Adyen (ADYEN 1.95%) is a global payments processor focused on online transactions and large enterprises. With its modern offerings that allow merchants to accept any form of payment anywhere in the world, the company has rapidly increased its share of global payments volume over the past few years, from just 0.2% in 2016 to 2.1% in 2022.
But as we sit here in October 2023, Adyen's stock is down more than 40% year to date. This is due to investor worries over competitive threats on pricing in North America, slowing revenue growth, and narrowing profit margins. However, when you dig into the numbers and management's long-term strategy, it is clear that these concerns are misguided.
Here's why the market is missing the forest for the trees with Adyen, making it the best growth stock for investors to put spare cash to work right now.
Adyen: Start again
Adyen is a relatively young company. It was started back in 2006 by Pieter van der Does and Arnout Schuijff, two veterans of the payments industry who worked at Bibit, a company that was sold to the Royal Bank of Scotland. After working under a larger payments company, the two realized that the industry was rife with old, poorly functioning, and jumbled-together software programs that made it difficult to innovate and provide the best value for customers.
So the two -- along with other colleagues -- started Adyen. The word literally means "start again" in Sranan Tongo -- which is spoken mainly in the African country Suriname -- in a reference meant to show they wanted to build a modern payments company from scratch. With a hard rule on not acquiring any other companies, Adyen has built its modern payments software from the ground up, slowly working to add more and more capabilities for its merchant customers.
Originally, the company focused on the European market and large enterprises, winning large start-ups like Spotify and Uber in its early days. Today, it offers a plethora of products, including point-of-sale (POS), major geographical coverage, customer authentication, and fraud detection.
Why have merchants chosen Adyen over long-standing payments processors such as WorldPay or Fiserv? The key is Adyen's best-in-class authorization rates. An authorization rate measures the percentage of successfully approved transactions for customers trying to buy something, which is especially important in online transactions. Adyen is known to have one of the best global authorization rates due to its ground-up approach. Authorization rates can make a huge difference for large retailers. For example, if a company has $1 billion in potential revenue from online transactions, an improvement from a 98% authorization rate to 99% would add $10 million in new revenue, all from just a software upgrade.
A lot of room for market share gains
With better products and a huge potential market to go after, Adyen has grown like gangbusters in recent years. From 2015-2022, the company's total payment volume (TPV) went from 32.2 billion euros ($34 billion) to 767.5 billion euros, a 57% compound annual growth rate (CAGR). It has done so with high efficiency, sporting earnings before interest, taxes, depreciation, and amortization (EBITDA) margins above 40%. Over the long term, management thinks it can hit 65% EBITDA margins.
Even at almost 1 trillion euros in annual TPV, there is still a ton of room for Adyen to grow as it only has about 2% market share of payments processing. It wouldn't be surprising to see the legacy providers steadily leak volume to Adyen this decade.
So, what's wrong with the stock? Why are shares down so much this year? The narrative has changed around Adyen as competitor Braintree -- which is owned by PayPal -- has cut its costs in North America to try and win customers. Adyen has decided not to engage in a price war and is remaining firm on what it charges merchants. While this has concerned investors, when you look at the numbers, Adyen is holding up very well in retaining its customer base. Its volume churn remains at 1% or lower, and there is still more than 90% of the payments market that is processed through legacy solutions. Both Adyen and Braintree can win over the long term, and the two entities only have about 3% global market share. This step-up in competition should not warrant a 50% haircut in the stock price.
Is the stock cheap?
Another reason Adyen shares have fallen is a narrowing of its margins for earnings before interest, taxes, depreciation and amortization (EBITDA). In the first half of 2023, the company posted an EBITDA margin of 43%, down from a 64% in 2021. This can be easily explained away. With major layoffs in the software industry over the past year or so, Adyen has accelerated its hiring to snap up talent while a lot is available. Seeing as the majority of its costs come from paying employees, this has temporarily ballooned its operating expenses, but management has been deliberate in saying it will moderate hiring in the next few years, which will lead to EBITDA margin expansion as long as TPV keeps climbing higher.
At today's market cap of 21.5 billion euros (the stock is listed in Europe but has shares that trade on the U.S. exchanges), shares of Adyen trade at 31 times its trailing EBITDA. This might seem expensive, but investors should remember that margins are temporarily depressed due to its accelerated hiring and that the company has a huge opportunity ahead of it to gain market share. Management believes it can increase revenue at a mid-20 percent CAGR for the foreseeable future. With this context, it is clear that Adyen is a great place to park your money for the long haul.
