Adyen: Growing Company With Competitive Differentiation But Limited Upside (OTCMKTS:ADYEY)

Young woman with credit card and laptop


Investment Thesis

We believe that the growth of e-commerce and the rise of new small-medium businesses (“SMBs”) will be tailwinds for Adyen N.V. (ADYEY, ADYYF) in the next few years. Adyen’s broad local payment methods and competitive pricing will pave the way for the company to penetrate fast-growing markets and acquire SMBs. In addition, we like Adyen because it is growing at an incredible rate, a profitable, cash-generating business, and running at a respectable ~30% ROAE. However, the stock at its current price does not provide a sufficient cushion for investors.

An Integrated Payment Processor

Since the so-called digital age arrived, consumers increasingly have accepted online payments as they become easier to use. Online shopping is here to stay, and Adyen, a Dutch payment company, offers an end-to-end integrated payment solution for businesses. But what is the problem that Adyen is trying to address?

As demand for online payments has mushroomed, payment processors have begun to acquire payment gateways – i.e., a web-based network that serves as a “gatekeeper” between a customer and an acquirer (the merchant’s bank account) – and integrate them into their value chain. Yet, this was easier said than done. Those acquired gateways must be “fitted” into the legacy infrastructure of a payment processor. Other functions, such as fraud detection, were provided by standalone companies, thus creating inefficiency within the whole value chain.

This is where Adyen comes into play. Rather than plugging separate payment functions into a value chain, merchants can utilize Adyen as their gateway and acquirer. It is essential because merchants seek a leaner and cleaner payment infrastructure that offers a seamless, high-quality experience. For instance, eBay (EBAY) cited “a more seamless experience” as one of the reasons it went with Adyen.

Adyen's value chain vs. traditional one

Adyen’s value chain vs. traditional one (Company)

How does Adyen monetize its business? And what are the primary costs that Adyen must pay for its operations? In general, the fee structure within the value chain is listed as follows:

  • Processing fee: The merchant pays the processing fee to Adyen
  • Acquiring markup: The merchant pays the acquiring markup to the Adyen
  • Interchange fee: An issuer, the customer’s bank, charges fees to Adyen. The interchange fee is usually passed on to the merchant
  • Card network fee: Card networks, such as Visa (NYSE:V) and Mastercard (NYSE:MA), charge Adyen. The card network fee is passed on to the merchant

Hence, being an all-in-one solution provider, Adyen can capture a larger share of payment value chain revenues.

How Adyen monetizes its value chain

How Adyen monetizes its value chain (Company)

Shifting Focus, Eyeing the Underserved Market

Adyen initially focused on enterprises. Yet, to capture the underserved SMB market, Adyen launched Adyen for Platforms, an end-to-end solution that allows online platforms, such as eBay and Etsy (NASDAQ:ETSY), to control the full payment stack. As a result, the company changed its reporting structure (see Figures 2 and 3).

Old reporting structure

Old reporting structure (Company)

New reporting structure

New reporting structure (Company)

While the digital segment made up the biggest share in total processed volume, the Platforms segment is catching up, bringing in €48 billion as of 1H22. eBay brought in considerable volume to the Platforms.

During the 1H22 earnings call, the management said that:

We strongly believe that a lot of SMBs are underserved by the traditional financial institutions, and those platforms are often the trusted partner for those SMBs. And what we can do is power them with other financial products, other financial products like capital, bank accounts, but also issuing. And we see this as an opportunity to serve the SMB market. So, we’re in a really good place there.

Adyen's processed volume details

Adyen’s processed volume details (Company)

In Search for Growth Opportunities

Adyen’s current strategies include: 1) ramping up investment in its unified commerce segment; 2) addressing the underserved SMBs; and 3) expanding globally. Adyen launched its first in-house designed terminals (the NYC1 and the AMS1), allowing businesses to customize their payment flow.

Adyen's terminal

Adyen’s terminal (Company)

In addition, Adyen introduced Tap to Pay on iPhone. Vince, G-Star, Scotch & Soda, and NIKE (NYSE:NKE) are the first adopters of the Tap-to-Pay service.

Adyen's Tap-to-Pay

Adyen’s Tap-to-Pay (Company)

But Adyen is looking beyond the role of traditional payment service provider: the company launched embedded financial products to cater to the underserved SMBs.

To capitalize on this banking-as-a-service opportunity, Adyen has developed an innovative suite of financial products comprising cash advances, business bank accounts, and card issuing. Together with embedded payments, these power the future of financial services by enabling platforms to deliver superior financial experiences to their SMB users.

Platforms will be able to offer bank accounts and financing opportunities for their users. Furthermore, platforms can provide their customers with physical or virtual payment cards through Adyen Issuing.

Adyen's new embedded financial products

Adyen’s new embedded financial products (Company)

We believe more financial products delivered to customers could help platforms build stickiness.

According to McKinsey:

Deposit and payment products are attractive to distributors not only because they represent substantial revenue pools and promote stickiness, but also because they are a powerful tool for building customer relationships and capturing customer data that can be used to inform underwriting decisions for future higher-margin lending products.

Lastly, Adyen is looking to diversify its revenue from the European market. For example, net revenues from the North America and APAC markets grew more than 50% (Y/Y) as of 1H22.

The North America and APAC markets are gaining traction

The North America and APAC markets are gaining traction (Company)

Furthermore, the company is ramping up hiring and investment in the Asia-Pacific, as it continues to diversify its revenue from the European market.

However, is the industry expanding? What is Adyen’s competitive differentiation?

Industry Analysis

E-commerce Has Been on an Upward Trajectory…

The global pandemic has changed the way we buy things. Research by McKinsey shows that the share of e-commerce as a percentage of total retail sales grew two to five times the rate pre-COVID in 2020. In 2021, retail e-commerce sales reached $5.2 trillion and are expected to reach $8.1 trillion by 2026.

Even as the world is slowly back to normal, McKinsey noted that e-commerce is here to stay, for cash usage only increased 1% in 2021 from a 15% decline a year earlier. Data from Statista suggest that e-commerce share as a percentage of total retail sales will be up from 19% in 2021 to 24% in 2026.

E-commerce is expected to take up more share

E-commerce is expected to take up more share (Statista)

…And Will Also Be Driven by the Rise of New Businesses

Furthermore, layoff sprees and global economic slowdown might encourage people to start businesses, in our view. In the early days of the pandemic, people losing their jobs decided to open new businesses: more than 550,000 business applications in the U.S. in July 2020, almost double the number a year earlier. The reopening of the economy did not stop people from being self-employed.

Business applications in the US

Business applications in the US (FRED)

Furthermore, a Google trend on the keyword “start business” in the U.S., for example, started to pick up in 2020, and the trend remains elevated.

Google trend on the word

Google trend on the word “start business” (Google)

As a result, we believe the rise of new of SMBs and the growth of e-commerce will be Adyen’s tailwinds in the next few years.

Highly Competitive Industry with Players Heading to the Same Direction

Nevertheless, Adyen is not the only player in the industry. For example, Stripe and Block (NYSE:SQ) have intensified the competitive landscape, processing hundreds of billion dollars of transaction volume annually.

There is not much information about Stripe’s historical operating metrics, but the company recently reported that it processed $640 billion last year, a 60% increase from 2020. Adyen came second with €516 billion, and Block brought in $168 billion in gross payment volume. In the last five years, total aggregate volume of Adyen and Block grew 51% and 28% per year, respectively.

Total processed volume ($ billions)

Total processed volume ($ billions) (Companies)

Stripe caters to the start-ups and smaller merchants, and it was not until the launch of Stripe Connect in 2012 that Stripe begun to serve marketplace and platforms. According to the Wall Street Journal, Shopify (NYSE:SHOP) reportedly has invested more than $350 million in Stripe and is one of Stripe’s largest customers.

Unlike Stripe, Adyen first focused on enterprises and expanded its product offering to platforms. Yet, like Adyen, Stripe is transforming from a sole online payment processor to a banking-as-a-service provider, offering financing, card issuance, and treasury services.

Stripe Treasury

Stripe Treasury (Stripe)

On the other hand, Block offered a POS solution to retailers before expanding its wings online by launching Square Market. In 2013, Block launched its Cash App service, a peer-to-peer payment service. Last year, Block acquired Afterpay Limited–a buy now, pay later platform–for a staggering $29 billion to “accelerate Square’s strategic priorities for its Seller and Cash App ecosystems.”

Block's products

Block’s products (Block)

Block offers financial products through Square Banking. For example, Square rolled out Square Loans addressed to small businesses in Australia.

Square Banking represents a major milestone in Square’s continued efforts to expand access to financial tools for underbanked populations and marks the beginnings of the company’s journey to provide more banking solutions to small businesses.

So, we see a trend: payment processors are eyeing the SMB market and providing embedded financial products.

But what is Adyen’s competitive differentiation? How can Adyen penetrate fast-growing markets and acquire SMBs?


Read More: Adyen: Growing Company With Competitive Differentiation But Limited Upside (OTCMKTS:ADYEY)

2022-11-16 13:21:00

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