Exploring Adobe’s Base, Bear And Bull Cases – Part One

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Adobe (NASDAQ:ADBE) has successfully transformed its business from perpetual licensing to a cloud-based subscription model. Investors have given a thumbs up to this transition as indicated in the stock’s performance over the past few years. While the rise in stock price has been meteoric over the past two years, when it rallied from $38 in 2013 to over $80, most of its future depends on increasing adoption of its Creative Cloud and marketing cloud solutions. In part one of the note, we explore the base case for the company. In Part two, we explore the bull and bear cases. All three scenarios explore the impact on Adobe’s topline due to the adoption rate of its services. A summary of this is as follows:

EPS in 2015 Price
Base Case $           1.51 $  70.22
Bull Case $           1.74 $  101.87
Bear Case $           1.24 $  42.64

Check out our complete analysis of Adobe

Base Case Scenario

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The base case scenario justifies the current estimate of Trefis’s stock price. We currently estimate that the stock is fairly priced at $70.22. The explanation of this is as follows:

The Creative cloud division: – The Creative Cloud (CC) division makes up 63.5% of Adobe’s estimated value. The key drivers for this division are the average revenue per subscriber and total creative software market. While Creative products (Creative Suite and Creative Cloud) contributed nearly 45% to Adobe’s revenue in 2014, the total number of licensees for Adobe’s creative products stood at 14.7 million, according to our estimates. In 2014, Adobe added 3.45 million subscribers to its CC services, which translates into a growth rate of 140% over 2013’s 1.43 million. The company added 517,000 Creative Cloud (CC) subscriptions in Q1 FY15, a 28% increase over the prior year, achieving a total of 3.971 million. We estimate that the subscriber base will continue to grow at a robust 75% in 2015 and add over 2.55 million subscribers during the year. We also believe that the company is on track to add 16.39 million paying subscribers by the end of 2021. This figure represents 63.5% of the 25.8 million point and suite licensees, which we estimate will grow at a CAGR of 8.6%.

Average revenue per subscriber (ARPS) for the company consists of a blend of subscribers that have enrolled into different levels of cloud services. While access to the complete Creative Cloud suite costs $74.99 per month, access to standalone Photoshop is priced at $9.99 per month. We estimate that the blended ARPS for the company was $31.74 in 2014. The recent trend in subscriptions indicates that users are subscribing to the annual full version of Creative Cloud. The company has also reported good growth in its enterprise term licensing agreement (ETLA), which have tenure of three years. This leads us to believe that the ARPS will increase in the coming years as it converges towards the sticker price of $74.99. However, since the company is adding products at lower price points, it will lower the blended ARPS for the company. We estimate that the ARPS will grow to $37.00 by the end of our forecast period.

Marketing Cloud Division: – Adobe’s cloud marketing division is the second biggest division and makes up 17.7% of its value. Over the past few years, Adobe has built a comprehensive digital marketing platform that addresses most of the needs in digital marketing. This build-up started in 2009 with the acquisition of Ominiture. Since then, the company has scaled up the functionality and product offering of its marketing platform through organic and inorganic growth. Currently, Adobe offers six products under its marketing cloud solution. The Adobe marketing cloud includes a complete set of analytics, social media optimization, consumer targeting, web experience management and cross-channel campaign management solutions. It generated around $1.2 billion in annual revenues in 2014. Having been built from the acquisition, the business has had a compounded annual growth rate (CAGR) of 83% over last five years. Well positioned in a growing market, this division is expected to witness robust growth in the coming years. Adobe is aiming to increase its revenues from cloud-based marketing solutions by expanding in new geographies and verticals. Recently, the company introduced two new Adobe Marketing Cloud solutions, Adobe Primetime, a multi-screen TV platform, and Audience Manager, a data management platform, thus supplementing its marketing cloud capabilities. According to the company, the marketing cloud is easily a $10 billion opportunity. [1] Currently, we project revenues from its digital marketing division to reach $3.1 billion by the end of our forecast period.

Acrobat Family Revenue: – Acrobat family is the third largest division and makes up ~11% of Adobe’s estimated value. In the past few quarters, revenues from this division have been on a decline, primarily due to launch of document cloud services that have subscription fee spread over the period of usage. The company has amassed over 2.3 million subscribers for document cloud service. We expect this trend to continue and forecast the subscriber base to grow to 8.83 million by the end of our forecast period. Furthermore, as this service gains momentum, we expect the ARPS to increase from $8.00 in 2014 to $12.70 by the end of our forecast period.

Life Cycle And Print & Publishing:- Smaller divisions of Adobe, which include Adobe packaged software, LiveCyle software and Print & Publishing, makeup 6% of its estimated value. The adoption of Creative Cloud will negatively impact Adobe’s packaged software, while up-selling to Adobe marketing cloud will pressure LiveCyle & Connect pro revenues. We expect revenues from these divisions to decline in the future. We estimate average selling price of packaged software and LiveCycle software will decline in the future to $165 and $85,160 respectively. We also expect the number of licenses sold for both the divisions to decline. Even if these metrics were to improve for both the division, it will have little impact on our stock price valuation, since the contribution from these divisions is small.

See our complete analysis of Adobe’s Scenario

In the next note, we explore Adobe’s bull case and bear case scenarios.

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Notes:
  1. Digital Marketing, Adobe and $10 Billion Worth of Opportunities, August 18 2014, www.mobilemarketingwatch.com []