The Capital Cycle Hits Payments
Adyen’s American Adventure
In summer 2017, Bob Iger, CEO of The Walt Disney Company, stood up in front of investors. “One of the most compelling brands for a direct-to-consumer product is Disney,” he told them. “And to that end, we will launch a Disney-branded streaming service in 2019 – which will be unlike anything else in the market.” Iger’s announcement came exactly two years after a fateful call during which his frank analysis of the disruption Disney faced caused its stock to tank. Streaming was his response.
The strategic rationale has been much discussed, but from a financial perspective, the incentive to go into streaming was clear. Netflix had amassed a market value of $77 billion, equivalent to half of Disney’s valuation, up from a quarter when Iger warned of disruption. By the time Disney+ launched in November 2019, Netflix had a value of $128 billion. The size of the prize was simply too great.
One of the most useful frameworks for thinking about business is the capital cycle. Popularised in the book Capital Returns (a compendium of investor letters published by Marathon Asset Management) it looks at how the competitive position of a company is affected by changes in an industry’s supply side. While demand-side projections are useful – the number of long-haul flights passengers will take in 2024, the number of electric vehicles drivers will buy in 2030, and so on – the capital cycle framework focuses instead on supply: how much capital is being spent in an industry. In many ways, forecasting supply is actually an easier exercise since there is less uncertainty around it. The problem is that it lands with a lag. One leading indicator, though, is valuation. Once it hit a large enough market value, it was inevitable that Netflix would entice new entrants to its market.
When it launched, Disney+ aimed to win 60-90 million subscribers by September 2024. Iger budgeted that the cash investment in content required to support such a target would rise from $1 billion in 2020 to the mid-$2 billion range by 2024 but that by the end of that timescale, the project would be at breakeven. After just ten months, the company was already inside the range of its subscriber target. “If you’d asked us a year ago, ‘What are the odds that they’re going to get to 60 million subscribers in the first year?’” remarked Netflix CEO Reed Hastings, “I’d be like zero. I mean how can that happen? It’s been super impressive execution.” Disney’s new CEO, Bob Chapek, promptly ramped up investment spend and upgraded the subscriber target: to 230-260 million by the end of 2024.
The numbers proved too lofty. In August 2022, Chapek trimmed his target back to 215-245 million, after spending a massive $32 billion on content that year. The project was a long way from breakeven. In the final quarter of fiscal 2022, it reported an operating loss of $1.47 billion, taking cumulative losses to $11.7 billion. Meanwhile, growth was slowing; that quarter, revenues were up just 8% over the same period the prior year. Within two months, Chapek was gone, Bob Iger brought back to replace him.
Right now, Disney+ has 150 million subscribers. It lost $420 million last quarter and its stock recently fell below its pandemic low. Bob Iger, and certainly Bob Chapek, may have underestimated the number of new entrants equally seduced by the valuation-based opportunity presented by Netflix. Between them, Disney, NBCUniversal and Paramount lost $8.3 billion on streaming in 2022. That year, the net number of subscriptions added in the US across all streaming services fell from 45 million to 26 million. However strong subscriber projections looked, the upsurge in supply and the ensuing Streaming Wars have been defining features of the industry.
Payments is a different industry to video streaming but the capital cycle provides a similarly useful lens through which to view it. While it’s popular to look at demand-side measures such as the share of cash payments that are migrating to electronic settlement and the total addressable market such a trend feeds, it’s also true that payments is an industry that is seeing rising supply. And why wouldn’t it? At its peak in August 2021, the market value of Adyen, a leading payments platform, reached almost $100 billion. The same year, competitor Stripe raised funding at a similar valuation and shortly after, Checkout.com did a capital raise at a valuation of $40 billion.
Unsurprisingly, a lot more capital entered the market. Private companies with a focus on payments raised over $35 billion of capital in 2021 and everyone across the industry hired staff and increased investment.
In a recent interview, John Collison, COO of Stripe, cited what he calls “the Buffett billion dollars test”. According to Warren Buffett, the test of a good industry is one where if a guy is given $1 billion to blow on building a company in an industry, it wouldn’t have much of an impact. “There are lots of places, like real estate or whatever, where you can actually have a pretty good swing at it and they will make life harder for you,” Collison said. “Whereas I think there’s lots of people who have tried to put $1 billion competing in this or other software industries, and it's really hard to just turn a billion dollars into high quality software.”
He may be right, it’s hard to turn a billion dollars into high quality software, but that doesn’t mean the capital can’t buy distribution or find an edge in some other part of the business, particularly in a fragmented industry. Adyen may be the test of this. We touched on Adyen two weeks ago in A Reckoning in Payments. This week, the company held an investor day in San Francisco to outline its competitive position after a setback in August when it reined in growth expectations. Let’s take a look.