2023-09-21 08:30:00 ET
Summary
- Like Cinderella's carriage turning into a pumpkin at the stroke of midnight, the market has shifted from believing Adyen N.V. is the best FinTech on earth to a commodity business.
- Adyen's exceptional growth in tandem with robust free cash flow margins certainly communicates another narrative, i.e., the one in which the market believed during the preceding decade.
- Today, we will explore the nature of Adyen, the macroeconomic context in which the business operates, and the industry in which it will grow for decades to come.
- In short, I believe buyers of Adyen will generate fairly easy ~20% annualized returns buying at ~$7/share.
We Will Start By Revisiting And Contextualizing Adyen; Then, We Will Consider Its Valuation
It's worth stating plainly that Adyen N.V. (ADYEY) is one of the best businesses on earth, with massive free cash flow margins, sustained elevated growth, and a long runway for growth ahead. Stripe ( STRIP ) has been argued to be the best FinTech on earth over the last half decade; however, I'm fairly convinced that Adyen holds this title as of today.
The data below reveals as much (specifically, note the headcount and related efficiency metrics).
X
While Stripe has indeed created an extraordinary platform, Adyen has likewise created an extraordinary platform, with ~1/3rd the full-time employees, which has afforded Adyen exceptional free cash flow generation, culminating in a pristine balance sheet. (Adyen did aggressively hire in its most recent H1 2023, effectively "buying low" on tech talent in a countercyclical fashion. The market may think this is bad now, but I believe it will be revealed to be brilliant capital allocation over the long run. Adyen's peers spent all of 2020 and 2021 "buying high" on tech talent that they had to turn around and fire just 6-12 months later).
Adyen's extraordinary nature as a financial technology platform has been known for about the last decade, and one great H1 2023 that simply did not live up to market expectations did not change this reality, like Cinderella's carriage turning into a pumpkin at the stroke of midnight.
With that in mind, over the last 3-4 years or so, we (as in the two analysts I formerly had on staff at Beating The Market) considered the Adyen business at multiple points, visiting and revisiting it.
In each case, we found that it was too expensive to purchase. That is, the expectations for growth that were priced into Adyen's valuation were simply too optimistic. In short, we believed Adyen was overpriced, or too expensive, to be bought for all of 2020, 2021, and half of 2022.
That said, we did produce exceptional amounts of research in anticipation of the day when we'd get to buy the business at attractive valuation levels (I am not allowed to share the links to that research here but feel free to follow up with me in the comments section if you're interested).
With these due diligence notes as our platform, in mid-2022, I began buying at $12.88/share, which represented an approximately 62% decline from its all-time highs.
I then produced a review of Adyen's H1 2022 earnings (again, please feel free to follow up in the comments section if you'd like to review this).
Incredibly, I found that Adyen was still not perfectly attractive from a valuation perspective. I wrote,
With ~3.1B shares outstanding at $15/share, and [$1.7B in cash and no long term debt], the company trades at an EV to 2023 free cash flow of about 51x.
This is relatively expensive, but considering the idea that Adyen could sustain ~30% growth for the next, at least, five years, we believe it's fairly reasonable.
We can simulate the next 5 years and determine what this valuation represents by the end of 2027. Were Adyen's share price to remain static until September 2027, its free cash flow yield by that time would be 5.5%, or about $2.6B in free cash flow divided by an EV of about $46B.
Candidly, this is not exceptionally exciting to me, and it further reinforces our commitment to waiting to strike when the iron finally became hot, i.e., Adyen's share price declined.
Over the last year or so, I've held off on purchasing it as it drifted into the mid to high teens.
As of today, the stock's share price has declined, and then some, with shares now down ~80% from their all-time highs, and, as we will explore later today, I do like buying the shares in the mid $7s quite a bit. I think we're, for the first time in Adyen's public company history, at a valuation where we can be sure we will outperform the market in the decade ahead by purchasing shares of Adyen.
We're Living In Exceptional Times (Adyen % Off All Time Highs)
In subsequent sections, we will discuss the environment in which Adyen operates that's created fertile grounds for its business to underperform relative to market expectations (this underperformance relative to expectations has created the monumental stock price decline).
It certainly should be noted that Adyen had a pretty fantastic earnings report, though it did not live up to the expectations that were priced into Adyen's valuation; hence the share price decline has reflected the market's re-structuring of expectations (the same can occur to the upside once the current economic environment shifts more positively in the years and decades ahead).
I would also like to reiterate that we live in quite exceptional times. Meta's ( META ) share price decline from ~$380/share to ~$88/share was something straight out of the Great Recession, Great Depression, or liquidity crises of 1973-1974.
In late 2022, Amazon ( AMZN ) experienced its largest decline from its highs since The Great Recession and, before that, the Dot Com Bubble.
These are just two examples, though there are almost innumerable examples of very high-quality businesses, such as Meta Platforms, Amazon, or Adyen, experiencing simply breathtaking declines from their all-time highs over the last 18 months.
We do, indeed, live in exceptional times for many companies, and this has likewise created the exceptional opportunity we've seen over the last 12 months. Without these exceptional times, we'd not have the opportunity to buy arguably the best FinTech on earth, down 80% from its all-time highs.
And, of course, these breathtaking declines and exceptional times have been precipitated by a wave of inflation not seen in over 40 years, which precipitated the fastest interest rate hiking cycle in American history, which has precipitated the most inverted yield curve in over 40 years, alongside dramatically higher interest rates.
Detailing The Environment In Which Adyen Operates
As I mentioned, we've seen share price declines for the best businesses on earth (measured by size and profitability) only experienced once every couple decades or so.
Of course, as I noted to begin this review, valuations were vastly too high in 2020/2021 due to ZIRP (zero interest rate policy) and the U.S. choosing to 1.4x its money supply.
That said, for instance, Adyen had over three years to grow into its early to mid-2020 valuation (at about $12/share), and, a few weeks ago, Adyen still experienced a one-day decline of about 50% from that mid-2020 valuation. Such a decline following a 50%+ decline from all-time highs is reminiscent of declines experienced in '08-'09, '00-'02, and '73'-'74, all of which were exceptional periods in the history of American capitalism, which created exceptional opportunity from a capital allocation perspective.
With that nuance out of the way, the environment in which Adyen now operates should be noted as well, as a component in the answer to the question of why Adyen's growth has slowed and, correspondingly, its share price has declined.
In a recent review of Marqeta ( MQ ), I detailed salient economic data that illustrates the idea that the American economy is currently experiencing immense drag on its activity. Below, I simply substituted "Adyen" for "Marqeta." (They are, indeed, both vertically integrated, cloud-native payments platforms. Adyen also loosely competes with Marqeta after having launched an issuing/processing product recently, which is a component of the bull thesis for Adyen.)
... I believe I could best serve you by first contextualizing the environment in which [Adyen's] business currently operates. In fact, I think it would be hard to understand what's going on for [Adyen] without first understanding the economic backdrop in which the business operates.
In short, the Fed, i.e., U.S. central bank, has embarked on a very aggressive financial suppression operation. That is, credit is "wickedly tight," so to speak, and this has served to send the rate of inflation in the U.S. careening downward from a peak of ~10% in 2022 to [3.2%] as of the U.S.'s most recent Consumer Price Index [CPI] report.
U.S. Consumer Price Index Year Over Year Change
We can see this very aggressive financial suppression (economic suppression) via a series of charts.
Credit Card Interest Rates Hit Highest Levels In Over 30 Years
Notably, Adyen processes digital payments from credit cards and debit cards. When interest rates rise this fast, 1) payment activity slows and 2) it creates difficult year-over-year growth rate comps, creating an illusion that the company's growth is screeching to a halt, possibly forever! (said somewhat flippantly)
This interest rate serves to channel dollars in the economy into interest servicing as opposed to spending via credit cards and debit cards, slowing [Adyen's] growth rate.
This higher interest rate broadly serves to slow economic activity; thereby it slows the rate of inflation as well, and it's been working well, as inflation has fallen precipitously.
The same dynamics have been playing out in the auto and personal loan industries, also serving to collapse the rate of inflation.
Average U.S. Auto Loan Interest Rate
Average Personal Loan Interest Rate
Of course, these last two data points do not directly impact [Adyen's] business, but they invariably serve to slow the growth of virtually all businesses in the economic system, including [Adyen and Marqeta].
To be sure, I understand that houses were bought with mortgages at 12% in the late '80s or early '90s. I believe the takeaway here is that the rate of economic growth for all businesses year over year gets compressed immensely (growth rates slow for all businesses in the economy) due to the rate of change of these interest rates year over year.
Of course, interest rates are not "Paul Volcker tight," but their incredible rates of change year over year have served to create dramatic slowdowns in economic and business growth, even if they don't serve to create total economic collapse, as some have speculated would be the case (despite credit being so wickedly tight already and despite inflation collapsing to such a large degree, the Fed has said that it may hike rates further, which is notable).
And these increases in rates, to remind you, have been spawned by the fastest rate hiking cycle in American history.
Visual Capitalist
Since Adyen's fairly dramatic stock price decline, I've seen all sorts of explanations as to why the company's growth rate decelerated in H1 2023.
Most have revolved around competition: the same competition that has existed for the last decade, during which Adyen has grown at the rates exhibited below.
Adyen 14x's Its Gross Profits And 14.5x's Operating Income Over The Last 7 Years
Like the clock striking midnight for Cinderella, the market believes this profitable growth for Adyen will suddenly stop.
Another Perspective For Adyen's Growth
In H1 2023, Adyen grew at 21%, which represented a rather significant further deceleration, but, as we now know, this is not a mystery in any sense.
No, Adyen did not lose its edge in six months. Yes, credit has tightened at a historic pace, serving to slam the brakes on economic activity.
Auto And Credit Card Delinquencies Are Soaring Higher, Pushing Above Pre-Pandemic Highs
Washington Post
We have clear, definitive economic data that illustrates precisely why a digital payments platform would experience slowing growth. We just went through it but it bears repeating:
Credit Card Interest Rates Hit Highest Levels In Over 30 Years
And, as we know, dramatic tightening of credit in the economy has been precipitated by the fastest interest rate hiking cycle in American history.
This cycle of accelerated growth and more depressed growth rates plays out over and over again in our economic system, and this is principally why stock prices fluctuate above and below their intrinsic value, which is a phenomenon with which we are all familiar.
Stock Prices Overshoot To The Upside And Overshoot To The Downside, And It Has Always Been This Way, And It Will Always Be This Way
Truemind Capital
Very Roughly, Adyen's Intrinsic Value Depicted
Of course, the above illustrations are in no sense a perfect science, but there's immense truth to them as well.
To the same degree Adyen overshot to the upside, it's completely within the realm of possibilities that it will overshoot to this degree to the downside, as is so often the case in equity investing.
As I've mentioned already, we've witnessed this ad infinitum over the last 12 months in the share prices of, for instance, NVIDIA ( NVDA ), Meta, Amazon, and so, so many others.
Adyen's TAM Still Has A Long Runway For Growth
Now that we have context for what Adyen's business has experienced, let's turn to the company's industry, which defines its total addressable market [TAM].
As we've explored in this note, though it certainly bears repeating, Adyen has grown at astronomical rates over the last 7 years, while growing within a stagnant, mature, highly competed TAM full of legacy payments platforms against whom Adyen has easily won business.
Further, with the exceptional growth of digital payments (of all kinds; in stores and online), this large TAM full of legacy payments platforms has itself continued to grow, providing Ayden the runway to grow at the astronomical rates we've witnessed over the last 7-10 years.
Adyen's Astronomical, Profitable Growth
And this profitable growth has been driven by the growing adoption of digital payments, or, "non-cash transactions," the growth of which we can see below.
Number of cashless transactions worldwide from 2013 to 2021, with forecasts from 2022 to 2026, by region
In 2021, the U.S. Federal Reserve published data that mirrored the above data, which you may review below.
Growth Of Digital Payments Such As Credit And Debit Cards According To U.S. Federal Reserve
The growth of digital transactions, i.e., payments via cards, such as debit and credit, has fueled Adyen's growth over the last decade or so, as the business provides core infrastructure necessary for these transactions to occur.
That is, Adyen has vertically integrated the digital ecosystem that underpins debit and credit card transactions, and it sells this platform to enterprises of all sizes globally.
Adyen's Vertically Integrated Acquiring Platform
Adyen's acquiring platform allows merchants (enterprises) to accept digital payments globally.
And, as I noted earlier, Adyen has also launched an issuing platform, which allows banks and digital banks to offer debit and credit cards to their customers.
Adyen's vertically integrated offering for both the acquiring (merchants/enterprises) and issuing side (banks/digital banks) of the payments ecosystem can be seen below:
Adyen's Vertically Integrated Acquiring And Issuing Platform
Adyen Capital Markets Day 2021
Here is one last version of these charts whereby I elaborate the platform to the highest extent for you:
Adyen SEC Filings
In short, Adyen's industry-defining, best-in-class platform will continue to consume market share within a market that will grow for decades to come.
"Cash was used for 59% of point-of-sale transactions in 2022 , down from 72% in 2019. It is the means of payment most often used for small-value payments in stores and for person-to-person transactions."
This suggests that digital payments still have a long runway for growth in Adyen's home turf [Europe], and data from other regions suggests this is the case internationally as well:
Capgemini
Adyen Valuation Exercise
Adyen's management has explicitly stated that it will target a 65% EBITDA margin on its net revenues long term.
Considering the business has negligible debt and is an asset-light business, the "I" and "DA" are not material concerns, by which I mean that the 65% EBITDA is close to free cash flow, though we still need to deduct 25% for Netherland taxes.
In Adyen's most recent first half, it reported the following metrics:
Revenue | $739.1M |
EBITDA | $320M (43% of sales vs 65% long-term target) |
Free Cash Flow | $250M (33% of sales) |
Effective Tax Rate | 25.8% |
Assumptions:
- Note: Instead of using management's 65% EBITDA target, I used a 55% EBITDA target to create conservatism in the modeling.
- Management has also guided for growth between 25-30% over the next decade.
H1 2023 revenue annualized [A] | $1.58 billion |
Potential Free Cash Flow Margin [B] | 41.25% |
Average diluted shares outstanding [C] | ~3.1 billion |
Free cash flow per share [D = (A * B) / C] | $.21 |
Free cash flow per share growth rate (reasonable) | 25% |
Terminal growth rate | 3% |
Years of elevated growth | 10 |
Total years to stimulate | 100 |
Discount Rate (Our "Next Best Alternative") | 9.8% |
Of course, you could argue that a 22.5% growth rate is too optimistic, but that is below the low end of what management has guided, and the digital payments & e-commerce industries globally still have a long runway for growth ahead.
Further, we may not technically be in a recession, but with, for instance, credit card interest rates at the highest they've been in over 30 years, by a lot, and delinquencies on credit rapidly rising above pre-pandemic levels, we are in something.
And Adyen is not alone. I've demonstrated quantitatively that software, digital ads, and, especially FinTech, i.e., Marqeta or Affirm ( AFRM ), have seen their growth rates totally collapse.
Growth rates in the software space are in free fall. The digital ad market has been locked and frozen for a year. FinTech growth rates have ground to a halt for most businesses (implying that Adyen's 20%+ sustained, high-margin growth is indicative of one of the best FinTechs on earth operating in a difficult macroeconomic environment).
Credit card interest rates are at their highest in over 30 years.
We just experienced the fastest interest rate hiking cycle in American history.
We've not seen a real IPO, except CAVA Group ( CAVA ), in two years.
The IPO Window Has Been Locked, Shut, And The Key Has Been Thrown Away For Years Now
And, incredibly, Adyen just grew at 21%.
I believe it's entirely within the realm of possibilities that the business accelerates growth quite materially once we emerge from this unique economic period.
And, even if we use a 20% fcf/share growth rate, Adyen will generate market-beating returns at these levels.
Thank you for reading and have a great day.
For further details see:
Adding To Adyen