Adobe Inc. operates as a diversified software company worldwide. It operates through three segments: Digital Media, Digital Experience, and Publishing and Advertising. The Digital Media segment offers products, services, and solutions that enable individuals, teams, and enterprises to create, publish, and promote content; and Document Cloud, a unified cloud-based document services platform. Its flagship product is Creative Cloud, a subscription service that allows members to access its creative products. This segment serves content creators, workers, marketers, educators, enthusiasts, communicators, and consumers. The Digital Experience segment provides an integrated platform and set of applications and services that enable brands and businesses to create, manage, execute, measure, monetize, and optimize customer experiences from analytics to commerce. This segment serves marketers, advertisers, agencies, publishers, merchandisers, merchants, web analysts, data scientists, developers, and executives across the C-suite. The Publishing and Advertising segment offers products and services, such as e-learning solutions, technical document publishing, web conferencing, document and forms platform, web application development, and high-end printing, as well as Advertising Cloud offerings. The company offers its products and services directly to enterprise customers through its sales force and local field offices, as well as to end users through app stores and through its website at adobe.com. It also distributes products and services through a network of distributors, value-added resellers, systems integrators, software vendors and developers, retailers, and original equipment manufacturers. The company was formerly known as Adobe Systems Incorporated and changed its name to Adobe Inc. in October 2018. Adobe Inc. was founded in 1982 and is headquartered in San Jose, California. The company is publicly listed on NASDAQ under the ticker “ADBE”.
Adobe has one of the strongest software offerings and one of the highest quality business models in the cloud space. After the latest earnings, Adobe once again fell double-digits, apparently due to slowing growth rate but probably more because of a general pessimistic sentiment toward technology stocks.
Historically, Adobe has always traded at a large premium and now things have changed so much that we need to really think about this possible opportunity. Indeed, while Adobe’s growth rates were already slowing down by the end of 2020, its share price continued to increase following other high-growth peers, allowing it to reach the peak of over $670 per share. Then, during the general tech collapse we experienced last Autumn, Adobe showed worse-than-expected results and guided towards a lower growth rate, making the price decline down to $450 level in less than six months.
The main problem is that both retail and institutional investors put too much attention for the high growth and high margin players in the cloud sector, such as Adobe, resulting in valuations that are almost priced for perfection and do not allow much margin of error as far as revenue growth is concerned. Therefore, even the slightest change in future prospects has devastating results for shareholders returns. Moreover, as the growth seemed to have already peaked before 2021, the conditions are almost an incentive for the management to take in more risk in order to keep up with growth expectations: perhaps this could be the reason behind the recent engagement in the acquisitions of Workfront and Frame.io. However, no smart investor would accept greater risks without having greater returns, thus the price decline.
It is important to note that Adobe is one of the most profitable enterprises in the cloud space: indeed, on a gross margin basis the company is, at the moment, unrivaled, and on EBITDA margin basis, the company appears to be comparable to Microsoft and Oracle. The main factor that allowed the company to reach such high margins is the scalability of its business model, that combined with the revenue growth made the company grow into the giant we all know today. But not everything that shines is gold: in the cloud sector today, in fact, expected revenue growth is way more important than margins. While we cannot say Adobe is playing bad in that regard, as we said earlier there are already the early signs that this 20% annual growth might be slowing down, especially when considering the management’s words on the first quarter earnings call.
This year, Adobe finished its first quarter with results that, on the surface, appeared to be disappointing: revenue grew only by 9%, adjusted to 17% when considered constant currency and the extra week for Q4FY21.
As we will see in more detail in the business section, Adobe main products are the Digital Media, which includes both Creative Cloud and Document Cloud, and Digital Experience, which includes a whole range of advertising and business management software. Creative Cloud is the most well known Adobe’s product and includes flagship products such as Photoshop, Illustrator and Premiere Pro: since this is the largest revenue producing segment, it makes sense that it grew at the slowest rate. At the same time, Document Cloud grew the most at an unadjusted rate of 29% on a year-over-year basis, taking market share from other players such as DocuSign. Finally, Adobe saw 23% unadjusted revenue growth in its Experience Cloud offerings, with an unadjusted increase in subscription revenues of 27%. The company surely isn’t struggling at making money, but investors were expecting even higher numbers.
Besides, Adobe repurchased $2.1 billion worth of its stock during this first quarter, which makes sense considering the decline it experienced and the incredible amount of free cash flow that the company has available.
During the earnings call, the company released its guidance for the next quarter, expecting roughly 13% revenue growth on a year-over-year basis, which isn’t bad but still far from the numbers seen in other players in the sector. While the management announced that they expect a strong second half of 2022, investors seem skeptical and have not given the company the benefit of the doubt.
Moreover, the second quarter targets are slightly lower than what announced on the previous earnings call for the full fiscal year 2022: Digital Media growth was expected to grow at 14%, and it is now expected to grow at 13%. Besides, considering that in 2020 the management guided towards a 19% year-over-year growth for the segment, we can understand why the skepticism.
Adobe offers a line of products and services used by: creative professionals, including photographers, video editors, graphic and experience designers and game developers; communicators, including content creators, students, marketers and knowledge workers; businesses of all sizes; and consumers for creating, managing, delivering, measuring, optimizing, engaging and transacting with compelling content and experiences across personal computers, smartphones, other electronic devices and digital media formats.
Adobe’s products and services are marketed directly to enterprise customers through the company’s sales force and local field offices, and they are licensed to end users through app stores and Adobe’s own website. Many of the products are offered via Software-as-a-Service (SaaS) model or managed service model (both of which are referred to as hosted or cloud-based) as well as through term subscription and pay-per-use models. Also, Adobe distributes certain products and services through a network of distributors, value-added resellers (VARs), system integrators (SIs), independent software vendors (ISVs), retailers, software developers and original equipment manufacturers (OEMs). In addition, Adobe licenses its technology to hardware manufacturers, software developers and service providers for use in their products and solutions. While Adobe offers a broad portfolio of products, services and solutions, the company distinguishes three reportable segments: Digital Media; Digital Experience; and Publishing and Advertising.
The flagship of Adobe’s Digital Media business is Adobe Creative Cloud, a subscription service that allows members to use Adobe’s creative products integrated with cloud-delivered services across desktop, web and mobile devices. Creative Cloud addresses the needs of all content creators, from creative professionals, such as artists, designers, developers, students and administrators, to knowledge workers, marketers, educators, enthusiasts and communicators and to consumers. These customers rely on Adobe’s product for content creation, photo editing, design, video and animation production, mobile app and gaming development and more. Adobe Creative Cloud offerings include:
- Photoshop: the most powerful and known photo-editing software in the market;
- Illustrator: a professional photo-editing software similar to Photoshop, but specifically designed for making minor edits on a large collection of photos;
- Lightroom: a powerful photo editor that help enhance shoots and edit images;
- Adobe Stock: a marketplace where it’s possible to buy stock photos, videos and 3D models;
- Adobe Typekit: a marketplace where it’s possible to buy fonts;
- Adobe Bridge: an easy-to-use visual media manager that allows the user to organize, browse and view media files that works also with any other Adobe software;
- Premiere Pro: a professional video editing tool used for making anything from simple videos to movies;
- After Effects: a powerful software for creating all kinds of visual effects (VFX), commonly used to create animation, motion graphics and other cinematic effects;
- Adobe Media Encoder: a specialized software created to render videos made in Premiere Pro or After Effects;
- Adobe Prelude: a video-editing software dedicated to rough-cutting and organizing a large amount of videos;
- Adobe Audition: a dedicated audio-editing software designed to record, edit and mix audio;
- InDesign: a publishing software that excels at projects that require multi-page layouts like magazines, newspapers and books;
- InCopy: a text editor that writers to write the text content while designers are simultaneously working on the graphics of the same document in InDesign, improving work efficiency and making possible for publishers to keep up with their schedules;
- Adobe Flash Professional: a software used to make simple 2D animations, games and applications. However, due to increasing popularity of better technologies like HTML5, Flash was abandoned, and the animation software was renamed to “Animate”;
- Animate: an animation software that allows the user to export them in several formats, including HTML5;
- Adobe XD: a user-experience and user-interface prototyping tool for designing apps;
- Dreamweaver: a web-designing software which lets the user visually make websites without having to touch the code, but it also features a powerful code editor which supports numerous programming languages.
Adobe’s Digital Media segment also includes Adobe Document Cloud business, a unified, cloud-based document services platform, which integrates Adobe’s PDF technology with Acrobat and Adobe Sign applications to deliver fully digital document workflows. Adobe Document Cloud offerings include:
- Adobe Acrobat Reader: the industry standard for viewing, printing and signing all kinds of PDF documents;
- Adobe Acrobat Pro: a software used to create, edit and manage PDF documents;
- Adobe Sign: a specialized software used to digitally PDF documents.
Moving to the Adobe Digital Experience segment, this is powering digital businesses by providing cloud-based solutions for delivering digital experiences and enabling digital transformation. The applications and services offered in this segment are designed to manage customer journeys, enable personalized experiences at scale and deliver intelligence for businesses of any size in any industry. Under this segment, the products offered are divided into four categories:
- Data insights and audiences: these products deliver robust customer profiles and AI-powered analytics across the customer journey to assist customers in providing timely, relevant experiences across platforms;
- Content and commerce: these products help customers manage, deliver and optimize content delivery, and to enable shopping experiences that scale from mid-market to enterprise businesses;
- Customer journeys: these products help businesses manage, test, target, personalize and orchestrate campains and customer journeys across B2E use cases;
- Marketing workflow: the product offered under this category, Adobe Workfront, is a work management platform directed toward marketers to orchestrate campaign workflows.
Finally, the Publishing and Advertising segment contains legacy products and services that address diverse market opportunities including eLearning solutions, technical document publishing, web conferencing, document and forms platform, web application development, high-end printing and Adobe Advertising Cloud offerings. Adobe Advertising Cloud delivers an end-to-end, demand-side platform for managing advertising across digital formats and simplifies the delivery of video, display and search advertising across channels and screens. Under this segment, revenue is generated by licensing the technology to OEMs that manufacture workflow software, printers and other output devices. Revenue from this segment is typically generated through usage-based offerings.
Adobe participates in a highly competitive environment globally, characterized by new industry standards, evolving distribution models, technology innovation, frequent product introductions, short product life cycles, price cutting with resulting downward pressure on gross margins and price sensitivity on the part of consumers. The competitive environment is different for each business segment.
Adobe’s Digital Media segment faces competition from large, established companies, as well as a variety of point offerings, free products and downloadable apps. More specifically, the company faces significant direct or indirect competition from:
- Desktop software companies;
- Device, hardware and camera manufacturers;
- Operating system developers that integrate digital imaging and image management features within their operating systems;
- Smartphones and tablet manufacturers that integrate imaging and video software;
- Proprietary and open source web-authoring tools; mobile-first applications;
- Social media platforms that provide imaging and video offerings, including editing capabilities;
- Stock content marketplaces;
- Digital document creation, storage, collaboration and signing providers.
Thanks to its products’ features and functionality, ease of use, reliability, value and performance characteristics, Adobe is in a strong competitive and leading position for its Creative Cloud offerings. On the other hand, while the competitive advantage in the Document Cloud offerings is also strong, there are a lot of alternatives such as DocuSign that make the product easily replaceable. Therefore, here the company competes based on the global use of the PDF format and on the features and functionalities offered by Acrobat software.
Adobe’s Digital Experience segment competes in markets that are growing rapidly and characterized by intense competition from large, established companies, including large enterprise software, Internet and database management companies. Also, it faces competition from point product solutions and focused competitors, and new competitors are constantly joining the market. Adobe’s competitive position is also strong both with enterprise and low-cost alternatives due to the company’s strong feature set, the wide product offerings, the scalability and the performance.
Finally, Adobe’s Publishing and Advertising product offerings face competition from large-scale system and XML-based publishing companies, as well as lower-end desktop publishing products. Competition involves a number of factors, including product features, ease-of-use, the level of customization and integration supported, the number of hardware platforms supported, service and price.
We evaluated the company using our discounted cash flow model. The model relies on the past 15 years worth of financial statements data in order to estimate the future growth of the company. Each company is valuated in a slightly different way, and in this specific case we estimated the future free cash flows for the next 10 years by estimating line by line each of the three main financial statements.
We made some assumptions in order to valuate the company:
- The terminal growth rate is 3.00%;
- The total shares outstanding are 473 millions;
- The effective tax rate over the forecast period will be, on average, 16.84%;
- The United States 10-year treasury bond yield will reach 2.50% by the end of 2022;
- The risk premium is 6.00%;
We used those assumptions to model the weighted average cost of capital, which resulted equal to 8.80%, and to estimate the future revenue growth and free cash flows. We estimated a fair value of $487.27, meaning that according to our valuation there is a possible upside in the stock price of 5.95%. Therefore, we give the company a “hold” rating. A lot of factors could influence the valuation, including but not limited to economic policies, markets development and real economic growth: therefore, we will update this valuation at the start of the next quarter.