Exploring Adobe’s Base, Bear And Bull Cases — Part Two

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In the first half of this two-part note, we explored the base case scenario for Adobe (NASDAQ:ADBE). In this article, we look at the bull and bear case for the company. The common string running through the three cases is the lack of growth in smaller divisions—i.e., Adobe packaged software, LiveCyle software and Print & Publishing. Even if the metrics for these divisions were to improve, it would have little impact on our stock price valuation as the contribution from these divisions is small. Accordingly, in our bull and bear case scenarios, we will focus on the impact of Creative Cloud (CC) and Marketing Cloud business on the company’s valuation.

Check out our complete analysis of Adobe

Bull Case: Upside of 45%

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In the bull case scenario, Trefis estimates that the Adobe’s stock is worth $101. The expected change in key drivers is as follows.

The Creative cloud division: – The key drivers for this division are the average revenue per subscriber and total creative software market. 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 of these 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. Considering the rapid adoption of Adobe CC among creative professionals (so-called creatives, or professionals requiring the software), coupled with increasing penetration of Internet, the total addressable market (TAM) for creatives can expand to over 30 million by 2021. Its subscriber base can grow to over 21 million instead of 16.39 million paying subscribers by the end of 2021. This figure represents 70% of the 30 million point and suite licensees.

Average revenue per subscriber (ARPS) for the company consists of a blend of subscribers that have subscribed to 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. 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 has a tenure of three years. Additionally, the company continues to expand its portfolio by  adding new services to it. This leads us to believe that the ARPS can grow at an increasing rate in the coming years. As the ARPS converge to the sticker price of $74.99, we estimate that it can grow to $49 by the end of our forecast period.

Marketing Cloud Divisions: – Over the past few years, Adobe has built a comprehensive digital marketing platform that addresses most of the needs in digital marketing. 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. Well positioned in a growing market, this division is expected to witness robust growth in the coming years. Considering that the marketing cloud is easily a $10 billion opportunity, the growth rate for this division can be higher. [1] In Bull case, we project revenues from its digital marketing division to reach $3.6 billion by the end of our forecast period.

Link For Bull Case

Bear Case: Downside of 40%

In the bear case scenario, Trefis estimates that the Adobe’s stock is worth $42.64. The expected change in key drivers is as follows.

The Creative Cloud division: – In bear case scenario, we estimate that the total creative software market will grow at a slower rate to 21 million, and Adobe’s subscriber base will grow at a slower rate to 10 million paying subscribers by the end of 2021. This figure represents 50% of the 21 million point and suite licensees.While access to the complete Creative Cloud suite costs $74.99 per month, access to standalone Photoshop is priced at $9.99 per month. However, since the company is adding products at lower price points, it will lower the blended average revenue per subscriber (ARPS) for the company. We estimate that the ARPS can decline to $24.50 by the end of our forecast period.

Marketing Cloud Divisions: – Although, the marketing cloud is easily a $10 billion opportunity, it might be difficult for Adobe to become a leader considering the intense competition in this space from companies such as IBM, Accenture, Salesforce and Oracle . [1] Therefore, it is possible that revenues from its digital marketing division can grow at a slower rate to reach $2.41 billion by the end of our forecast period.

Link For Bear Case

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