r/valueinvesting
Adobe is now flirting with single digit SBC adjusted FCF multiples
Adobe trades at 10x GAAP earnings with a 10% true FCF yield, offering deep value despite the CFO's departure to an AI chip firm.
- Extremely attractive valuation with a 10% true free cash flow yield and trading at roughly 10x GAAP earnings.
- Solid underlying business performance with ~10% top-line growth, stable margins, and a strong focus on share buybacks.
- Strong balance sheet with room to take on more debt for leveraged buybacks, similar to Salesforce.
- The CFO is departing for Marvell Technologies, which is a terrible look and raises concerns about internal confidence.
- Ongoing debate and uncertainty regarding whether Adobe is being disrupted by AI competitors.
Earnings just dropped, and it was (mostly) more of the same from Adobe. Whether you think that's a good thing or a bad thing is basically a Rorschach test that shows where you stand on the "Adobe is/isn't getting disrupted" debate.
Revenues grew 13%, or roughly 8-9% if you strip out currency fluctuations and the contributions from the Semrush acquisition. Not jaw-dropping, but certainly not bad. Margins were pretty much in-line, but GAAP margins took a write-down on an asset impairment. Given the size, it's pretty immaterial to the big picture of the quarter, and non-GAAP margins were largely unaffected. I know a lot of people here are allergic to non-GAAP figures, but it can be useful as a proxy for underlying earnings power, and is a pretty good estimate for "owner's earnings" after you strip out the SBC add backs. Basically, the numbers looked solid across the board. The story continues to be \~10% top line growth, stable margins, and a focus on buybacks (less so this quarter because of the acquisition).
However, their CFO announced his departure from the company at the worst possible time. He's leaving to join Marvell technologies, a fabless semiconductor design company whose stock has gone parabolic and has seen a huge surge of new business from the AI boom. I don't think I need to tell you why this is a really, really terrible look for Adobe.
If tomorrow's share price opens up where it currently is in the after-hours (about $207 at the time of writing), Adobe will have a market cap around $83 billion. In the trailing twelve months, they produced \~8.3b in free cash flow, after subtracting stock based compensation from the operating cash flow total. This is a 10% true free cash flow yield, with a balance sheet that has room for more debt if they choose to do levered buybacks like Salesforce just did.
In all my time researching companies, I don't think I've ever seen a business trade at 10x GAAP earnings with a revenue or FCF/share chart like Adobe's, outside of cyclicals that saw an unusually long boom cycle. People like to bring up Meta in 2022 as an example of a stock that got impossibly cheap, but revenue and DAU's were literally in decline when the stock bottomed, combined with apple's ATT policy and the metaverse embarrassment. Adobe has seen very little deterioration in the fundamentals since the AI/competition threat really began, and definitely not any deterioration that isn't expected as they fight against the law of large numbers.
This post was mostly a look at the numbers, and didn't discuss the qualitative aspect of Adobe's competitive positioning. There is obviously a huge debate about their moat, which will probably continue for at least another year or two. But as it stands right now, there is no credible evidence in the numbers to say that Adobe is getting meaningfully disrupted.
I own shares and remain pretty bullish, so I'm curious to get feedback and see if I'm missing anything in the numbers. I'm also interested in any bears that have a compelling case against their competitive positioning going forward, specifically in the enterprise segment. And I mean an actual compelling case that amounts to more than "I cancelled my Adobe subscription in my photography business in favor of Canva, therefore Nike is probably going to cancel their 3000+ seats at some point soon."
Only in fantasyland does that happen. This is what drug fueled analysts come up with.
Agree 100%
Agree 1000%, as a software dev 🤪
"Relatively simple software product" 🤡
That's correct. That's their only product.
I agree, but it is worth noting that the Chinese companies carry a different set of risks. The sketchy Cayman Island VIE structure is one, as well as the CCP dictating business practices, capital return policies, or even public vs. private status.
That said, Tencent definitely isn't going to get disrupted by AI in the next decade, so I suppose it depends on what probability you assign to a "doomsday" risk.
Dear OP,
Excellent post.
If scenario I is the company will grow at the rate of the economy and scenario II is that they cease to grow but merely maintain the current earnings, and scenario iii is where they lose half of the business to Ai and stay there.
Scenario I is coveted. Scenario II is where the company share price is right now. I can’t seem to find a good buy case for scenario iii ( it is ridiculous i know since adobe doesn’t have any real competitors)
Thank you, I appreciate the read and the feedback!!
Scenario 3 is basically IBM in 2011. I don't know what multiple you'd have to pay on today's earnings to eek out a decent return, but I imagine its probably in the mid single digits or even lower.
By my back-of-the-napkin math, it's hard to assume you get too much less than a double-digit CAGR in scenario 2 or especially scenario 1.
I would suggest that scenario 1 isn't even a true bull case. Digital marketing/advertising, DIY creative work, and professional entertainment all grow in excess of nominal GDP. Adobe is a leader here, and the bull case reasonably assumes they maintain their pricing power and maintain their churn at historical rates. Those assumptions could absolutely support a 10% growth rate in revenues for another 5 years or more, while margins stay at least mostly intact. Combine that with a buyback, and you're easily at a high teens CAGR. And after 5 years of proven resilience during a stress test, it's not unreasonable at all to assign a 20x earnings multiple on 10% growth, low capital intensity, and high ROIC. At that point, you're looking at a 20-30% annual return without assuming anything heroic.
The assymetry is really attractive to me in this situation. There's definitely a chance that I get cut in half on my position by 2030, but there's also a not insignificant chance that I get a massive return if I'm right.
Market can be irrational for a long time. What I don't see is the number of customers going down, and yet these AI tools like Midjourney, runway, Grok are on their 4th, 5th iteration and have been out for years. Why hasn't the numbers been disrupted yet?
Then why hasn't it shown already in the numbers? Midjourney, Openai, grok etc... these image generation tools have been around for 2-3 years at this point. They're at their 4th, 5th iteration. And yet Adobe's customers number keeps growing
The questions is how many of their user base leverages the full capabilities of their software or just need some 10% of the features that they can find much cheaper elsewhere
You wouldn't consider Microsoft Word to be a relatively simple software product? I understand the cost to create software has come down, but it wasn't hard to create a notepad app/program for free, even before generative AI took off. Bundling/enterprise integrations/user behavior can form one hell of a switching cost moat.
Lines of code are not the same thing as a business. Sales, tech support, compliance, security, all of these are no less important today in the AI boom than they were 15 years ago.
As I said, you can be both right and wrong at the same time. Colloquially, you just won’t hear “that’s photoshopped” anymore. You’re going to hear “that’s AI generated”. That’s called a shrinking moat.
yup, and "Enterprise switching costs are real" and "We aren't buying a growth story anymore, we are buying an extreme structural share cannibalization play at deep value multiples." are also obvious GPT lines.
So buy today? Ive been eyeing it forever and think it looks ridiculous right now price wise. Bought google at 150 when similar doomerism was making the rounds. ADOBE is even more below that in price.
Yo amplié hoy
I think Apple should buy Adobe. I know they won’t but they would have if they were smart enough. Apple could bundle Adobe into its devices - turn the combo into the ultimate designer/creative must-have.
But I think coding agents weaken their moat significantly. I’m not saying Joe blow will make photoshop by vibe coding, but it might be possible soon for Chad 10x developer abd friends to make a clone with 100k in tokens
I’m genuinely curious about how many tokens image generation consumes. Sometime soon, all AI will be priced per token and presumably at far higher prices per token than currently. At that point, what’s the actual cost of image generation via AI? I don’t know the answer I’m actually asking. Maybe it’s still cheaper than adobe.
AI can do more than one thing.
I bought a very small position today. It’s just too cheap. I’m going to need to do extensive research on the business / software / threat of disruption before I go for a bigger position. I generally run a concentrated portfolio, so I don’t risk 10% for something I don’t understand. But this valuation seems crazy. The world has decided, with 100% certainty, that AI will ONLY hurt their business and have no positive impacts whatsoever. Hard to believe that’s the truth.
I would love to see this down at <$100 on today's earnings.
I would probably remortgage my house and sell a kidney to buy shares at 5x GAAP earnings and a 25% buyback yield while growing revenue in the teens.
I disagree with your framing on the last part. You might be correct that their growth isn't durable on today's margins, or vice versa. But there is just straight up not enough evidence to claim we know that for certain yet, we've only seen one or two quarters that somewhat suggest it.
Also, you don't need revenue growth or margins to be sustained at current levels to get a good return at 10x earnings. Suppose they can only grow revenue at 4 or 5% if they want to maintain operating margins at exactly 35%... Do the math, that's still a low teens EPS CAGR with the current buyback, on a valuation multiple that would very likely expand. You can also do the math on the inverse scenario of sacrificing margins to maintain growth and arrive at a similar conclusion.
Basically, the question is how much either margins or revenue growth would have to erode before the buybacks cannot offset if enough to boost EPS. I think you have to make some pretty bearish assumptions to get the numbers to not work from here.
Exacto
You're right. The evidence is circumstantial. The example given by Bristlemoon's piece was based on a few corporates (Coca Cola and some other examples), using less adobe each year for the creation of assets. And so far revenue is still growing.
But you have both the CEO and CFO leaving...maybe they can see usage data? usage time in app?
Market seems to not want to wait around until it turns into a melting ice cube.
Buying on valuation alone, i think is what ends up being a value trap. I think you have to have a hypothesis on how it turns the corner or how it turns back into a growth stock. I can kind of see it, if they started to try disrupting themselves and tried to create better models but then that is going to be expensive and so margins will go down. Or if the completely opened up their tools and the "credits" they sold were not super marked up (Bristlemoon piece pointed out how they basicaly marked up the tokens by some high amount so that the user would be much better off actually just using AI on the side and importing the work).
Anyway...i think all of this may be moot. because in a few chip generations when inference speeds are very fast and token costs come way down, we could be in a whole new world again.
You make some fair points, and I'll definitely look into that Bristlemoon writeup. I think you and I diverge a bit on our willingness to underwrite the safety of the existing cash flows. You place more weight on an existential event happening that craters (or at least somewhat quickly bleeds) their largest and most profitable contracts, whereas I am comfortable assuming that enterprises still make up the lion's share of the core business and are not going to be willing to switch away from Adobe's software within the next 5 years or so.
Thanks for your thoughts!
Hope we all win
The only thing I would mention is accounting for dilution in your numbers. Adobe does issue roughly 2b in SBC per year, which makes the buyback a little less effective than you implied (if I'm reading your response correctly).
You're not missing anything, the bears are just doubting your net income growth assumptions. If you believe they can eek out high single digits organic net income growth for years to come, the stock is objectively undervalued. That the entire argument that exists around them rn.
Thanks for that insight. We'll see how the numbers turn out. Those numbers have been very good to date, but as you said, the argument is whether or not that continues going forward based on AI/other unknowns. We're living in unprecedented times. IDKWTF is going on.
Thanks for making this bag holder feel a little better