We always take the surest path towards long-term, sustainable return, even if that road is more extensive and complex to navigate.
From Adyen’s H2 2022 shareholder letter
Last week, Adyen’s stock (OTCPK:ADYEY) (OTCPK:ADYYF) was down a lot after it had announced its earnings, ending the day down more than 15%. It was the biggest single-day drop since the company had its IPO in June 2018, almost five years ago.
This fact alone made many investors think the earnings were bad, but you shouldn’t judge on price alone. Let me explain what’s happening here in this article.
We will look at the results using much of the information Adyen provides in its shareholder letter. Just like any other company, Adyen was not immune to the macroeconomic circumstances:
The world economy was volatile in H2 2022, with high inflation and geopolitical instability creating a challenging period for global commerce. Adyen closely monitors these developments and is not immune to their effects.
If you are a shareholder of Amazon (AMZN), Meta Platforms (META) or Netflix (NFLX), I think you have seen that sales screeched to a halt in the second half of 2022 and those giants are all Adyen customers.
Let’s start with the processed volume. That’s all the money that goes through Adyen’s system. It came in at €421.7 billion (about $450 billion) up 41% year-over-year.
If you look at this number, it’s great no matter how you look at it. Growing at more than 40% at this size already is nothing else than impressive.
Some will point to the deceleration compared to last year. If you look at sequential growth, so H1 vs. H2, in H2 2022, processed volume came in at €300 billion versus €216 billion in H1. That means 38.9% growth between H1 and H2. This year, with €421 billion versus €346 billion, you only get 22% growth sequentially. I’m not worried about this. You shouldn’t forget that Adyen gets 55% of its revenue from Europe and we all know that H2 2022 was a tough period for the economy in Europe. As Adyen writes in its shareholder letter:
The overall macro environment was still marked by turbulence. The second half of this year saw soaring inflation impact households globally. The war in Ukraine waged on, catalyzing both humanitarian crises and economic knock-on effects felt around the world. Commerce naturally slowed as businesses and consumers alike grappled with supply chain disruptions, record debt, and energy price spikes.
Let’s go to net revenue. This is sometimes a source of confusion. Many sites give Adyen’s gross revenue and then Adyen has very low margins. The reason is simple; if Adyen handles a payment, it takes a percentage, but from that percentage, it has to pay other companies in the payments chain too. If you use Visa (V) or Mastercard’s (MA) network, you have to pay them. That money is never theirs, but it’s on their books for a short time and that’s why it has to be called revenue under GAAP. That’s why Adyen reports ‘net revenue’, which excludes all the fees it has to pay to others. Adyen visualizes this as follows:
Net revenue was up 30% to €721.7 million (almost $775 million) or 33% to €1.3 billion on a full-year basis (almost $1.4 billion).
As you can see, revenue is up less than payment volume. Bears and people not understanding what Adyen does will always point that out as a weakness, quoting margin pressure. That sounds convincing and it looks like the numbers back this up. But Adyen does this on purpose, as it has been repeated many times in the past. It gives rebates for volume and the reason it does this is to get even more volume.
Let me explain. Suppose you are an executive at Spotify (SPOT), another one of Adyen’s customers. Spotify has several payment platforms it uses. If Adyen gives more rebates for volume than the others, wouldn’t you give them more volume? It’s cheaper for Spotify to do so and that’s a pretty good argument, right?
You may think I’m defending Adyen too much here, but this is one of the reasons Visa and Mastercard have done so well. They give sizeable rebates as well and I wouldn’t call them no-moat companies, to use an understatement. Adyen is just following that same path. Thinking over the long term is an advantage.
But let me show you the numbers as well. From H1 2021 to H2 2021, Adyen’s processed volume was up 38.9%. Its net revenue was up 25%. From H1 2022 to H2 2022, processed volume was up 22%, but net revenue was up 18%. 18% vs. 22% is better than 25% vs. 38.9%. That shows Adyen is not pushed out of its profits by other players in the payment chain, just that it does what it has repeatedly said is its strategy, lowering fees for bigger volume.
80% of its growth comes from existing customers and even in this tough macroeconomic environment, churn was below 1%. Adyen applies the land-and-expand model, but in a personalized way. From the shareholder letter:
We initially solve a single problem, then ramp up our collaboration by helping businesses identify and address far more complex needs.
Let’s break down net revenue with another quote from the shareholder letter.
EMEA contributed 55% of total net revenue, followed by North America (…), APAC (…), and LATAM (7%).
In terms of net revenue growth, North America (up 45% YOY), was narrowly followed by APAC (up 44% YOY), LATAM (up 36% YOY), and EMEA (up 20% YOY). H2 2021 was an exceptionally strong period for EMEA contribution, which impacted H2 YOY growth rates.
So, despite the macroeconomic weakness in Europe and the high revenue growth in Europe in the comparable period in 2021, revenue was still up 20%. That’s still very strong. This is the visual representation of the same data. It shows you the size of importance and the growth rates.
It’s good to see that revenue keeps diversifying geographically.
What will be most cited as the reason for the big stock price drop is probably this.
As you can see, EBITDA was only up 4% year-over-year to €372 million, about $400 million. The consensus stood at €464 million, so Adyen missed earnings by a wide margin, almost 25%. Analysts thought the company would add 800 employees or less for the full year 2022, but Adyen added almost 1,200, 50% more than expected. How analysts could still project EBITDA margin growth from 60% to 61.5% even with ‘just’ 800 hires is hard to figure out, to be honest.
EBITDA was still up 32% in H1 2022. This will be used to explain the stock price drop. But this had already been announced in November 2022.
Adyen is doing what I think is a great countercyclical move. During the pandemic, it had scaling problems and needed to hire more people to consolidate future growth. But tech talent was so expensive that only the necessary number of people was hired.
Now there are layoffs in tech everywhere, think of Google (GOOGL) (GOOG), Amazon, Microsoft (MSFT), Spotify and many others. As this process accelerates, Adyen goes on the market to hire all that tech talent at much lower prices. The company added 757 new employees in H2 2022, which brings the total to 3,332 full-time employees at the end of 2022. That means Adyen added 29.4% new employees in 6 months.
Also important: Adyen stresses that it doesn’t compromise on quality and has no quota to reach. It still filters for both quality and mentality, as it has always done. Adyen’s hiring has always been very strong and the corporate culture is both excellent and a competitive advantage. Adyen is careful not to harm this. On the conference call, CEO Pieter van der Does emphasized that the hires were with a clear function in mind:
We are hiring to make products, not the other way around.
So hiring is not just hiring for hiring’s sake. Van der Does also stresses that with this quote:
We have been in this market for a long time, we have been speaking to merchants for a long time, so this is not just a guess, as in “let’s meke a feature”. No, we are building what we know is needed and will be used.
It’s normal this has an impact on the profitability of a company that usually doesn’t do this. And Adyen expects to add a similar number again in 2023. That means another 1,200 employees or so or 35% growth again. Compare that to Adyen’s competitor Stripe, which has laid off 14% of its workforce already. Adyen wants to profit here too, by cranking up its land-and-expand. The land phase will not immediately impact revenue but expand will in a few years. Adyen is really sowing the seeds for continued growth.
Adyen expects the team to have reached the next stage of maturity in early 2024, so that’s when Adyen will stop hiring faster and you should expect EBITDA margins to go up again, although the real power will only be visible in 2025.
Adyen started its hiring acceleration in 2022 and that has consequences for its profitability. And Adyen follows up on this in its shareholder letter.
So, the fact that EBITDA growth was down so much was a consequence of Adyen’s hiring, which was more successful than foreseen because of the economic circumstances. The economic headwinds for other companies are a tailwind for Adyen when it comes to attracting talent.
You should not expect to see EBITDA up much more in H1 2023. H2 will have easier comps, so it will probably be up a bit more then. But in 2024, the hiring acceleration is expected to stop. Again from the shareholder letter:
At that time, we will slow our hiring pace and allow the operating leverage inherent to our business model to kick in. We remain in full control of and intentional about this dynamic. Although we could quickly reach our projected 65% EBITDA margin if we shifted to optimizing for this metric, our gaze is fixed on the horizon.
For context, the EBITDA margin in this quarter was 52%. CFO Ingo Uytdehaage said on the conference call Adyen also invested heavily in 2015, 2016 and 2017, but that resulted in the sustainable high growth we still see today. So, yes, there will be continued pressure on the EBITDA margins in 2023, but that should go away in H2 2024, setting up the company for continued high growth in 2025, 2026, 2027 and beyond. For me, as a long-term investor, this is exactly what I want to see.
By the way, the higher interest rates will partly offset the costs Adyen makes. Don’t forget that most of Adyen’s money is in Europe, at the ECB, and the interest rates there are still lower. For commercial banks, there is always a lag. But the rates are expected to follow the US’s path, as usual, for the same reason: fighting the high inflation, which is still quite a bit higher than in the US.
As a company with no debt and a cash mountain of more than €2 billion ($2.15 billion), Adyen will make a ton of money from interest. It also has €3.5 billion ($3.75 billion) in money for merchant settlement and CFO Uytdehaage made it clear on the conference call that this money moves fast, but Adyen still gets some interest here as well.
Uytdehaage also said the company does not want to build this out to a separate business model from interest payments. It’s just a nice tailwind. With negative interest rates in Europe, Adyen had to pay for its cash. Now, you can expect benefits from it in 2023. The company didn’t want to give guidance on how much interest income it expects, but with €2 billion in cash, and €3.5 billion in floating cash, this could be substantial.
There was another reason for the lower profitability too, another investment. From the shareholder letter:
While our platform continues to scale, so too must the infrastructure powering it. Exceptional investments into our data centers resulted in CAPEX increasing to 8% in H2. (…)
Scaling our data center footprint in globally strategic locations is critical to supporting customer needs and handling our ever-growing processed volume. With our infrastructure in a sound position to withstand the coming years, we will return to our 5% guidance in 2023.
I can only cheer for a company investing in its future, especially because I know how well Adyen allocates its money. Don’t forget that this is a very profitable company, with no debt and a heap of cash that still manages to snowball revenue fast. The company has proven that it lives up to what it says and therefore you should believe the quote I started this article with.
We always take the surest path towards long-term, sustainable return, even if that road is more extensive and complex to navigate.
Adyen provides a good example of what it means and the consequences.
After disrupting the online payments landscape, in 2013 we saw an opportunity to tackle in-store payments as well. This space was already crowded but lacking a tech-first solution.
Rather than taking the fastest route to market entry, we opted for the most comprehensive and promising. This meant engineering solutions in-house for the highest end of retail and enterprise customers. These businesses provide far more complex consumer journeys and thus require an equally advanced back-end infrastructure, which we remain the first and only to build.
When the company says it is building the foundations for the next growth phase, this is the path you can expect. This is not a company focused on the next quarter, but on the next decade. That means there will be periods in which you will have to trust management and be patient while waiting for the investments to pay off. Because the company is the only one doing this so thoroughly, it is digging its moat and differentiates itself more and more from its competitors. And while investing heavily, profitability still grows, albeit much slower.
By starting with the most complex cases and building everything in-house, Adyen builds slower, but the result is much more scalable and flexible and sets it up for success over the next decades. Most others start fast, stitch together several solutions from other payment platforms and then find themselves constrained by the limits of their system a few years later.
Compare that to Adyen, which started building ten years ago, but now its point-of-sale solution volume was up 62% year-over-year to €67.6 billion ($72.5 billion). This is still only 16% of the total processed volume, and I think this has the potential to get to 50% of revenue or even more. After all, e-commerce is still less than 20% of total sales in almost any country in the world, in-store is 80%+. A great point-of-sale solution has much room for growth and the unified platform for payments across e-commerce and in-store gives Adyen another competitive advantage.
Another example is Platform, which accounts for about 50% of Adyen’s revenue. It allows platforms to offer sub-sellers an intuitive payment solution through a simple API. Think of eBay, which is a big customer of Adyen. We all know eBay is not a fast grower and that’s why Platform revenue was up just 16%. Excluding eBay (EBAY), the processed volume would have been up 79% on Platforms. This is another sign of strength that is masked a bit. And this also opens up the SMB market for Adyen. Here too, in-store payments are growing fast, by more than 300% year-over-year, although the overall revenue is still just 7.5% of e-commerce Platform revenue.
Co-CEO and executive shake-up
Besides the EBITDA miss, which is a short-term issue, there could have been another reason for the stock price drop. Ingo Uytdehaage, the long-time CFO of Adyen, became the co-CEO. Uytdehaage started as Adyen’s CFO in 2011 already. The fact that he’s now promoted to co-CEO was explained by Pieter van der Does as follows:
Ingo’s new role formalizes how we have been working together for a long time already.
But the market could worry about this. Many think co-CEOs don’t work. In this case, it’s different because they have already worked together for so long, since 2011. On top of that, Uytdehaage probably already does a lot of the work of a CEO now that Pieter van der Does is recovering from surgery for two months. Some may worry that van der Does’ health conditions are worse than communicated and this is a preparation for the moment he has to leave because of his health.
Nobody really knows, of course. Having listened to presentations, interviews and conference calls, I can testify that what van der Does says about him and Uytdehaage is probably just true. They have worked together as a strong combination stronger than the sum of the parts for over a decade. I also think the company culture could survive with Uytdehaage if van der Does would have to leave.
Let’s just hope this speculation is not needed and Adyen’s co-founder and CEO just returns as foreseen. On the conference call, he sounded sharp and ambitious as ever and he said:
There is nothing which I know is coming up that I would be out of the office.
So, I think we shouldn’t worry about this too much. Van der Does is always very honest, straight and to the point, so I think he would have communicated worries if he had them.
There are other changes in the management team as well. Uytdehaage needs a successor as a CFO, of course. That will be Ethan Tandowsky, who will be transitioning into the CFO position from his position as Head of Group Finance. Van der Does sounded very delighted by the fact Tandowsky joins the executive suite.
In addition, Kamran Zaki will be stepping down in his role as COO. He’s a long-time executive as well, with a decade of experience at Adyen. He will remain active until the summer. He says he will miss the excitement of building Adyen’s platform but that it’s time for something new.
Zaki will not be replaced. His responsibilities will be split between Ingo Uytdehaage and Chief Commercial Officer Roelant Prins, who has been at Adyen practically from the start 17 years ago.
On the conference call, Pieter van der Doest rightfully pointed out that it was not easy for Zaki to be an executive for Adyen, being based in the Pacific time zone in the US. That’s a difference of 9 hours, but still, Zaki stayed for a decade. Van der Does said that considering the circumstances, he had always thought Zaki’s stay would be limited in time and that he was surprised and thankful it lasted so long, as it was tough for Zaki. A source told me he heard that there were regular meetings from midnight to 3 am or starting at 5 am in Zaki’s time zone.
Overall, I think investors shouldn’t worry about the executive changes. Adding Ingo Uytdehaage as co-CEO is just the formalization of what was already a reality. And considering the circumstances of Zaki, it is a sign of Adyen’s fantastic corporate culture that he stayed for a decade.
Management doesn’t provide guidance numbers, but it said it doesn’t see any reason to change its long-term goals, which are these:
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.
EBITDA margin: We aim to improve EBITDA margin, and expect this margin to benefit from our operating leverage going forward and increase to levels above 65% in the long term.
Capital expenditure: We aim to maintain a sustainable capital expenditure level of up to 5% of our net revenue.
Adyen has never been cheap and let’s be clear: it’s still expensive today. That’s one of the many reasons I always scale into positions over long periods. This drop is for me an opportunity, as it could hold down the stock price for a while. I took advantage of the drop to add to my position again. After all, I expect this high-quality company to grow for decades, just like its stock price. What’s expensive now can look like a bargain in a few years.
Adyen had its biggest stock price drop since it became a public company almost 5 years ago. The biggest reason was arguably the big EBITDA miss.
This doesn’t worry me at all. The company hired almost 50% more people than analysts had projected, as it’s taking advantage of all the tech employees laid off at the best companies this planet has and even from its competitor Stripe.
Many companies hire too easily, but Adyen is not such a company. It is very disciplined and has long-term goals. Higher interest rates could even pay for some of the costs of the investments, so that’s a tailwind.
Overall, I think Adyen does exactly what it should do, investing for continued growth. It will bring down the profitability for a while, but it is very important for the future.
I’m a long-term investor, so I rub my hands when a company writes this in its shareholder letter:
We continue to look beyond short-term changes, and are instead committed to our long-term growth.
In the meantime, keep growing!
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.