3: Some thoughts on Checkout.com vs Adyen

This post might be of interest to existing and potential shareholders of Adyen. Adyen has had a very successful 2.5 years on the public markets, both in terms of fundamentals and the share price (see chart below).

But even when you believe the business you are invested in is a “winner”, I think it pays to always be vigilant and monitor for potential changes in competitive intensity. To that end, today we’ll be looking at one of the fastest-growing B2B payment processors that is billed as “the next Adyen” and increasingly, loosely cited as a risk to Adyen’s growth rate in the long-term.

Checkout.com (in this post, I refer to it as just ‘Checkout’) is a privately-held, rapidly growing payments company that is a direct competitor to Adyen. Checkout continues to raise significant funding (with backers including some illustrious names - Tiger Global, Coatue, DST, Insight Venture Partners), at ever-increasing valuations. As of January 2021, Checkout’s post-money valuation was $15 billion. For Adyen’s public investors, there’s not a huge amount of existing analysis out there assessing Checkout’s business model (the sell-side certainly hasn’t done it, or at least not that I’ve seen) and comparing it against Adyen, so I took a stab at putting something together to stir up some discussion.

1. Checkout is prioritizing growth, and is raising A LOT of money to do it.

In less than 2 years, across its Series A, Series B and Series C, Checkout raised a total of $830M. That’s a conspicuously large amount. Based on the disclosed $260M cumulative sizes in 3 out of 4 of Adyen rounds in 2006-2015, it’s probably safe to say Adyen raised less than half of what Checkout raised, and Checkout has not even gone public yet (while Adyen’s IPO was purely secondary). This raises some questions. Why is Checkout raising so much more capital than ever raised by Adyen? I think the simplest and truest answer is that Checkout has an explicit goal to grow as fast as humanly possible. This means maximizing new client wins. And those wins are acquired organically by hiring salespeople or through M&A. On both fronts, Checkout is aggressive. As of mid-2020, Checkout employed c.750 people. That’s the same as the size of Adyen’s employee base at the time of Adyen’s IPO in 2018 (and Adyen was founded 6 yrs before Checkout was founded). And on the M&A front, in just the past year Checkout made two outright acquisitions: buying technology (ProcessOut), and buying an existing payments business in a specific geography (Pin Payments in Australia). Compare this to Adyen’s explicit strategy of only organic growth and zero use of M&A.

2. Checkout’s business model has some important differences vs Adyen.

Let’s remind ourselves of Adyen’s business model first, before comparing it to Checkout.

By now, the ‘Adyen legend’ is well-known in the market. Adyen was founded in the Netherlands by experienced Dutch payments industry operators who wanted to create a more efficient, cutting-edge payments platform using modern software and not dependent on the old systems developed on bank mainframes. Adyen grew gradually, initially starting as a Payfac of larger payments groups (e.g. Adyen was a Payfac of Vantiv in the US) before eventually acquiring the scale, a good word-of-mouth reputation / customer confidence and all the necessary clearances / licenses to become a full-fledged integrated acquirer and processor in the majority of its most important markets (and now more than 70% of Adyen’s revenue is ‘single platform’). Adyen’s business approach ran contrary to the ‘federation’ structure of the large payments incumbents, with their technological stacks stitched together using old infrastructure and replete with technical debt. Adyen’s model produced superior authorization rates, a feature initially most highly valued by the largest category of merchant (e.g. a merchant with more than $1B of annual volume), a merchant for whom even a seemingly tiny improvement in authorization rates can mean a big difference to the bottom line. To put it simply, Adyen’s USP (unique selling proposition) is that it has the best technology and thus best authorization rates and most comprehensive list of payment methods. Adyen was effective in pitching this USP, and was fortunate in winning the likes of Spotify, Booking and Uber as its clients. Adyen ended up growing alongside these clients; each year, Adyen reports that the majority of the incremental $ volumes generated in that year came from existing clients, which is indicative of the strong independent growth profile of its clients as well as Adyen’s ‘land-and-expand’ client strategy. In this context, 'land-and-expand' simply means that when Adyen wins a new merchant, that merchant will initially only give Adyen a portion of the total volumes, but Adyen’s share will end up growing over time based on merit. To that end, Adyen incentivizes the client through a clean, ‘interchange-plus’ pricing structure with volume-based stepdown in the commission rate, as well as significantly more flexible contract terms (whereas the incumbents usually try to lock the customer in). Adyen is also generally confident that its technical performance (i.e. authorization rates) will continue to prove superior, motivating the merchant to shift more volume to Adyen. Adyen’s approach proved highly successful in the market, and over the years Adyen expanded so much that they are now basically in every major Internet geography (except China) and also have a big in-store POS offering (serving brick-and-mortar merchants, e.g. the Subway sandwich chain).

By all accounts, Adyen has a strong culture. In my assessment, some of the defining attributes of that culture are directness, customer-centricity, self-reliance, thriftiness, and a certain degree of conservatism. These attributes reveal themselves in various ways, e.g. Adyen has tried hard to keep its cap table small and could have essentially bootstrapped itself; when Adyen raised its first venture round from Index Ventures in 2011, Adyen was already profitable and did not need the money; Adyen steadfastly refuses to do acquisitions; the company insists that each new hire is interviewed by at least one member of its board; Adyen avoids controversial (but lucrative) business such as merchants in the gambling and adult entertainment industries; Adyen foregoes some business because it refuses to customize its platform for an individual merchant and will only roll out new features to everybody at the same time; Adyen’s contracts with merchants have a shorter term and allow the merchants to cancel with 1-month notice, which is substantially more flexible than the industry standard; the management and IR of Adyen keep a lower profile in the press and in the capital markets than one would expect for a company of its size and growth profile.

Sell-side consensus estimates Adyen’s FYE (Dec) 2020 business size at roughly €307B of annual payment volume (up 25% yoy), €683M of annual net revenue (i.e. a 0.22% net take rate after scheme and interchange fees), €372M of annual EBITDA (a 54% EBITDA margin), and €247M of annual net income (a 36% net margin). Adyen’s management has guided for ‘mid-twenties to low-thirties’ % revenue CAGR and a >55% EBITDA margin in the medium term, a guidance that they have unwaveringly stuck to and exceeded since the IPO in 2018.

Now, what about Checkout? There are many similarities with Adyen. Checkout claims that its payments platform is built on modern software and results in high authorization rates that are at least occasionally superior to that of Adyen. But beyond that, there also are some important differences.

• Checkout does not (yet?) have a physical / POS / omnichannel offering. Checkout is a purely Internet & ecommerce-focused payments vendor.

• Checkout’s strategy in recent years was to focus on merchants that are 1 or 2 rungs below the Adyen merchant-size. You could say that Checkout was forced into going after that segment because the small & start-up space is occupied by Stripe and the large / enterprise space is taken by Adyen, so Checkout had no choice but to go after the mid-market. I think there are some advantages in the mid-market approach when it is applied to the Internet, as Checkout has done. Mid-sized Internet businesses of today can become the behemoths of tomorrow, and it can give Checkout a longer runway to “grow with” its merchants. However, Checkout’s ‘mid-market’ focus shouldn’t be overstated. Today Checkout shares some decent-sized large merchants with Adyen - Farfetch, The Hut Group, and Deliveroo. And of course, Adyen also intends to sign up more mid-market merchants in the future, which will pit the two providers to compete against each other more directly. So the spaces of the two players already overlap, and will overlap more in the future.

• While Adyen will not offer significant individual customization for a merchant, Checkout is a lot more flexible. It will be interesting to see whether this is a result of either a conscious long-term strategic decision that Checkout will stick to as it scales, or it is a temporary tactic to gain market share.

• I occasionally see feedback that Adyen sales teams are somewhat “arrogant” and overconfident that their solution is the best, while Checkout is more humble, hungry and flexible. Checkout will fly out very senior management (like the CEO Guillaume Pousaz) to go see the merchant and try to clinch the deal. Or at least, this was the case pre-Covid.

• As outlined in the previous section of this note, Checkout does not shy away from making acquisitions as a way to buy technology, licenses or customers (or a mix of the three, ideally). M&A supercharges revenue growth. It helps sidestep the two biggest limiting factors to revenue growth in the B2B payments business model; the first barrier is that the sales cycles can be long, especially since many merchants are on 2-3 year contracts with their processors, providing only limited opportunity to unseat an incumbent processor; the second barrier is headcount and hiring - it takes a long time to hire and train-up someone to be effective, and the supply of candidates of appropriate quality is not endless. Thus, if we make the crucial assumption that the payments market has some merchant stickiness (an assumption that has generally proved to be true in Adyen’s case thus far; this is something that we can get into in another Substack post at some future date), the logic of using all available tools (including M&A) to grow as fast as possible makes a lot of sense. The potential downside of this is that this introduces complexity and technical debt. Adyen’s rules (“no M&A - ever”; “minimal customization for individual merchants”) are consistent with guarding against long-term complexity with extreme vigilance and prioritizing that against growth in the short term or even in the medium term.

• It is rumored that Checkout is less rigid than Adyen in turning away merchants from higher-risk industries.

• Adyen has a relatively global presence nowadays, but it is still mainly a European business (65% of FY19 net revenues from Europe). Checkout is headquartered in London but its roots lie in founder & CEO Guillaume Pousaz’s earlier activities in the payments industry in Asia and Mauritius. I believe Checkout’s footprint is more lopsided than that of Adyen, and is weighted towards Europe and Asia / Middle East, with a relatively smaller US presence thus far. For instance, in the Middle East, Checkout has won large merchants such as Careem, and Checkout’s CEO Guillaume Pousaz lives in Dubai.

• Checkout’s aggressiveness and large amounts of VC funds raised likely align to boost the remuneration of Checkout staff. This should help distinguish itself against Adyen. In the payments industry (especially in the US), Adyen is known to be relatively ungenerous with pay, particularly on share-based compensation. Some of it is cultural, and a lot of it has to do with Adyen being a Dutch company. Adyen’s compensation policies have been an especially significant issue for Adyen in the US. Checkout has hired away some Adyen staff (and I have not seen a single person go in the other direction), and compensation was likely a factor, in my view.

3. There’s not enough reliable public information available for a good analysis of Checkout’s valuation vs Adyen.

First, note that Adyen currently has a €57B market cap (adjusted for the dilution from the warrants issued to eBay), a roughly equal EV (treating the short-term merchant deposits as debt), and thus trades at the following EV multiples (using consensus 2020E numbers): 0.2x total payment volumes, 84x net revenues, 154x EBITDA, and 231x unlevered free cash flow (using net income as a rough proxy and giving zero value for movement in merchant deposits). These multiples should be assessed against Adyen’s medium-term guidance of c.25-32% revenue CAGR (and the implied guidance that EBITDA will grow at least as fast) along with the longer-term expectation of how big the TAM will be and what share of that TAM Adyen can end up occupying. I’ll save a more detailed discussion of these topics for a future Substack post. In the meantime, let’s turn to Checkout.

On Checkout: as mentioned previously, Checkout has a $15B post-money valuation. But finding some recent, accurate financials is tougher. I infer that Checkout is growing a lot faster than Adyen. Checkout’s transaction count in May 2020 grew 250% yoy. Checkout’s total $ volume grew 200% in 2018. These are clearly very impressive growth rates. The last time Adyen grew its revenue by more than 100% was way back in 2015. And in December 2020, Checkout confirmed that it its weekly volumes are in the billions; my interpretation of this is that the weekly volume run-rate is somewhat north of €52B. If this is correct, this suggests that from a volume perspective, Checkout is currently of roughly the same size as Adyen was in 1H 2016 (Adyen FY2016 volumes were €66B).

Further triangulation is required to get a better sense of Checkout’s revenue and margin structure. I have not seen consolidated financials, but the financials for the UK & Europe division are filed with UK Companies House here. On the understanding that Companies House financials do not paint the complete picture (ie they ignore the Asia, Middle East and Americas part of Checkout’s business; it’s even possible that some of the European business is booked through some other entity for tax reasons), I still find these financials somewhat useful (or at least, better than nothing). I make the following observations:

• Checkout’s “gross profit” is the P&L line most comparable with Adyen’s “net revenue” line.

• Checkout’s UK & Europe net revenues in FY2019 were $55M and grew 52% yoy. Gross revenues grew considerably faster. There’s not much disclosure on the ‘cost of sales’ (i.e. the scheme and interchange fees). For Adyen, scheme & interchange as % of gross revenue ex POS increased from 73% in 2014 to 84% in 2019. It’s a steady industry headwind, but I was still surprised to see such a large implied headwind for Checkout in a single year.

• Checkout’s UK & Europe adjusted EBITDA in FY2019 was $5.5M, which is a 10% EBITDA margin. I found this to be surprisingly low. When Adyen was of a comparable size (2015/2016, when Adyen’s net revenue was €98M / €158M), its EBITDA margin was solidly above 40%. Adyen’s volume & net revenue growth in 2015 was 112% and 110%, and in 2016 it was 106% and 60%. Checkout UK & Europe’s net revenue growth wasn’t meaningfully superior. I think one potential explanation is that Checkout’s UK & Europe division absorbs a meaningful portion of groupwide central costs.

• The Companies House financials do not disclose $ processed volumes, but if I apply Adyen’s net take rate of 0.22% to Checkout’s net revenue, I’d estimate Checkout’s UK & Europe 2019 volumes at roughly $25B. Checkout’s growth in the gross revenue suggests a volume growth of 96%; though note that merchant deposits (i.e. the merchant creditors line item) grew only 41%. I would bet the yoy $ volume growth is likely somewhere in between those two figures.

• If we make a very crude simplifying assumption that Europe & UK account for 2/3rds of Checkout’s revenue and volumes, then we can estimate Checkout’s FY2019 consolidated volumes and net revenues as $38B and $83M. That’s roughly similar to Adyen’s size in 2015/16.

• It is seductive to then follow-through with the above logic by saying “Checkout should be worth what Adyen was worth in 2015/16” but I think that would be too simplistic and punitive, for various reasons. Today there is less uncertainty about the longevity and resilience of the Adyen (or Adyen-like) business model than in 2015/16. Witness Adyen’s continued growth and robust profits in FY20 YTD. Less uncertainty about how a business performs in various environments means higher valuations. And Covid has brought the offline-to-online and cash-to-cashless secular transitions forward (likely by a lot), which has some impact on the intrinsic value of an Internet-focused payments facilitator. So I am not that surprised that Checkout’s current valuation in the private markets ($15B) is way higher than what Adyen was valued in 2015 ($2.3B in the Iconiq round).

• I am concerned by Checkout’s continued, outsized venture rounds. There’s a variety of ways to interpret them.

  • On the optimistic end of the spectrum, a Checkout supporter would say that what we have here is a top-notch growth platform with a top-tier management team that sees (i) strategic ‘land’ in the market that it must occupy ASAP lest others occupy it first, because merchant relationships are sticky, (ii) a fundamentally good business model with superior revenue growth potential in each individual merchant due to the merchant being an Internet business as well as thanks to some wallet-share gain potential over time, and an opportunity to steal clients from the bank payment departments (i.e. the US Bancorp / Elavon, JPM / Chase Paymentech’s, Barclays Payments of the world) and the dedicated payments incumbents distracted by merger integration (FISV / FIS / GPN), (iii) an opportunity to make investments that will deliver a good % IRR for a very long period of time with little downside. When it is raining gold, reach for a bucket. Another way of saying this is that to win a motor race that’s worth winning, you should jump into a Formula 1 car, not a regular car. A Checkout supporter would argue that Checkout’s aggressiveness is rational and optimal, and competitors that are being too timid (i.e. Adyen) will end up regretting it long-term.

  • There are also more pessimistic (‘Red team’) arguments that can be made. If the margin structure that we can see in the Checkout UK & Europe financials is representative of what the consolidated numbers looked like in FY2019, then I’d be anxious to understand why is it that Checkout’s EBITDA margins (10%) are so much lower than what Adyen’s margins were (40%) when Adyen was of a comparable size. The optimist would counter that perhaps Checkout is being more aggressive with headcount additions and marketing, and that some really benign operating leverage will soon come to the fore. But then the ball would be in the optimist’s court - it would be on the company and its supporters to show that the margins can get to Adyen levels, i.e. a ‘show me’ story. For the skeptic, some hard evidence is needed to disprove the readily available Occam’s razor explanation - Checkout seemingly frequently needs fresh capital to keep going while competing with a proven, well-run business in Adyen that never really needed capital; maybe Adyen is a better business than Checkout, and maybe Checkout isn’t that similar to Adyen at all.

As of now, I think more time and more data is needed to have a strong view one way or another.

Summary

If you’re a current or potential investor in Adyen, it is sensible to monitor Checkout very closely (and of course, it’s always a good idea to keep an eye on Stripe, FISV, FIS, GPN, as well as JPM’s payments business). I will probably post more thoughts on Checkout, Adyen and the payments sector more generally as time goes by, so be sure to subscribe.

DISCLAIMER: Nothing written here is investment advice. I and parties associated with me may or may not have positions in securities mentioned in this post or elsewhere in my Substack.