ADYEY - How Adyen Regained The Market's Trust

2023-11-28 12:08:36 ET

Summary

• Adyen's stock experienced a significant crash following the release of its half-year report, with factors including weakness in the North American segment and a deceleration of growth.
• The company's Investor Day helped restore market confidence, leading to a 70% rally in the stock.
• Adyen's Q3 business update showed accelerated growth, and the company provided specific guidance for FY26, addressing concerns about a slowdown in growth and profitability.

The (fallen) European Fintech star Adyen ( OTCPK:ADYEY ) ( ADYYF ) has been a very volatile ride for investors since its IPO in 2019, growing 400% to 2700 € per share, to plummet over two years to a bottom of around 650 €. Shares fell about 50% after the company announced its half-year report in August. Let's see why shares plummeted, how the Investor Day regained the market's trust and how the stock is priced after the runup.

The crash

Adyen is one of those rare high-growth companies that managed to scale the business while also being highly profitable; in sharp contrast to most of the Pandemic era fallen angels printing negative AEBITDA margins, Adyen showed 65% margins at its peak with a 90% FCF conversion rate (note that Adyen calculates FCF as EBITDA less CapEx and "Lease payments" due to the large impact of working capital on its business in the payments stack).

Adyen profited from the sharp and partially forced acceleration in digital spending through the pandemic. Especially for Omnichannel, Adyen is well positioned with its Unified Commerce platform, which allows an easy way to scale payments through different verticals. Payments are getting increasingly complex, especially for Adyen's target customers (large multinational corporations). Customers have many options to pay, varying strongly between countries and regions. Adyen has a wholly in-house developed tech stack instead of a patchwork of M&A deals, enabling faster adaptation, product development, and a low-cost structure. Over the 5 years of being public, revenue grew at a 35% CAGR, EBITDA at 38% and net income at 43%.

Adyen has been incredibly highly valued since its IPO, peaking at 115 times forward EV/EBITDA. This required continued high growth rates and showed exuberance in the market. Adyen started to trade down and ranged around 45 times range for a while. This was around when I opened a tiny (<1%) speculative position in the company, given the high quality of the business, but aware of the valuation risk. Following the earnings release, shares crashed and continued falling for three months to a low of 16 times forward EV/EBITDA.

The crash following the earnings is well covered in previous articles like this article from contributor From Growth To Value , so I'll keep it short and focus on the solutions. The reasons for the crash were the following, in my opinion:

• Weakness in the North American segment
• Deceleration of growth
• Increased spending and declining EBITDA
• An accounting change

Adyen saw revenue growth deceleration to 21% Y/Y while EBITDA decreased 10% due to higher costs. The increased spending was due to increased hiring due to the improving tech talent pool during the slowdown and increased investment in CapEx, which were communicated in previous quarters. Lastly, Adyen changed accounting and switched reported revenue from gross to net. This showed a 78% drop in revenue on many financial data providers, probably triggering quant bots to sell. The severity of the fall probably then led to a cascade of stop losses and other short-term oriented trading. This was not based on fundamentals but on the reality of algorithms and bots dominating short-term share prices.

Management affirmed that the long-term guidance remained intact in the earnings call and referred to the company's long-term orientation. I was convinced and heavily increased my Adyen position from <1% to around 8% during the three months leading up to the Investor Day.

The solutions

Investor Day made the business more transparent, addressed the issues the market had with the business, restored confidence in management, and sent the stock on a 70% rally over the last few weeks.

Breaking down the growth

For the first time, Adyen reported a Q3 business update and showed that growth accelerated with 22% Y/Y revenue growth and 21% processed volume growth with steady growth in all three segments.

The most important part of the Investor Day was the specification of the guidance from "medium term" to FY26 guidance and the breakdown of the growth algorithm. Adyen's medium guidance was 25-33% revenue growth, 65% EBITDA margin and 5% CapEx/sales ratio. For the first time, this was specified and backed up with data. While guidance was lowered to 21-29% revenue and an EBITDA margin of 50%+, this lowered fears of a severe slowdown in growth and especially profitability in the market. One of the typical bear cases was the commoditization of the business by competitors like PayPal ( PYPL ) owned Braintree. Adyen addressed this in the algorithm: Tiered pricing impact of low to mid-single digits per year is more than offset by market volume growth (high single to a low double-digit), the share of wallet gains (low double digits to mid-teens), new wins (low single digits) and ramp of previous year cohort (mid-single digits).

The emphasis was on making the growth understandable: Very little of Adyen's growth comes from new wins. It is mainly the ramping of customers as they push more regions and volumes towards Adyen, as they can provide the best authorization rates.

Increased spending

To better showcase the impact of the increased hiring, Adyen visualized the growth in the global team between the end of 2021 and September 2023. Adyen grew from 2180 to 4058 employees, still with the majority (2908) in EMEA. These new hires need time to contribute to the bottom line, especially with the long sales cycles and the slow scaling of new wins turning into significant revenue impacts. Hiring is slowing now, and Adyen will benefit from operating leverage in the future, as these new costs will contribute revenue and ultimately, cash flow growth.

Going forward

Adyen is a growth story and needs to give the market confidence that it will be able to continue growing at a rapid pace to justify its valuation. While in the past, the guided growth rate of Adyen wasn't transparent, now the market should have a better idea of the levers and growth drivers Adyen is pulling. The market vastly overestimated the impact of the tiered pricing model: Adyen always expected take rate to decline, it is part of its business model. As large customers scale their volume with Adyen, the take rate declines. This is more than made up for by the wallet gain as these customers ramp up. Adyen is not looking to start a price war and will stick to its value proposition going forward, as they have always said. By offering an easy-to-implement solution to ramp up a business globally with the best authorization rates (according to the Investor Day industry average rates with card are at 96% and without at just 85%, leaving a lot of room for improvement), it can maintain its pricing strategy.

Adyen is still attractive after the runup

To value Adyen, I'm using an inverse DCF model, which aims to calculate which growth rate the market estimates to arrive at the current share price. Investors then have to judge if they think that the company can match or exceed this growth rate. I adjusted Cash for payables to financial institutions of 4.48 billion. Adyen is basically debt-free, with most reported debt in Capital Leases. Adyen reaffirmed in its Investor Day that capital allocation priorities are to maintain an A- credit rating, as this is a vital piece of trust customers need in the platform. We shouldn't expect dividends or share buybacks anytime soon. I used 70/110 million of CapEx as growth due to the significant investment in hiring, office space and tech infrastructure. We can see that the market prices Adyen to grow by 20% over the next five years, followed by five years of 15% growth. Adyen expects to grow between 21-29% for the next three years and beyond as the secular tailwinds (increasing complexity of payments and war on Cash) remain intact. This is just revenue growth, we should also see operating leverage from growing into the new employee size, adding a few more percentages of earnings growth. We must also remember that this DCF reverts to a 3% growth rate after the tenth year. The upside expectation with Adyen is that the growth runway is much longer than portrayed in this model, yet I prefer to be more conservative and only model ten years. I believe that this is a more realistic approach than a direct price target.

Conclusion

Adyen's fall has presented an excellent opportunity for investors with trust in a high-quality management team and still offers a good opportunity after the runup. It also shows the downfall of a long-term mindset on short-term share price performance. Adyen experienced a self-inflicted crash and managed to regain the market's trust. After heavily buying leading up to the Investor Day, Adyen now represents my top position, tied with Danaher ( DHR ) at 10%.

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