INVESTMENT THESIS
Adobe Systems Inc. (NGS: ADBE) to a target price of $520. The company has an admirable track record of innovation in enabling digital content creation. While Adobe expects its target markets, particularly small and medium-sized businesses, to continue to recover from the pandemic in FY21, it remains cautious about the bottom line for the year as a whole. Adobe plans to ramp up hiring and invest in growth initiatives in FY21, and some travel and entertainment cost savings should reverse in 2H21. We believe that these factors have contributed to management’s caution.
Our target price implies a multiple of 46-times our FY21 EPS estimate.
RECENT DEVELOPMENTS
Adobe reported fiscal 4Q results (for the quarter ended November 27) on December 10. Revenue beat management’s guidance by $74 million and the consensus by $63 million, while EPS topped guidance by $0.17 and the consensus estimate by $0.15.
Revenue rose 14% year-over-year to $3.42 billion in 4Q20. As usual, the Creative Cloud business drove results, with 20% revenue growth, helped by new user acquisition across geographies and segments, including single-application and complete Creative Suite subscriptions. Creative revenue growth also included the imaging, video, and stock categories. In 4Q20, Creative Cloud annual recurring revenue (ARR), a key performance indicator, rose 20% year-over-year and 5% sequentially to $8.72 billion, slowing marginally from recent quarters, as the company added $425 million in incremental ARR. Total Digital Media segment ARR rose 22% year-over-year to $10.3 billion. The Digital Experience segment saw 10% revenue growth, with 14% growth in subscription revenue.
The growth reflected management’s decision to abandon its lower-margin, transaction-driven Advertising Cloud business, as well as travel and entertainment expense savings during the pandemic. Management expects continued ‘T&E’ expense savings in fiscal 1H21; however, it looks for these expenses to ramp back up in 2H21, creating an operating margin headwind. Management also expects to ramp up hiring and invest in growth initiatives in FY21, which could also impact margins. Non-GAAP net income rose 22% to $1.36 billion. Non-GAAP EPS rose 23% to $2.81. Share repurchases over the last year boosted non-GAAP EPS growth relative to net income growth.
For FY20, revenue rose 15% to $12.87 billion. Non-GAAP EPS increased 28% to $10.10 from $7.87 in FY19.
On December 7, Adobe completed the acquisition of Workfront, a workflow management platform for marketers, for $1.5 billion in cash. Adobe plans to integrate the Workfront platform into its Digital Experience segment.
EARNINGS & GROWTH ANALYSIS
Our FY21 estimate is above management’s midpoint guidance of $11.20. As Adobe emerges from the pandemic in FY21, management expects to both ramp up hiring in the critical areas of R&D and sales and see a reversal in its travel and entertainment expense savings in 2H21. While not explicitly guiding to margin compression, the company’s non-GAAP EPS guidance implies much slower EPS growth of 11% after the 28% growth experienced in FY20.
Adobe’s Creative Cloud, with its software tools for creating all types of web content, is the company’s flagship product and primary revenue stream. Digital documents rely on the venerable
Adobe Acrobat pdf format, the de facto standard for digital documents, with 300 billion pdf’s opened in the last 12 months. The Adobe Experience Cloud offers tools for advertisers to manage, measure, and track the effectiveness of digital advertising campaigns. Adobe sees its three industry categories continuing their rapid growth.
Adobe management expects its Creative Cloud total addressable market (TAM) to expand to $31 billion by the end of 2022 and $41 billion by the end of 2023, a 32% growth rate. The 2023 total is segmented as follows: $20 billion from the company’s traditional base of creative professionals plus $15 billion and $6 billion, respectively, from its newer customer bases of communicators and consumers. The Document Cloud total addressable market is expected to reach $13 billion by the end of 2022 and $21 billion by the end of 2023, implying 62% growth. Some $11 billion of the 2023 TAM is expected to come from Acrobat Applications and $10 billion from the Document Services Platform, a natural product xtension into eSignatures, embedded pdf’s, and document intelligence services.
Digital Media’s underlying growth strategies are to continue to drive customer engagement, extend category leadership through innovation and product extension, accelerate individual customer and team productivity through digital documents, and expand from the company’s traditional base of creative professionals into new user bases including students, marketers, and ‘knowledge workers,’ as well as consumers.
In the Creative business, the company is increasing investment in new solutions that address the needs of the ‘communicator segment,’ boosting users’ ability to author materials from a web browser. We take ‘communicator segment’ to mean the burgeoning population of social media influencers on YouTube and other social media platforms. In Adobe Document, the company is ramping up the Adobe Sign business and increasing PDF functionality to capitalize on the new work-from-home paradigm. In its Digital Experience division, the company is increasing investment in artificial intelligence/machine learning and in next-generation applications on the Adobe Experience Platform. It is also accelerating the integration of its content and commerce offerings. As we have noted, the company is closing its low-margin/high-resource-use Advertising Cloud business. In addition, it will no longer invest in its advertising software solutions business.
Management also expects the Experience Cloud TAM to reach $74 billion in 2022 and $85 billion in 2023, implying 15% growth.
It believes that the integrated content and data platform under the company’s machine-learning platform, called Sensei, provides significant differentiation and a competitive advantage. The acquisitions of Marketo and Magento Commerce should also boost this segment’s reach.
The company’s adoption of a cloud SaaS model has enabled it to execute a faster product refresh cycle and rapidly introduce new and adjacent product offerings, raising the value of its products for existing customers. Indeed, management touts its ‘innovation engine’ as a primary long-term revenue growth driver. It has also increased the company’s ability to attract and retain users through new offerings and enabled it to segment products to appeal to new classes of users.
The company is seeking to attract new customers by expanding its current market and by pursuing adjacent markets through product segmentation, as in the case of its Photoshop offering for photography enthusiasts. The company is also adding new services that add value to a customer subscription, such as Adobe Stock, introduced in 2015. These added services may justify price increases over time as subscribers perceive more value. In addition to its basic growth strategies, Adobe believes that its transition to the cloud-based subscription model supports international expansion, the diminution of piracy, and increased penetration of the education market.
FINANCIAL STRENGTH
Our financial strength ranking for ADBE is High. The credit agencies give Adobe ratings in the low A’s, comfortably within investment grade, and outlooks are stable. Adobe’s share repurchase program has resulted in a modestly declining share count over the last few years.
VALUATION
On December 14, BUY-rated ADBE closed at $486.42, up $10.51.
Source: Argus
