2023-08-22 17:29:33 ET
Summary
- Adyen's stock price dropped significantly after releasing its H1 2023 results, surprising investors.
- The company reported missed estimates in payment volume, revenue growth, and EBITDA.
- Adyen's profitability was impacted by increased hiring and upfront investments in infrastructure, but the company reconfirmed its medium-term goals of 25%-30% revenue growth and 65% EBITDA margins.
- We look at 5 reasons why the stock dropped, with a sixth one that could have spurred the sell-off. There are also many opportunities left for Adyen and we highlight 5 of them.
- We look at the details of the earnings and make a distinction between signal and noise.
If we look at our long-term opportunity, nothing changed. It's still out there, it's still huge.
Adyen founder and CEO Pieter van der Does (the man in the picture) on the H1 2023 earnings call.
Introduction
Last Thursday, the Dutch payment player Adyen ( OTCPK:ADYEY ) ( OTCPK:ADYYF ) released its results of the first half year of 2023, and the stock dropped like a rock.
The huge drop in Adyen's share price was a real surprise. I had already shared previously to my subscribers that it could be that the market would react negatively to Adyen's hiring spree again, just like it did in H2 2022. But I would never have guessed something like this would happen.
For those who don't know Adyen, it's a payment provider that mainly focuses on huge customers such as Spotify ( SPOT ), Netflix ( NFLX ), Microsoft ( MSFT ), Uber ( UBER ), Booking ( BKNG ), McDonald's ( MCD ), Dunkin, Shein and many others.
Unlike other platforms, the company has not stitched together several payment platforms to offer its services but has built everything from the ground up. That's why it also has the lowest cost to service its customers. But because it also has a better product, it usually charges a premium price. That model was somewhat under pressure in the first half of this year.
The Numbers
These were the numbers Adyen reported for the first six months of 2023:
- Payment volume: +23%, missed the estimates by 8.1%.
- Revenue growth: +21%, missed the consensus by 3.6%.
- EBITDA €320 million, down 10% YoY, missed expectations by 15%.
You can see these illustrated here.
The company added this context for the EBITDA drop:
"This figure was primarily impacted by increased wages and salaries stemming from Adyen's investments into scaling its global team for the long term."
When it came to EBITDA, the results were as I expected: pressure on profitability because of the increased hiring spree.
Just to remind you, as I wrote in my review of the H2 2022 earnings , Adyen didn't hire much during the pandemic, as it judged tech people were too expensive back then and they asked for too much stock-based compensation. Now that so many big tech companies (Meta, Alphabet, Microsoft etc.) have done layoffs, Adyen started hiring at high speed to be ready for the next growth phase. Of course, that temporarily impacts profitability.
To me, this countercyclical move is a great example of long-term thinking.
For context, Adyen is still hugely profitable, with an EBITDA margin of 43%. So, it's not as if the company sacrifices profitability for growth. It invests some of its huge profitability to invest for the future. Isn't what companies are supposed to do?
Adyen hired 551 full-time equivalents, of which 75% were in tech. Adyen was disappointed that in North America, it couldn't find enough affordable tech employees to reach its goals. Especially for sales roles (which also has tech people, as they have to understand the needs of customers), Adyen couldn't hire fast enough in the previous periods and that's one of the reasons why North American revenue "only" grew by 23%.
The company has always said it sees long-term revenue growth of mid-20% to 30% and EBITDA margins of 65% and it reaffirmed these goals for the medium-term.
Price Drop Started By Bots?
Before we look at more details, just this thought about the stock price drop first.
If you Google Adyen's results, you see this.
The reason is simple. Up to this earnings release, Adyen had to report gross revenue because of accounting standards. It changed its terms and conditions and can now recognize revenue in another way. That's also why the net profit margin is up so much.
Adyen has to pay other parties involved in the payment process. Think of Visa ( V ) and Mastercard ( MA ), but also banks etc. That's totally normal in payments, but it doesn't give a clear picture. That's why Adyen has always reported Net Revenue to investors.
How much of the initial selling pressure has to do with this strange anomaly? We all know bots are programmed to buy or sell if they see certain patterns. A 78% drop in revenue is definitely one of those patterns. The automatic selling then triggers stop losses, and that can cascade.
We saw something similar for Global-e ( GLBE ). The company had fantastic earnings, but the stock dropped by 15%. The reason? A data provider had switched Q2 2022 and Q2 2023, so instead of 53% up, revenue looked to drop by 53%. Of course, the other things we saw at Adyen, like the pressure on EBITDA because of accelerated hiring, only fortified the bots. Let's look at these things now.
5 Reasons For The Drop
The first problem investors saw was the EBITDA miss of 15% . Just like in the previous quarter, according to the company's plan, Adyen continued adding employees at a fast pace. Adyen also raised wages. Just to make sure, these are still much below Silicon Valley wages on average. I think both are great and bashing Adyen for doing this is just plain short-sightedness. Management said this about the hiring spree:
We foresee our team reaching its next level of maturity at the start of 2024 with a mix of both commercial and tech roles. After this point, we will phase out of our accelerated investment mode and hire as needed.
On the conference call, van der Does even (accidentally?) spoke of the end of the year. This means that the end line for fast hiring acceleration has been brought from mid-2024 to early 2024 or the end of 2024 because of the faster hiring. Great to see that.
And I loved this quote by van der Does:
We don't do acquisitions. So this is the way, how we grow the company.
I prefer this strategy. Yes, this has a temporary impact on profitability, but if you look at the history of the stock market successes, you'll see that most great CEOs always thought about the long term, not the short term. The 15% EBITDA miss was the result of a predetermined choice, not of weakness. Management about EBITDA:
We could have actively optimized this metric, but prefer building the team that can realize the long-term potential of our single platform.
The second reason EBITDA and FCF were impacted, besides the faster hiring, was a bigger upfront investment in infrastructure. This makes total sense, as you need more infrastructure for more people. But this is already expected to go down significantly in H2.
To allow for this efficiency at even larger scale, we front-loaded this year's priority infrastructure investments. This resulted in CapEx of 7.6% for H1, which is expected to be at 5% for the full year.
As the quote shows, this is a temporary thing again and H2 will have lower CapEx.
The third reason the stock price dropped was probably the low growth of H1 2023 compared to H2 2022. While 21% year-over-year revenue growth still looks pretty good, the growth of H1 2023 compared to H2 2022 is just 2.5%. There is always seasonality involved here, as H2 has the fourth quarter with the holidays and gifts season, which is an outlier for every e-commerce or payments company. Last year, there was 18% revenue growth in H1 compared H2 2021, the year before that it was 25%. But in the coronavirus period, H1 2020 was up just 1.5% compared to H2 2019. Adyen was able to accelerate revenue back then as well.
This time, it may take a bit longer, but I'm confident management knows what they say if they reiterate the long-term growth projections.
The fourth reason is competition. Next to the impact of Adyen's accelerated hiring spree on the profitability, this passage from the Investor Letter is what spooked investors probably the most:
As a result of higher inflation and interest rates, North American digital customers shifted focus from growth to cost savings in H1.
Adyen's management writes in the shareholder letter that the economy has shifted from growth to profitability in the first half year of 2023 and that American companies now prioritize cost optimization. It saw more competition for volume and companies de-emphasized functionality. Digital volumes are relatively easy to switch. Adyen stood its ground and did not go into a price war with competitors:
We consciously continued to price for the value we bring.
On the conference call, van der Does was even clearer:
We could -- I mean, we run a single platform. We run at the lowest cost. So we could join a price fight. We don't think that's the right strategy.
To me, that looks like a good decision. You don't price a Ferrari like a Subaru. And while TPV (total payment volume) missed by 8.1%, revenue only missed by 3.6%, which shows that Adyen still has pricing power.
I hear all kinds of comments now about Adyen losing customers to Stripe, PayPal's Braintree, Worldline and others. Reality check: Adyen's churn was less than 1%. Of course, this doesn't mean there is no strong competition. Adyen's management also admitted this, but once Adyen boards customers, they remain there and they add new functionalities. That's why 80% of its growth came from existing customers, by adding volume or more services and mostly a combination of both. And as van der Does pointed out:
What you see if the competition cannot follow, is price pressure because you can always play with price.
Ask yourself this question: if all compete on price and one doesn't and still grows by 23%, probably faster or at least as fast as the competitors, who shows real strength then?
Adyen explains to its customers that it's more cost-efficient because of the unified platform.
The fifth element that had a negative impact on the stock price was not having enough salespeople in North America .
Another factor that impacted our growth was one we wrote about at the end of 2021 too: the fact that we would have liked to grow our team at a higher pace but were unable to hire enough top-quality talent. We now see the impact of a sales team size that did not match our ambitions, particularly in North America. Since then, we have ramped up our investments. That being said, investments in the team and revenue never move simultaneously. Rather, the former drives the latter over time.
My comments
I have read many uninformed comments about Adyen's hiring over the last year. But the company has shown several times in the past that it knows very well what to do. It has been through hiring sprees a few times before and each time, the result was the same: more growth after a while. I don't understand why so many investors don't seem to trust such a capable management team.
Most of the analyst questions were about the short term, including asking for quarterly updates. This is the answer CFO Ethan Tandowsky gave to one of those questions:
So when we, as a management team, look at the opportunity that we have, it's really a medium- to long-term opportunity. To make investments today, they won't pay off in the short term. They'll pay off in the medium to long term. In the business we're in, enterprise payments business, it takes time for things to grow and to mature
The EBITDA pressure is temporary, like management shared in the last earnings call. But both van der Does and Tandowsky had to repeat this over and over. This is Tandowsky:
I've said it before on the call, but there will be some trailing impact to when people join the company and when their costs are fully in the number. But we expect to get quite quickly back to the operating leverage that we feel is really inherent to the model given that single tech stack.
And just to make sure, this is the EBITDA target for Adyen (from the H1 2022 shareholder letter ):
EBITDA margin: We aim to improve EBITDA margin, and expect this margin to benefit from our operational leverage going forward and increase to levels above 65% in the long term.
Just like in the previous quarter, management said it could reach that goal immediately if it wanted, but it has its eyes fixed on the horizon, doing what's suitable for the company over the longer term.
Also very important, as analysts kept poking and repeating the same questions, management repeated several times that its revenue targets also have not changed for the medium term. Just to make clear, management has always insisted on the medium-term time horizon of these goals. It's not that they suddenly changed the time horizon. These are the goals, also from the H1 2022 shareholder letter:
Net revenue growth: We aim to continue to grow net revenue and achieve a CAGR between the mid-twenties and low-thirties in the medium term by executing our sales strategy.
I have followed Adyen since its IPO, initially from afar but more intensely for two years now and I have never seen a moment where I doubted management told the truth. Everything they predicted happened. Yes, the slower growth for North American digital revenue this time was slower than anticipated. But this high-quality management repeating their medium-term goals despite these headwinds is confidence-inspiring:
We know that growth will not always be linear, and while we saw net revenue growth decelerate in H1, we did not see any substantial developments that structurally change our medium to long-term opportunity.
According to research, the average investor only holds stocks for 5.5 months now, compared to 8 years in the fifties.
Analysts also have to give one-year targets. But these are very arbitrary. Still so many act as if these are the most important thing in investing. If you want to stand out, you can go against the mainstream and hold stock of great companies for the long term.
Pieter van der Does was very clear in the Q&A, when only questions about the short term kept coming.
If your question is so what's happening next -- the next half year, that's not really the window that we look at. We are building for a longer -- for a way longer window.
One of the things I like about Adyen earnings calls is the overall openness. Analysts don't hold back. Probably, that is because Adyen doesn't raise debt and makes it clear it doesn't make acquisitions. So, analysts tied to investment banks don't have to hold back, fearing their employees would lose business because of their thorny questions. It's actually sad that Adyen is the exception here.
One of the concerns investors have was voiced by this analyst's question:
Is there enough value-added payments market in the U.S., which is more commoditized than Europe, that performance differentiation can be enough versus peers that have good enough products and actually price below you today?
This was probably the best question from the call. Adyen's CFO was clear:
There is increasing complexity, in any market, including the US and that trend plays to Adyen's advantage. More products are being rolled out, more data is collected, more granular authorization levels are needed, etc. That's why Adyen is confident that functionality will allow it to seize the opportunity.
5 Big Opportunities Left
For Adyen, there are huge opportunities left. Let's highlight a few.
1. Regional expansion
Adyen only recently started in big markets such as India, Japan and Mexico. Latin America in general is still very early. Growth there can really make a difference over the long term and more geographies can be added.
2. Point-Of-Sale
While initially, Adyen only did digital payments, it also started with Point-of-Sale a few years ago. This is still growing fast, at 49% year-over-year and it's already responsible for 16% of revenue now. The point-of-sale market is estimated to be $30 trillion a year.
3. Unified Commerce
As the intertwined combination of online and offline is growing, the opportunity for Adyen's Unified Commerce, which combines digital and offline payments, is big. Revenue was up 36% year-over-year here.
4. SMBs through Platforms
Up to now, Adyen has only worked with the biggest companies, but that changed when it introduced Platforms. My co-author Leandro made this great overview of what Platforms does:
In other words, small merchants also can benefit from Adyen's great services through the platforms they collaborate with, like Etsy in this case. eBay is also a partner but as we all know, the platform has been a laggard for years. Excluding eBay, though, Platforms revenue was up 82% year-over-year.
5. Growth of customers
Adyen grows together with its customers. More success for the customer, in the form of more sales, means more volume for Adyen and more revenue. This is a powerful flywheel.
Valuation
There's no denying Adyen has never been cheap, but that's what you usually get with the stocks of premium businesses.
Adyen currently has a market cap of €24.4 billion. The company has about €2.1 billion in net cash, so there's an enterprise value of $22.3 billion. In H1 2023, there was €739 million in revenue. Management doesn't give guidance for H2 but let's be conservative and say that revenue grows 20% YoY. That would mean €866 million in revenue or €1.61 billion for the full year 2023.
Right now, Adyen is in full investment mode, which brings pressure on the EBITDA margins. But the company had 60%+ EBITDA margins in the past and there is no reason to believe that management can't reach its 65%+ goal. So, let's normalize the EBITDA margins to 65%. That means €1.05 billion in EBITDA. If we take the enterprise value of €22.4 billion, this means Adyen now trades at a 'normalized' 2023 EV/EBITDA of 21.
Of course, I know there are already quite some assumptions here, but that is always the case for valuations. Maybe you don't believe management can go to 65%+ EBITDA margins. Or do you think revenue growth will be lower than 20%? Or maybe higher?
If Adyen can grow revenue at 25% again in 2024, within its target range and EBITDA margins would be 65% (which they won't, as there is a lagging effect of the hires), it now trades at a normalized 2024 EV/EBITDA of just 17, in the same ballpark as the broad market.
For a premium company expected to grow in the mid-twenties for many more years and highly profitable, that looks like a great buying opportunity to me.
Of course, that doesn't mean the stock can't go down more. The market is fickle and Adyen continues for another half year with its investments. But looking back in, let's say, five years, I think this will look like a great buying opportunity.
Conclusion
Of course, the results were not impeccable. The company missed the expectations for many of its key performance indicators. But the stock price reaction to these misses was exaggerated, creating opportunities for long-term, patient investors. After all, the stock now trades at a 3-year low, down 47% from its price three years ago.
Compare that to the improvement in its fundamentals.
Of course, when the stock price is high, all investors are optimistic; when the stock price is low, there are dozens of reasons investors worry about. I expressed that in this meme.
To me, I'm happy to add substantially to my Adyen position. The long-term thesis has not fundamentally changed, although I foresee pressure on the stock price for several months and maybe longer.
In the meantime, keep growing!
For further details see:
Adyen: Why I'm Buying With Both Hands