Adobe Stock Analysis & Deep Dive
Adobe Stock Analysis & Deep Dive
Finally an interesting buying opportunity
Adobe is one of these companies which I wanted to add to my portfolio for a long time. Most of the last years it was too expensive for my taste and I had to watch the increase in the share price from the sideline. Luckily for us, all shares eventually come down to a reasonable valuation and when they do, it’s time to buy them.
If you are interested in how to identify outstanding companies, read this article:
What does Adobe do?
Adobe is a US based company with headquarters in San Jose, California and employs about 29.000 people.
Adobe’s business is split in 3 different segments.
Adobe Creative Cloud:
I am sure most of you have heard of Photoshop, but Adobe Creative Cloud is home to many more products. Illustrator for icon design; Premiere Pro the video editor; InDesign for magazines, books and PDF publishing to name a few.
This segment had 10.5bn of revenue in 2022 while growing 10% YoY and contributed 61% to the overall revenue of the company.
Since switching to a subscription model, solutions like Photoshop became a lot more affordable. Now users pay a monthly fee of 20$ compared to a couple of hundred dollars once in the past.
Adobe Document Cloud:
The document cloud is the smallest segment with 2.4bn of revenue in 2022 while growing 21% YoY and contributed 14% to the overall revenue of the company.
The document cloud focuses on all forms of creating, editing, signing and workflows around PDFs.
Some people believed that the competitor and one trick pony for e-sginatures Docusign is worth $61bn at the peak of the corona bubble in 2021. As a comparison, Adobe is currently trading at a marketcap of $157bn and has a wide range of products and solutions for the customers.
Adobe Experience Cloud:
While most consumers are familiar with Adobe Photoshop and Adobe Acrobat Reader, many are not aware, that they are at least passive users of the Experience Cloud.
Sitting between the more well known segments of Adobe in terms of revenue, the Experience Cloud had 4.4bn of revenue in 2022 while growing 14% YoY.
Adobe describes the experience cloud with these nice words, which say everything and nothing at the same time: “set of digital experience tools that lets you give your customers what they want, exactly when, and how they need it”.
The experience cloud consists of different offerings, which I will describe briefly:
Experience Platform: Collect and connect data about customers to built customer profiles. This data is stored and made available for AI driven insights and further use in additional programs.
Data, Insights and Audiences: Data based insights into the customer profiles in real time, made available for the whole team and machine learning algorithms.
Content and Commerce: Personalized web content and mobile applications.
Customer Journeys: Manage cross channel campaigns.
Marketing Workflow: enable teams to work together on the same campaigns.
To summarize the Experience cloud: All these programs are used to create detailed customer profiles and then offer an individualized website/app in order to reach higher sales conversion rates. On top of that, the marketing and sales team can work together in a workflow based approach and have a cloud based store of all the relevant assets.
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MOAT:
I am looking for a business with a strong moat. In the best case we even have some alligators and crocodiles in our moat.
If you ask anybody who is serious about photography and editing pictures which software they use, they will answer Photoshop. Ask a random person on the street, which PDF viewer and editor they use, you will most likely get the answer: Acrobat Reader.
Once you learn how use Photoshop, you are very unlikely to change to a different software and learn how to handle it from scratch. Since Photoshop is the default for image editing, it is already being taught in universities and the graduates will naturally apply their skills also in their professional life.
Adobe’s experience cloud is the leader in the 2023 Magic Quadrant for Digital experience Platforms.
Even in regards to the all present topic of AI, Adobe has something in store for you. Midjourney made text generated images popular and Adobe Firefly which is currently available in a Beta version does the same. This will change how computer based images are created forever. The main benefit of Adobe Firefly will be the safe for commercial used generated content, since Firefly is trained on licensed content and will be integrated into Adobe’s other software solutions.
Check out this video to get an idea how powerful generative AI already is:
Many companies are struggling with the darkening macro outlook and companies are looking for ways on how to cut costs. Adobe is not affected by this change in customer spending. Adobe’s CEO spoke of customers who are actually increasing their usage of Adobe products to save money.
Management
The CEO Shantanu Narayen is with Adobe since 1998 and was appointed CEO in 2007. You rarely find a CEO in one of the big tech companies with a longer tenure. He personally owns $162m worth of Adobe shares and has an interested in a great long-term performance of the company and therefore its stock.
In the last 16 quarters, Adobe only missed once the analysts forecasts. I personally like companies which are planning conservatively and don’t promise the moon to the investors.
The focus of the management is on cash flow and not on earnings. That shows me, that the management understood what’s really important for the long-term well being of a company.
In stark contrast to Meta or Alphabet, Adobe did not over hire like crazy in the last 2 years and therefore does not fire people compared to the other two companies. This shows a strategic long-term focus without irrational based acting. Also as an employee this must be seen as a good sign for their own job safety.
Some words on the Figma Takeover
One controversial topic regarding Adobe is the announced 20bn dollar heavy takeover of Figma. While I believe that 20bn dollar for such a small company is outrageous, I understand the rationale behind the deal. The UX designers I worked with described Figma as a religion, not a product. Especially in UX/UI design for software and apps, Figma was adopted very fast and threatened the almighty Adobe suite.
By buying the largest threat in a while, Adobe cements its position is the untouchable number 1 in all creative matters. At the end of the day, the takeover will be decided by the regulatory bodies who are currently investigating if this will give Adobe too much market power. We shall see what the regulators will decide on.
Track record & Fundamentals:
To say it in simple terms: Adobe’s track record is outstanding.
Revenue has been growing at 18% p.a. in the last 10 years, but even more importantly, earnings AND cash flow have followed suit.
Adobe’s management has fully understood, that the focus has to be on cash flow and not on EPS.
Since stock prices follow earnings, it is not surprising, that Adobe’s stock has been spectacular. I am sure, that most of you know Adobe since many years and wonder why they have never bought the shares. Now is the time for you.
Gross Margins and Operating Margins have been stable or even slightly rising over the last years. Management has shown to be mindful when it comes to spending.
The total share count has been slightly decreasing thanks to increasing share buybacks. On top of that the company has no net debt and has more cash & cash equivalents compared to long term debt.
Operating and Free Cash flow only know one direction: Up and to the right.
Free Cash Flow margins are now above 40% (I just love SaaS business models). Adobe’s CEO recently said, that on the rule of 40, which is used for SaaS companies, Adobe scores 60 (40% FCF margin + 20% growth).
Looking at these numbers, it is clear, that we are dealing with an outstanding company. In order to achieve stellar investment results, we need to buy beautiful companies for beautiful prices (just ask uncle Charlie).
Valuation:
Adobe has been historically expensive on traditional terms. The median P/E ratio of the last 5 years was 49.8 and reaching 70 at the top.
As of today (14.05.2023) we are looking at a P/E ration of 33 and a forward P/E of 19.
Since the P/E ratio is traditionally flawed, I prefer to look at the EV/FCF ratio.
EV, or Economic Value is defined as the overall Market Cap (stock price * number of shares) - cash and short term equivalents + long term debt. The EV gives you the actual price you would pay for the operating business.
Based on the EV/FCF Adobe has been traditionally trading between 30 and 40, while reaching 50 at the peak. At today’s levels we are at an EV/FCF valuation of 20.8, which is extraordinarily cheap for a company growing in the mid-teens.
With the still growing business and the current cheap valuation, the all time high seems realistic in the next two years. This implies an upside of ca. 100%.
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If you like this post, check out my previous deep dives on
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Fortinet: https://41investments.substack.com/p/fortinet-stock-analysis-and-deep
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British American Tobacco: https://41investments.substack.com/p/british-american-tobacco
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Datagroup: https://41investments.substack.com/p/datagroup-deep-dive
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Invest at your own risk, this is not financial advice!