Do you like Fintech stocks? This Dutch payments giant should be at the top of your watchlist

Financial technology (fintech) is one of the most popular sectors for growth-oriented investors. Digitizing the global financial infrastructure has been an important task that has taken decades of investment, and is likely to require decades of investment in the future. Leaders in the fintech industry can extract much of the value from these investments by providing software and payment services to individuals and businesses.

A little-noticed fintech company has skyrocketed to the top of my watchlist in recent years, and if you’re interested in fintech stocks, I think it should move to yours as well. The company is Adyen (ADYE.Y -2.40%)a Dutch payment processor that I believe is one of the highest quality companies in the world.

Here’s why I like Adyen’s business, but why I’m not buying shares—at least not yet.

What is Adyen?

Adyen’s business started as a merchant for large companies in Europe. Some of the biggest customers include Spotify and Uber.

What is a merchant? This is an entity that sits between the credit card networks, merchants, consumers and card-issuing banks. Without getting too bogged down in the details, acquirers like Adyen send all relevant information to other stakeholders and authorize the approval or rejection of a card transaction at the time of each purchase. Adyen’s merchant creation software can be used by companies to purchase in-person, online and mobile applications, and it earns revenue by taking a small cut of each purchase made through the platform.

On top of its core merchant acquisition business, Adyen has expanded up and down the payments value chain. It now offers online point-of-sale (POS), credit card issuance, revenue optimization and many other value-added services. It has also slowly moved its products to work in international markets such as the US, where it received full approval to operate in late 2021. The company wants to become a one-stop shop for merchants’ digital payment needs.

Better authorization rates than competitors

The most important value add that resellers provide is high authorization rates for their merchant customers. In simpler terms, a good acquirer is one where most credit card transactions that should be approved are approved. If Spotify can process 95% of credit card transactions around the world with one merchant, compared to just 90% with another, that’s a huge difference in how much revenue it can make.

Adyen is known as the retailer with the highest authorization rates. This has helped the company win contracts from large companies such as sandwich chain Subway, where just small changes in authorization rates can mean big changes in revenue generation.

But why is Adyen better? It simply built its fintech services from the ground up with 21st century technology, while its main competitors are a mash-up of acquisitions built from separate codebases that struggle to work seamlessly together. This allows the company to easily win contracts away from legacy suppliers, even though Adyen (usually) has higher fees.

Higher authorization rates give Adyen a competitive advantage within the merchant niche. It continues to expand its moat by expanding internationally (this is a great value for its multinational customers) and adding the other services mentioned above such as POS solutions, analytics and card issuance. As the company continues to invest in these new services and expand its geographic footprint, I believe this moat could widen over the next five years and further differentiate Adyen from the competition.

The valuation is steep, but don’t lose sight of it

Because it has gained market share, Adyen’s revenue and earnings have grown at an impressive rate in recent years. In 2022, net income rose to $1.41 billion from $581 million in 2019 and $218.3 million in 2017. The company has wide profit margins, generating an EBITDA (earnings before interest, taxes, depreciation and amortization) margin of 55% last year. In the long term, management believes that it can reach an EBITDA margin of 65%.

Although growth and profitability have been impressive at Adyen, the share trades at a nosebleed value. With a market cap close to $44 billion, shares trade at about 50 times trailing EBITDA, which is much higher than the market average.

Does Adyen deserve a multiple of premium revenue? I think so, but probably not double or triple the market average that it’s going for now. From my perspective, this makes Adyen one you shouldn’t buy today, but a great business that should go on the watch list. If the earnings multiple falls significantly at some point in the next few years, it will be time to pounce.