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Adobe Fundamental Analysis

Disclaimer: This article by The Globetrotting Investor is general in nature. We aim to bring you long-term focused analysis driven by fundamental data, hence, providing you commentary based on historical data and analyst forecasts only using an unbiased methodology. This is not a buy/ sell recommendation, and it is solely for educational purposes. Please do your research before investing. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Please read the full disclaimer here.

Adobe

Last Updated: 3 Jan 2023

NASDAQ: ADBE

GICS Sector: Technology

Sub-Industry: Software — Infrastructure

https://www.adobe.com/

Adobe Fundamental Analysis | Adobe Logo | Fundamental Analysis by The Globetrotting Investor

Table of Contents

Management

Adobe Management

CEO: Shantanu Narayen

Tenure: 15 years

Adobe Inc's management team has an average tenure of 4.3 years It is considered experienced.

Source of Revenue

Adobe Inc. operates as a diversified software company worldwide through three segments: Digital Media, Digital Experience, and Publishing and Advertising.

 

Digital Media

In a creator economy that is continually expanding, creators are looking for tools to help them easily make and share unique and beautiful content without complexity. At the same time, creativity is becoming increasingly collaborative, more critical to every company’s success and more complex.

 

Adobe’s Digital Media business offers a range of products and services that allow individuals, teams, small and medium businesses, enterprises, and government institutions, including both professionals and enthusiasts, to design and deliver content. Its flagship products and services include Adobe Creative Cloud and Adobe Document Cloud.

 

Adobe Creative Cloud is a cloud-based subscription app that enables creative professionals and enthusiasts alike to express themselves with apps and services for photography, design, video, web and more that connect across devices, platforms, and geographies. Members have access to a vibrant creative community, publishing services to deliver apps and websites, cloud storage to sync and access their work, files and assets across apps, platforms and devices using Creative Cloud Libraries, and collaboration capabilities with team members and new products. Some of the applications include Adobe Photoshop and Adobe Lightroom, Adobe Illustrator and Adobe Fresco, Adobe InDesign, Adobe After Effects, Frame.io and Behance.

 

Adobe Document Cloud is a cloud-based subscription offering that enables digital document and signature workflows across desktop, mobile, web and third-party enterprise applications to drive business productivity. With Document Cloud, users can create, review, approve, sign and track documents and store them in the cloud for easy access and sharing, across desktop and mobile devices. Some Adobe Document Cloud applications include Adobe Acrobat DC, Adobe Sign, and Adobe Scan.

 

This segment serves content creators, workers, marketers, educators, enthusiasts, communicators, and consumers.

 

Digital Experience

Every business today is a digital business. Consumers today buy experiences, not just products, and they demand personalised digital experiences that are relevant, engaging, seamless and secure across an ever-expanding range of channels and devices.

 

Adobe’s Digital Experience offerings include Adobe Experience Cloud which is a comprehensive collection of products and solutions to manage the customer experience, all integrated into a cloud platform.

 

Experience Cloud is comprised of the following sets of solutions: Adobe Experience Platform; Data, Insights and Audiences; Content and Commerce; Customer Journeys; Marketing Workflow; and Digital Enrollment and Onboarding.

 

This segment serves marketers, advertisers, agencies, publishers, merchandisers, merchants, web analysts, data scientists, developers, and executives across the C-suite.

 

Publishing and Advertising

This 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.

 

Adobe markets its products and services directly to enterprise customers through its sales force and local field offices. The company licenses its products to end users through app stores and website. Adobe offers many of its products via a Software-as-a-Service (“SaaS”) model or a managed services model (both of which are referred to as hosted or cloud-based) as well as through term subscription and pay-per-use models.

 

Adobe also distributes certain products and services through a network of distributors, value-added resellers (“VARs”), systems integrators (“SIs”), independent software vendors (“ISVs”), retailers, software developers and original equipment manufacturers (“OEMs”). In addition, the company licenses its technology to hardware manufacturers, software developers and service providers.

 

For all periods presented, there were no customers that represented at least 10% of net revenue or that were responsible for over 10% of Adobe’s trade receivables.

Adobe Source of Revenue
Adobe Fundamental Analysis | Adobe Reportable Segment Revenue | Fundamental Analysis by The Globetrotting Investor

Adobe Reportable Segment Revenue for FY2022

Adobe Economic Moat

Adobe Economic Moat

Adobe Fundamental Analysis | Adobe Economic Moat | Fundamental Analysis by The Globetrotting Investor

Adobe Economic Moat

 

Economic Moat: Wide

There are many ways to identify Adobe’s economic moat, but I focus on the above 5 types. The rating is purely

subjective and based on my in-depth understanding and analysis of Adobe. Please check my summary to understand more about the economic moat.

Performance Checklist

Adobe Performance Checklist

Is Adobe’s revenue growing YoY for the past 5 years consistently? Yes.

Is the net income growing YoY for the past 5 years consistently? Inconsistent.

Is the cash flow from operating activities growing YoY for the past 5 years consistently? Yes.

Is the free cash flow positive for the past 5 years? Yes.

Is the gross margin % consistent/ growing for the past 5 years? Yes.

Is the EPS growing for the past 5 years? Inconsistent.

Adobe Fundamental Analysis | Adobe Revenue, Net Income, Operating Cash Flow, and FCF | Fundamental Analysis by The Globetrotting Investor

Adobe Revenue, Net Income, Operating Cash Flow, and FCF (USD Million)

Is the free cash flow per share growing for the past 5 years? Yes.

Adobe Fundamental Analysis | Adobe FCF per Share | Fundamental Analysis by The Globetrotting Investor

Adobe FCF per Share

Adobe Management Effectiveness

Management Effectiveness

Is Adobe’s ROE consistently at 12%-15% YoY for the past 5 years? Yes.

Adobe Fundamental Analysis | Adobe Return on Equity | Fundamental Analysis by The Globetrotting Investor

Adobe Return on Equity

Is the ROIC consistently at 12%-15% YoY for the past 5 years? Yes.

Adobe Fundamental Analysis | Adobe Return on Invested Capital vs Weighted Average Cost of Capital | Fundamental Analysis by The Globetrotting Investor

Adobe Return on Invested Capital vs Weighted Average Cost of Capital

 

The trendline for the number of shares outstanding is declining, which is something that an investor would be pleased to see.

Adobe Fundamental Analysis | Adobe Shares Outstanding | Fundamental Analysis by The Globetrotting Investor

Adobe Shares Outstanding (Million Shares)

Adobe Financial Health

Adobe Financial Health
Adobe Fundamental Analysis | Adobe Financial Health | Fundamental Analysis by The Globetrotting Investor

Adobe Financial Health (USD Million)

Current Ratio: 1.11 (pass my requirement of >1.0)

Debt-to-EBITA: 0.66 (pass my requirement of <3.0)

Interest Coverage: 54.45 (pass my requirement of >3.0)

Debt Servicing Ratio: 1.43% (pass my requirement of <30.0%)

Dividend

Adobe Dividend

Current Dividend yield: Adobe has not reported any recent payouts.

Adobe Valuation

Adobe Valuation

Estimated intrinsic value: $382.24

 

Value is calculated using discounted cash flow method (taking into account their cash and debt) and scenario planning.

Average free cash flow used: $7,000M

Projected growth rate: 10% - 14%

Beta: 1.24

Discount rate: 8.0%

Date of calculation: 3 Jan 2023

Adobe Fundamental Analysis | Adobe Price-Earnings Ratio vs its peers | Fundamental Analysis by The Globetrotting Investor

Adobe EV-to-EBITDA vs its peers

Adobe Fundamental Analysis | Adobe Price-Earnings Ratio vs its peers | Fundamental Analysis by The Globetrotting Investor

Adobe Price-Earnings Ratio vs its peers

Adobe Fundamental Analysis | Adobe Historical Price-Earnings Ratio | Fundamental Analysis by The Globetrotting Investor

Adobe Historical Price-Earnings Ratio

Additional Resources

I recommend reading The Five Rules for Successful Stock Investing as it greatly helps in my stock analysis. If you want a complete collection of recommended books, please visit here.

My Top Concern

My Top Concern

Mergers and acquisitions of technology companies are inherently risky. If Adobe does not complete an announced acquisition transaction or integrate an acquired business successfully and in a timely manner, the company may not realise the benefits. Other risks include:

  • Difficulty in, and the cost of, effectively integrating the operations, technologies, products or services, and personnel of the acquired business.

  • Disruption of ongoing business and distraction of management and other employees from other opportunities and challenges.

  • Failure of due diligence processes to identify significant problems, liabilities or other challenges of an acquired company or technology.

Adobe’s ability to acquire other businesses or technologies, make strategic investments or integrate acquired businesses effectively may also be impaired by the increased global scrutiny of foreign investments. For example, countries like the United States and countries in Europe and the Asia-Pacific region are considering or have adopted restrictions on foreign investments. Governments may continue to adopt or tighten restrictions of this nature, and such restrictions can impact Adobe’s business.

 

The process of acquiring and even developing innovative technology products and services and enhancing existing offerings is complex, expensive, and uncertain. If Adobe fails to anticipate customers’ rapidly changing needs or adapt to emerging technological trends, the company’s business will suffer.

 

Adobe must then make long-term investments, develop, acquire, or obtain appropriate intellectual property and commit significant resources before knowing whether its predictions will accurately reflect customer demand for its products and services. However, there is risk involved. If Adobe misjudges customer needs in the future, its new products and services may not succeed, and profitability may be impacted.

Summary for Adobe

Summary for Adobe

Adobe’s wide economic moat arises primarily from its switching costs and network effect.

 

Adobe offers a diverse range of products and services used by creative professionals, including photographers, video editors, and game developers; communicators, including content creators, and marketers; and consumers for creating, managing, delivering, measuring, optimising, engaging, and transacting with compelling content and experiences across multiple devices and digital media formats.

 

Since its introduction, Photoshop became the industry standard for image editing software. Instead of being complacent, Adobe has consistently invested in its solution by introducing new features and applications. These features and applications were both developed internally and through acquisitions.

 

The biggest determinant of Adobe moat is its high switching cost. Switching costs are costs that customers or businesses incur because of changing brands, suppliers, or products. Although the most common switching costs are monetary, there are also psychological, effort-based, and time-based switching costs.

 

Although there are competitive products out in the market, Adobe Creative Cloud is so prevalent within the creative industry that almost all creative professionals must use it. This also translates that creative professionals will find it challenging to work within the industry if they switch to a different product. Even the education system helps Adobe strengthen its moat by teaching students how to use Adobe’s suite of software. When these students graduate, there will be resistance for them to use other creative products as they have spent a significant amount of time and effort acquiring these skills during school days. These factors also give rise to the Adobe network effect.

 

As more graduates learn Adobe’s software, employers have more incentives to deploy Adobe’s software within their companies. And as more companies deploy Adobe’s software, more education institutions will equip their students on how to use Adobe’s applications. This perpetuates a positive flywheel effect creating a strong network effect. In addition, third-party developers have developed hundreds of plug-ins because the software is widely used within the industry. These added features not only help establish Adobe’s network effect but also attract even more users.

 

Besides its creative software, Adobe Document Cloud also further bolster the company’s wide economic moat. As far as I know, there are no truly competitive products to Adobe’s PDF file format to date.

Despite being inconsistent in its net income, Adobe’s performance is good. The company revenue, operating cash flow and even free cash flow are growing steadily over the past 5 years. Adobe’s gross and net margins are growing as well and are historically above its industry averages.

 

Both Adobe ROE and ROIC have also met my requirements. The company’s ROE is consistently above 15% over the past 5 years and is almost 3 times more than its industry average. Adobe’s ROIC is also above 15% consistently over the past 5 years and is 2.5 times more than its WACC. These financial indicators may suggest that Adobe has a great capital allocation.

 

Adobe’s balance sheet, in my opinion, is quite impressive. The company met all my requirements for good financial health. Adobe’s short-term assets exceed either its short-term liabilities or long-term liabilities. The company has more cash than its debt too. Interest coverage and debt servicing ratio indicate that Adobe’s interest payments are well covered.

 

Regardless of Adobe’s wide economic moat, impressive balance sheet and efficient capital allocation, as investors, we still must give a margin of safety. Therefore, with an estimated intrinsic value of $382.24, I will give a 25% margin of safety and will only consider investing if the price is trading in the range of $287.

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