Adobe Company Analysis - A SAAS Power House
An $ADBE deep dive
ADBE 0.00%↑ stats
Market Cap = $183.56B
EV = $183.53B
Gross Margin = 88.18%
5 Year Rev CAGR = 17%
10 Year Rev CAGR =13%
FCF = $6.84B
FCF Yield = 3.5%
EBIT = $5.93B
EV/EBIT = 30.97
ROIC = 25.9%
Introduction
You don’t have to be a designer or digital creator to recognise Adobe. There’s a strong likelihood you’ve opened a PDF file today. The Instagram adverts you’ve scrolled through were edited with Photoshop. The logo on the device you’re reading this on was designed using Illustrator.
A PDF file is just the tip of the iceberg when it comes to Adobe's creative suite of applications.
Originally founded in 1982 by John Warnock and Charles Geschke, Adobe is best known for their creative collection of software products; Photoshop, Lightroom, Illustrator, Adobe Sign, Acrobat and more.
A leader in the digital economy, the business is segmented into Creative Cloud, Document Cloud and Experience Cloud. With 26,000 employees, they are targeting a reported TAM of $205 billion.
As the consumption of digital and online media increases, so too does the demand for the products of the world’s largest SAAS companies.
With 12 month revenue growth of 22%, gross margins of 85%+ and ever increasing recurring income, Adobe is priced like a growth company. Down 40% from last year’s all time high, have investors over-reacted to recent weak guidance?
Time for a deep dive.
The Business
Adobe has grown revenue at a 17% CAGR for the past 5 years. With gross margins of almost 90%, net income has grown by over 23% in the same time frame. Over the past decade the business model has transformed from a stagnating, high-priced licence to a recurring-revenue machine. In 10 years, shares have risen 1,100% in comparison to the S&P’s 200% return. Adobe’s transition to a recurring revenue model may be one of the most impressive of this century.
With double digit revenue growth, high margins and recurring revenue, Mr Market is willing to pay a premium. On a fundamental basis, Adobe is not cheap. The shares trade at a P/E of 38 or P/S 11.6. Although expensive relative to the market, the stock is cheaper on a fundamental level than it has been for a decade.
Adobe generates income through three core segments of the business; Creative Cloud, Document Cloud and Experience Cloud.
Creative Cloud
Digital media makes up 73% of revenue. This includes both Creative & Document Cloud, which make up 84% & 16% of Digital Media respectively. The suite of Creative Cloud Apps cost £49.95 / $52.99 per month and is the driving force for recurring revenue.
Creative Cloud launched in 2011 with the aim of unifying the company's software applications. Today, Creative Cloud is a collection of 20+ apps for photography, video, design, web, UX, and social media. The software boasts over 26 million subscribers. Sustained growth for flagship applications, such as Photoshop, Illustrator and Premiere, ensured Adobe’s recurring revenue grew 17.3% on average between 2016 and 2021.
Photoshop is the industry standard and used by over 90% of the world’s creative professionals. It is an essential tool for photographers, designers and the digital creative industry. Originally designed for image editing, it provided users with a toolbox for editing, creating and manipulating images and photography.
Illustrator is vector based in comparison to Photoshop’s pixel (raster) graphics. It remains the go-to app for creating icons, drawings, and complex illustrations. In layman's terms, Illustrator ensures vectors avoid becoming part of a bitmap, and can therefore be resized without pixelation or loss of quality.
Document Cloud
Document Cloud enables the editing, scanning and signing of documents across web, desktop and mobile. Document Cloud includes Adobe Acrobat plus Sign & Scan. It remains the fastest growing segment of the company.
Adobe Acrobat software is used to create, manipulate, print and manage PDF files. Adobe Acrobat enables more than five million organisations to create and edit PDF files, acting as a gateway to related services.
A PDF (or Portable Document Format) was first introduced by Adobe in 1992 and is a fixed-layout flat document, including the text, fonts, vector graphics. More than 300 billion PDFs were opened in Adobe products in the last year.
Adobe Sign has facilitated over 8 billion digital document signings in the past year. The software allows users to receive fast and secure e-signatures and could be the future of agreements.
Adobe Scan boasts more than 138 million downloads and has been responsible for the creation of over 2 billion documents. The company claims that Document Cloud is responsible for a 90% cost reduction and 95% reduction in environmental impact in comparison to the paper based process.
Experience Cloud
Adobe Experience is used by a reported 75% of Fortune 500 companies and acts as the go-to personalisation engine for the digital economy. Competition in the CRM segment is fierce. Salesforce, SAP and Oracle, offer similar product lines which hold significantly more market share.
Previously referred to as Adobe Marketing Cloud, Experience Cloud offers a collection of integrated marketing products which include a CRM, data and analytics service. The 2020 acquisition of Workfront, for approximately $1.5 billion, allowed an integration of the work/project management service for managers.
Adobe Analytics is responsible for analysing more than 1 trillion visits to retail commerce within the US, providing insights to decision makers and consumers.
The Experience Cloud segment includes Marketo, a marketing cloud platform Adobe acquired in 2018 for $4.73 billion and Magento, an open source e-commerce platform acquired for $1.64 billion.
Transition To A SAAS Powerhouse
Adobe’s business defining decision was to transition from an upfront licensing fee model to a recurring revenue, cloud-based platform. This was an incredibly expensive and arduous process and almost impossible for any company to get right.
Shantanu Narayen's appointment as CEO in 2007 resulted in Adobe's first subscription product, Photoshop Express, in 2008. Former CFO Mark Garrett described the shift as a ‘burn the boats’ approach.
In November 2011, the company announced its intention to move away from selling its digital-media creative and design tools indefinitely. Doubters believed the transition would consume the high operating margin, whilst 50,000 customers signed a petition demanding Adobe abandon the new approach.
As the company began to transition their business model, net earnings fell for three years, from $833 million in 2011 to $268 million in 2014.
Before 2013, the Creative Suite package, which bundled Photoshop, Illustrator, and other programs, started at $1,300 and as high as $2,600, which led to high levels of piracy. A third of customers were new to Creative Cloud, a figure that highlighted the use of earlier pirated versions.
The move to subscription created a significantly larger TAM by reducing the upfront cost (previously over $1,500 for the license). Adobe's SaaS model provides greater certainty of revenue streams, whilst lower prices ensure both professional and home users.
Adobe now generates a huge 93% of revenue from subscription, marking a remarkable evolution.
Metaverse Builder?
The company’s mission is to Change the World Through Digital Experiences. At the Adobe Summit 2022, they outlined a Metaverse white paper, which highlighted new tools for Creative and Experience Cloud. Adobe’s tools will help to empower first time creators to build online universes within a new digital landscape. Adobe views the metaverse and immersive experiences as the new wave of digital interaction, opening further addressable markets.
The company is at the leading edge of software for designing, creating, and delivering engaging virtual experiences. Tools, such as, Substance 3D and the beta version of 3D Modeler will combine the physical and digital worlds, allowing today’s businesses to become ‘metaverse ready.’ Substance is already being adopted by global brands like Coca-Cola, NASCAR and NVIDIA for marketing and e-commerce
Bull Case
High User Tie In & Switching costs - Many Adobe software users have used the applications for years, or decades. This results in an unwillingness to switch away. Adobe is notorious for offering free or discounted software to students, encouraging them to become part of the ecosystem at an early stage in their career. As the products become more complex, users become even more unlikely to switch. This generates recurring revenue from sticky customers.
Horizontal Stack - When attacked by individual apps, such as GIMP for photo editing or Avid for video editing, Adobe offers a full suite of applications to fulfil the entire production process. The diversity of their suite means it is almost impossible to be challenged on all fronts whilst offering a high degree of diversified revenue.
Gold Standard for Creatives - Photoshop (with over 20 million monthly active users) and Illustrator are the gold standards in the creative industry. The high time commitment required to learn the new software results in high switching costs. Beyond high switching costs, the proprietary file format of their widely used products (including psd, psb, ai, xd) results in a network effect and helps preserve the company’s market position.
Optionality on the next stage of AR & VR - Adobe’s tools are already used to create games, immersive commerce, and augmented reality environments. The company’s investment in AR & VR software will enable present-day brands to become metaverse-ready.
Bear Case
Reductionist software and competition - Adobe owns their software stack. As users become frustrated with lock-ins they may seek alternatives. Their love-hate relationship with customers means it's unlikely Adobe will lose loyal customers, however, new users may look elsewhere. Competitors, Figma, Canva, and other tools are making it difficult for Adobe to attract new customers. New creators have several choices, a number of which are free.
Conclusion
The risk with a number of big tech businesses is their over reliance on a single revenue stream (Facebook on Ads, Netflix on subscriptions). Although Adobe’s products target creatives, their uses are multi-purpose and diverse.
Adobe remains expensive on a fundamental level, but is now almost half the price it was in late 2021. The company is a cash flow generating machine, with double digit sales growth, high margins and recurring revenue.
Slowing revenue growth and weak guidance in the Q1 2022 earnings was mostly a result of the Russia/Ukraine conflict, meaning income should normalise throughout 2022.
The company has been dominant in their field for over 20 years, it’s difficult to see a scenario in which they are displaced in the next 20. However, when the shares are priced for growth, the company needs to continue to deliver double digits.