Adyen Stock: Not a Bargain Buy at 50% Off

Having objecting rules to guide your investment process means less decision making. As risk averse investors, we only allocate a fixed amount of funds to any disruptive tech stock and that’s that. It’s kind of like the old saying. “If it’s the next Microsoft, all we need is a little. If it’s not, we only lost a little.” More importantly, it’s about removing the temptation to try and catch falling knives. That brings us to the topic of today’s conversation – Adyen (ADYEN.AS).

It’s been nearly a month since that fatal earnings call which saw the share price halve. Our initial take was that the accounting changes which affected revenues, along with sudden negative cash flows, wreaked havoc on valuation models which caused the precipitous drop. Market consensus is that the drop resulted from difficulties the company is having in the U.S. market where they compete against players like PayPal (PYPL) and Block (SQ). We decided upon a “wait and see” approach for several reasons.

Adyen hasn’t been a volatile stock historically. Waiting for the dust to settle a bit makes sense, but for how long? We’d prefer to see another round of earnings, but Adyen only releases results twice a year. Making our subscribers wait six months for an update hardly makes sense. They’ve been asking for more color around Adyen’s precipitous drop aside from our cursory alert, so let’s start by defining the issue at hand.

• Adyen saw revenue growth slow
  What geographies were affected? What’s the competition been seeing?
• Multiple accounting changes affected revenues and possibly other metrics
  Identify key metrics for investors to watch going forward
• Cash flows plummeted
  Try to better understand why

Let’s start with the first bullet point.

Adyen’s Slowing Revenue Growth

Forget about Adyen’s previously reported revenues. For all practical purposes, we should have always been looking at “net revenues” which now more closely resemble their actual revenues following some accounting changes. The result of that change is a set of financials that appear as if revenues dropped 78% this last earnings call. If we remove all that noise, here’s what Adyen’s “true revenues” look like.

It’s not the first time Adyen’s revenue growth stalled, and the slowdown in H1-2020 was attributed to “the pandemic’s impact on the travel and in-store retail verticals.” This is reflected in a decline of the “processed volume” metric which is highly correlated to revenues. That’s because Adyen makes their money taking a cut of the transactions processed (referred to as “take rate” in industry parlance). In looking at revenue growth by geographical segment, we see that North America and Latin America are where the concerns lie for Adyen.

	H2-2022	H1-2023	Change
EMEA	339,436	417,279	+23%
North America	190,689	187,452	-2%
Asia-Pacific	78,109	84,307	+8%
Latin America	53,403	50,069	-6%

Adyen talks about “increasingly competitive pricing in North America” which means they’ll need to start eroding those fat margins to compete on price, at least in the Western Hemisphere. That’s a good segue into our next topic.

Bottom Line Business Health

Like most fintech companies, Adyen’s unique business model is complex from an accounting perspective. It doesn’t lend itself well to the notions of “operating costs” and “cash flows” which means runway needs to be thought of differently. For disruptive growth companies, we’re always concerned with the amount of cash-being-burned vs cash-on-hand because this tells us how long the company can survive without needing to raise more capital. For Adyen, these metrics are deceptive because their business model involves shuffling around cash payments. Simply put, the $6.8 billion they have on their balance sheet provides plenty of buffer for the company in case operating cash flows should fall into the negative (they did as of last earnings). As one astute subscriber pointed out, this drop in cash flows is predominantly related to the timing of money that flows in and out of their coffers during business as usual.

In other words, we’re better off ignoring cash flows and operating costs because they lose their meaning when applied to Adyen. So, we need to take a different approach to monitoring the company’s health. While “net revenues” are the topline metric to watch, “income before net finance income and income taxes” is the bottom line metric to watch.

In the above table, we’re focusing on what happens to “true revenues” once they’re been realized and cost-of-goods-sold has been subtracted. Overhead costs like wages and salaries are then subtracted, and the leftover number reflects how profitable the business is. We’ve chosen not to include “finance income” because the cash stockpile that Adyen keeps in the bank generates a healthy stream of income that’s only sustainable for as long as interest rates stay high. Our focus is on how much cash the business generates after all overhead costs are covered.

The end result is that Adyen retains a healthy amount of cash that can either be invested back into the business or distributed to investors in some way. A running theme over the years has been Adyen’s focus on growing their business through increasing head counts, something that doesn’t seem to be bearing fruit when they talk about seeing “the impact of a sales team size that did not match our ambitions, particularly in North America.” All those future expectations are being called into question which is why Adyen’s valuation has plummeted, but it’s no bargain buy.

Adyen’s Valuation

Our simple valuation ratio (SVR) provides a way to value tech companies that are enjoying rapid growth. Provided there are healthy gross margins to reap future rewards from, we want our disruptive tech investments to be focused on capturing market share. Revenue growth is a proxy for market share captured, so we can divide market cap by annualized revenues to come up with an SVR number. Here’s Adyen’s (numbers in euros)

• Market Cap = 24 billion
• H1-2023 Revenues Annualized ( 739 million * 2) = 1.478
• SVR = 24 / 1.478 = 16

That’s pretty rich when compared to our tech stock catalog average of 6.5. We would have never invested in Adyen were it not for mistakenly calculating SVR incorrectly (using the “old” revenue numbers). That’s why our last article concluded that we wouldn’t find Adyen investable unless we see “an order of magnitude change in either net revenue (way up) or market cap (way down).” While market cap is now way down, the valuation ratio still remains more than twice our catalog average. Attempting to benchmark Adyen against competitors like PayPal (SVR of 2.4) or Block (SVR of 1.5) doesn’t work because it’s hardly apples to apples. For example, Stripe’s decision to count bitcoin sales as revenues means we’d need to scrutinize their financials to find a “net revenues” equivalent. As for PayPal, we previously discussed their opaque revenue sources which make it nearly impossible to find a trustworthy “net revenue” equivalent. Speaking of which, our 2022 piece titled Adyen Stock is a Pure Play on Digital Payments Processing talked about how Adyen differs from the biggest payments provider in the world:

Adyen [..] works behind the scenes by providing merchants a standardized back-end infrastructure for authorizing payments across their sales channels – online, in-app, and in-store. It is not a consumer-interfacing product with name recognition like PayPal or Venmo. 

Nanalyze

Adyen’s business model is more fundamental than just a single payments method and more closely resembles what dLocal does in emerging markets – they offer merchants one connection point for many payment methods. Perhaps dLocal’s SVR of 11 gives us at least one relevant comparison for determining Adyen’s appropriate valuation.

Key Takeaways

Perhaps investors ought to consider Adyen on its own merits and conclude the following:

• Growth in the Americas will be tougher than expected due to heavy competition. Competing on cost will put pressure on “income before net finance income and income taxes,” a key metric to watch going forward
• Adyen remains richly priced. Apples-to-apples valuation comparisons with competitors won’t work, for any number of reasons
• Shares have halved, but they could have further to go. Set a valuation target and stick with it.

When companies are richly valued, setbacks will be severely punished by those who ascribe most of the current value to future growth. Again we find ourselves wanting to wait until the dust settles. Is this bad half an exception or a new rule? If you’re considering a long position in Adyen, set an SVR target and stick to it. Accumulating your position over time helps reduce market timing risk.

Conclusion

Waiting six months to see what the year brings for Adyen doesn’t work well for investors who see the significant drop in share price as an opportunity to add shares of a quality company at a discount to previous values, but not at a bargain. Monitoring the stumbling revenue growth in the Americas will help investors understand if Adyen’s growth aspirations can extend beyond Europe, while monitoring net income will help us understand how much leeway they have to reduce prices or continue growing the company. Adyen’s not just a challenge to follow because it’s a foreign stock, it’s also operating a business model that makes some traditional financial metrics not so applicable.