  According to management, until 2018 Adyen has not been very focused on growing Mid-Market but they have recently added to headcount tasked with going after this segment. In my view, Adyen going public and continuing to win high-profile logos helps grow its reputation in the market and also helps win new clients.  I wonder whether in payments there is a version of “no one has ever been fired for buying IBM”, but where ‘IBM’ is replaced with ‘Worldpay’ or other incumbent providers. If the relationships with payment vendors are indeed sticky, this helps illustrate the hurdle that Adyen has to jump over to dislodge the payment solutions that the merchant is already using.  I am optimistic that the orthogonal approach that Adyen is pursuing (as expressed via the cost advantage, best technology, transparency and efficiency of having a single point of contact) will continue to result in a high win-rate.

From what I describe above, it is clear that Adyen’s business mix (being very heavily weighted to large-cap ecommerce clients) is significantly different from that of the legacy acquirers & processors, which skews much more offline / POS and SME; Square’s mix also skews to POS / SMEs and sole traders.  This raises the question of which of the two business mixes are preferable (all else being equal). On balance, I believe Adyen’s mix is preferable. Many of Adyen’s clients (such as Uber, AirBnB and Netflix) have clearly established themselves as secular share gainers (‘disruptors’, although an over-used term, is likely applicable) in their respective markets. Some of them have large user bases with network effects that the client is looking to monetize in new ways, e.g. Facebook Messenger is an Adyen client and it is expected that payment functionality in Messenger and Whatsapp will play a much greater role for Facebook in the future.   Also, in an economic downturn, I expect a large-cap ecommerce client to do better as merchant mortality in SME / POS spikes. There are some risks to being overweight the best-of-breed high-end, though – Adyen claims it is maximizing incremental EBIT as opposed to maximizing take-rate, and thus far Adyen is succeeding, but the skeptic will claim that the large clients will exert pressure on Adyen’s pricing over time. Smaller merchants have less bargaining power and have been relatively more under-served, resulting in rather high take-rates (e.g. see Square in SME), though those take rates are to some extent simply needed to make the economics work (the sales-force CAC-per-$-of-TPV on reaching, educating and winning SMEs and sole traders is likely high).  As an aside, Wirecard is an example of a payment vendor who seems to straddle an interesting middle-ground. European sell-side and European buy-side investors tend to see Wirecard as Adyen’s key comp in their (investable) universe. See below a client list comparison (per Citi). Over the past 9 months since Adyen’s IPO, brokers have been overwhelmingly buy-rated on Wirecard and hold/sell-rated on Adyen, on the basis that Wirecard is cheaper on PEG than Adyen.

To provide further nuance on how Adyen is different from other vendors, it also makes sense to comp it against Stripe.  Stripe is optically the most similar to Adyen in terms of size and reputation as a technological ‘disruptor’ – Adyen has ~800 employees, Stripe has 1,700-2,000 employees; Stripe was reportedly valued at $20 billion in the latest fundraising round in September 2018, and Adyen’s current market cap is €18 billion.  The key difference between the two companies is that Stripe is startup-focused, front-end focused and developer / API-focused; Adyen does have sophisticated APIs but its main strength is on the processing side, and Adyen’s focus is on larger customers (Adyen’s sales approach is ORCL-like whereas Stripe’s sales approach is TEAM-like, although that comparison is perhaps not very charitable to Adyen).  Stripe’s largecap well-known clients include Slack, Lyft and Shopify; Stripe also reportedly shares Facebook as a client with Adyen.

Stripe is based in San Francisco whereas Adyen is (primarily) based in Amsterdam; there is likely a significant difference in culture as Adyen founders’ desire to run reasonably lean, keep the cap table as small as possible and achieve profitability early (profitable since 2012/13) is evident.  Over the recent years, Stripe’s CEO has repeatedly declined to answer whether Stripe is profitable. Adyen’s CEO van der Does has also emphasized that being based in Amsterdam gives Adyen access to a pool of reasonably skilled (and English-speaking) engineering talent at a relatively low cost and with fewer retention problems than competitors based in the SF Bay Area.

Valuation

Given the high growth rates and a still evolving margin profile of the business, valuing the business off near-term (and even medium-term) revenue & EBITDA metrics is challenging.  The table above shows the consensus headline numbers as well as my own subjective view of them. There are two things to point out about the variance. On margins, I am considerably more optimistic than sell-side as Adyen’s incremental margins (75% incremental EBITDA margin in 2H yoy) continue to come in far above current margin levels as well as far above Adyen’s stated long-term goal of 55%.  I believe this guidance is conservative and stale, and expect management to potentially update it during the upcoming analyst day next month. My interpretation of the margin situation is that management sees many areas where it can productively deploy additional headcount and R&D (i.e. more growth in Mid-Market; new geographies) long-term but thus far management has been struggling to invest as fast as the money that is coming in.  I expect this to continue, and over the long-term, Adyen’s architecture implies margins that are high both from an absolute and relative point of view. On revenue, I gravitate towards looking at things from a top-down basis.  Adyen’s current TPV of €159 billion is still small relative to TAM – recent estimates (Goldman Sachs) put the current global market for payments at $200 trillion, of which $43 trillion (c.20%) is electronic.  If accurate, this suggests Adyen has a 0.4% share of the global electronics payment market. Adyen’s business momentum and low churn suggest to me that there is upside to that penetration percentage.   Per management, they are stealing away merchants from incumbents such as Worldpay. Worldpay/VNTV has a $1.5+ trillion TPV (and this number is not very big relative to $43 trillion, either; the acquiring market is still somewhat fragmented); some of that $1.5+ trillion should move to Adyen over time.  In addition, the electronic share of the total payments market should continue to secularly rise (which is a major component of the bull case for most payment stocks, including the card networks). Growth should continue for many years to come; I actually believe that even my above-consensus forecasts for 2020 and 2021 may end up being too low.

In my view, Adyen’s fair value is closer to €1,000 per share. My DCF is below, with key assumptions highlighted.

A few things to note: 1) Adyen expenses the vast majority of its R&D, and capex-intensity is low. 2) Both the brokers and management exclude merchant-related current assets and current liabilities from NWC movements, with their FCF numbers essentially equal to net income.  In sell-side DCFs, brokers model either zero (and sometimes even slightly negative) net working capital contribution to FCF. I am slightly more generous on this point and assume negative NWC-intensity declines over time but still contributes to FCF. If I were to follow the brokers’ lead and set this contribution to zero, DCF-derived fair value per share would decline by €50 to around €950.  3) My 2030 revenue number in the DCF is equivalent to a TPV of $2.7 trillion and a 20bps net take rate. Goldman Sachs projects a 2030 global electronic payment TPV of $91 trillion (up from $43 trillion currently); I thus implicitly assume Adyen captures 2.9% of TAM in 11 years from now, up from 0.4% today. If I cut my revenue projections such that the top-line grows in-line with consensus (and net revenue numbers in outer years are in-line with sell-side DCFs) but my margin assumptions remain the same (i.e. above-consensus), that would result in my DCF-derived value dropping from ~€1,000 to ~€770 (~25% upside).

Downside and risks

• Wrong on growth or wrong on business quality.  The headline multiples are undeniably high. In the short term, should issues in execution, macro or even temporary 'lumpiness' in customer wins or headcount additions cause Adyen to miss consensus expectations, there would be little multiple support and the stock could drop significantly. Over the longer-term, I may be too aggressive on top-line or too aggressive on margins; I may also be too aggressive on the implied terminal multiple. Underlying factors that may end up causing this would include Adyen struggling to unseat incumbent merchant / acquirer & processor relationships, client pressure on take-rates, and Visa/Mastercard scheme fee pressure on take rates.  Amazon and Google also handle all payment processing in-house and can end up being a larger long-term threat than currently anticipated.

• Poor execution.  Events such as security breaches, mishandling customer data or IT outages would result in dissatisfied customers, loss of reputation (and lower win-rate of new merchants), and/or fines.

• Profile.  The primary Amsterdam listing results in relatively limited (in the context of the market cap) trading liquidity.  It also results in Adyen being covered by a sub-optimal set of sell-side analysts (in my view, it would be more logical for Adyen to be covered by the same set of analysts who cover WP and SQ, for instance).  Unless management tells its story more aggressively or adds a dual listing, it may continue to be underestimated.

• Secondaries.  Key VC backers such as Index have sold only limited portions of their stock in the IPO, meaning that the stock price can come under pressure due to sizeable secondaries.

• Strategic value is nebulous.   In my mind, there is little doubt that Adyen is a scarce asset that the likes of Worldpay, Visa, Mastercard or PayPal would like to own.  It is tempting to think that this should put a ‘floor’ under the share price over the long run. However, there are some issues with this line of thinking.  Adyen is incorporated in the Netherlands and in my understanding, the Dutch anti-takeover rules are stringent. van der Does and Schuijff also appear to be driven to make Adyen as big as possible and are not necessarily interested in selling (or at least, not in the near future); their vision and execution is also important, and the platform (I believe) would be less valuable if they were no longer involved.

Other / eBay

Early last year, it was announced that eBay selected Adyen as a payments partner, transitioning away from PayPal on the un-branded payment side (i.e. cards and all payment methods other than PayPal payment) to Adyen.  This process is expected to intensify this year and in 2020 and eBay previously expected that >50% of its GMV will be processed by Adyen in 2021. The exact scope of this relationship and the EBIT implications for Adyen are unclear to me; I saw various estimates on what Adyen’s take rate is for this but I also heard that Adyen had bid aggressively to win this contract, likely prioritizing ‘non-monetary’ benefits of working with eBay such as a further public proof-case of Adyen’s technical capability.  eBay’s GMV is in the dozens of $ billions and if Adyen processes more than 50%, this would likely make eBay the #1 client of Adyen by TPV. In any case, pending further clues on the financial and strategic impact of the eBay win for Adyen longer-term, it is not a focus of my thesis; as part of the partnership, eBay now also has an option to take a stake in eBay (I attempt to factor that dilution potential in the DCF table above). Also, in my view, the whole eBay situation is currently somewhat in the air given the activist / potential break-up process there.

Similarly, I do not discuss or meaningfully factor-in any potential adjacent opportunities to expand into areas such as consumer / wallets or financing / taking credit risk (a possibility given that Adyen now has a European banking license).

Conclusion

Adyen is an excellent business in the fastest-growing area of payments, a market which is itself attractive and still sufficiently fragmented and immature to allow Adyen to continue taking market share. The quality of the business is supported by its margins, cash-conversion and high returns-on-capital. Management is guiding conservatively and is struggling to spend the cash that is generated by the business fast enough, resulting in high incremental and absolute profit margins that are exceeding IPO guidance, and the sell-side is only gradually adjusting to take account of this. The company's retention rate is effectively 99% and it is pursuing an approach in the market that is orthogonal / structurally superior and rather challenging for competitors to counter. There is also an under-appreciated potential for Adyen's working capital "float" to be worth something, yet both management and sell-side fully ignore it at present. All of the above factors interact such that I expect Adyen to grow FCF faster than the consensus expects over the long-term, and believe the shares are undervalued.

Catalyst

Adyen analyst day in April 2019 (potential raise of guidance)

Newsflow on new customer wins, license approvals, products or services

Financial results coming in above expectations