2023-08-18 09:35:55 ET
Summary
- Adyen's H1 results show a 21% increase in net revenue and a 23% increase in processed volume.
- The addition of new hires led to a decrease in EBITDA, but interest income offset some of the higher wage costs.
- Adyen's long-term growth opportunities include targeting SMBs and expanding their presence in the POS market.
Has my Adyen thesis changed?
In my last article on Adyen (ADYEY), I said that they have a competitive advantage in the form of lower wages because most of their employees are based in Amsterdam, and this is still the case. And I also mentioned that the new hiring they have announced will lead to margin pressure in H1 23.
These were announced investments in the future, so the H1 results should come as no surprise to anyone who listened to the last earnings call. My long-term thesis for the next 5 to 10 years is still intact, and because of the market overreaction, I think the risk/reward profile is even more attractive now than it was a few weeks ago.
Adyen's H1 results
Before I start discussing the H1 results, I would like to draw attention to the change in gross revenue recognition. Adyen changed the way it recognizes gross revenue this half year, but the number it has used for reporting has always been net revenue, so this should not be a cause for concern. I just wanted to point that out because it might make some people wonder when they look at the two numbers and see the big drop in revenue.
Year-over-year results are strong . Net revenue increased 21%, or 19% in constant currency, and processed volume was up 23% year-over-year. EBITDA, on the other hand, decreased by €36 million year-on-year, mainly due to the addition of 551 full-time equivalents. Wages increased to €247 million from €134 million a year earlier. However, interest income was €93 million compared to €1.4 million last year, so the higher wage costs were almost offset by interest income. The quarter was not as bad as reported on a net income versus EBITDA basis due to higher interest income.
If we now assume that the interest income in H2 will be the same as in H1, they will have almost €200 million of interest income in 2023 which they can use to invest in growth opportunities.
One thing that makes me a little skeptical is the extremely low growth rate from H2 22 to H1 23, because it is almost non-existent and only in the single digits. If this trend continues for a longer period of time and not just for 1 or 2 periods, it could really break the investment case for Adyen. But for now, I think the investment in the sales team will lead to growth in 2024 and I think the investments and the long-term thinking of the management will pay off.
In general, I am very impressed with the quality of management and their long-term, counter-cyclical approach. Maybe it is because I like this approach and think it has a high probability of success, but as a warning to myself, I should not fall in love with management and still try to make a clear assessment of the situation.
Asia Pacific continues to be the fastest growing region, but from a small starting base, EMEA and NA also grew more than 20%, so they are slightly below the mid-20s to low 30s guidance year-over-year. But with the macro headwinds that exist globally, it is a challenge for Adyen and its clients and it will be interesting to see how this plays out once the economy calms down.
I think it is important not to draw conclusions about the long-term outlook based on one less than ideal quarter. Many of the best investments of the past 20 years have had some temporary difficulties that, in retrospect, were fantastic buying opportunities.
ADYEY Financial Situation
Adyen's balance sheet and financial position are not a cause for concern. Cash and cash equivalents were €6,411,624 and H1 FCF was €248 million. So the downside is protected. And I think H2 will most likely have higher FCF and EBIT and EBITDA will also recover to even better levels in 2024 as the investments in new employees pay off.
ADYYF Growth Opportunities
Embedded finance , which is likely to drive most of the growth in the future, helps solve problems for SMBs. According to a study, 64% of SMBs are interested, so this is a huge market that Adyen can target even more in the future. The new sales team members have a lot of potential customers.
Total POS volume also increased 49% year-over-year and now represents 16% of total processed volume, with much potential to grow. This is an area where Adyen is currently underrepresented.
Their multiple product launches should also contribute to some growth. Data Only improves authorization rates through machine learning, a real benefit for Adyen's customers, and Trusted Beneficiaries also helps increase conversions by allowing customers to add stores to a trusted list, speeding up the sales process. In addition, more salespeople should lead to more sales in the future, which should be noticeable by 2024.
Was Adyen stock sell-off a market overreaction?
I think it was an overreaction, but some of the decline in the share price was justified. Adyen used to be very expensive and valued in such a way that any small mistake would lead to a sell-off. It still has a high valuation. So the comparison with Meta (META) that I saw on social media is not justified, in my opinion, because Meta was trading at a much lower valuation after its sell-off.
And I saw some comments that people said it was because of low switching costs, but Adyen's churn rate is less than 1% and they have really strong relationships with their customers. So that argument is not valid right now in my view, although I think the switching costs are really not that high, as I mentioned in my old article. But that was not the problem with the earnings report.
The e-commerce market in the US is generally in a slowdown this year and with Stripe and PayPal (PYPL) there is some really strong competition. And the biggest criticism, in my opinion, is that in NA Adyen is not willing to compete on price, so potential customers have decided to go to the competition. And that could mean that Adyen's product is not good enough if customers choose another customer based on price alone. If this were a long-term trend and not just a short-term one, it would cause problems.
However, this could be a short-term trend and things could change in the next quarter, but we cannot say this with 100% certainty after one sub-optimal earnings report.
Adyen still has a very strong return on capital and is investing in growth, so they are still high quality with a high probability to grow efficiently as their cost of capital is low. Adyen's growth creates value.
Conclusion
I strongly suspect that this is short term noise and the results in H1 24 and H2 24 will show that this was the right decision by Adyen's strong management team to focus on long term objectives rather than satisfying Wall Street. Returns on capital and the management are among the best in the industry, and barriers to entry are in place to protect earnings. In addition, Adyen is a growth company with positive free cash flow and a long-term outlook, which is a great combination for excellent results over 5 to 10 years.
And since I live 2 hours from Amsterdam, I know that they have a very high bar for their employees here in Europe, and yet they only have to pay European wages that are very much below American wages, which I think is one of the strongest advantages because wages are a very high cost for companies. Adyen's net profit per employee is much higher than that of its competitors, who mainly have their employees in cities such as San Francisco.
It will be interesting to see if Fundsmith will now buy a stake in Adyen as they said this is one of the highest quality companies they know, so I believe early next month when they report their new holdings could potentially help investors gain more confidence in the position if that's the case.
For further details see:
Adyen Stock: Risk-Reward Is Now More Favorable (Updated Thesis)