Why We Revised Our Price Estimate For Adobe To $132

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Adobe

Adobe (NASDAQ:ADBE) successfully transformed its business model over the past few years, from a perpetual licensing vendor to a cloud-based Software-as-a-Service (SaaS) provider. As this transformation gained momentum, the number of subscribers for its Creative Cloud (CC) grew, while Average Revenue Per Subscriber (ARPS) declined due to the introduction of the de-itemized suite.

Based on the company’s guidance, we have revised our price estimate for the stock from $107 to $132, which is about in line with the market price. The 24% upward revision in our price estimate was driven by the widespread adoption of Creative Cloud and the migration of Creative suite users to CC. Furthermore, based on the company’s guidance, we have revised the revenue growth rate for the Adobe Marketing Cloud division to 26% in 2017 and a CAGR of 17% through the end of our forecast period. The improvement in margins in 2016 and Q1 2017 has also prompted us to revise our gross margin estimates upwards by 100 basis points across verticals.

In its latest earnings announcement, Adobe said that its artificial intelligence and machine learning framework Sensei, which was introduced at the annual MAX conference last year, has witnessed widespread adoption. Sensei is a unified AI platform that will help users navigate across its Creative Cloud, Marketing and Document Cloud services. The company plans to unveil new Adobe Sensei capabilities at the Adobe Summit. We expect that the launch of new features and functionality should help the company to improve its Creative Cloud subscriber base and revenue from Marketing Cloud. In this note, we explore Adobe’s various verticals that are driving our $63 billion valuation of the company.

Check out our complete analysis of Adobe

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Creative Cloud – The Cash Cow

The Creative Cloud (CC) division makes up 52% of Adobe’s value, according to our estimates. The key drivers for this division are the average revenue per subscriber and total Creative Software market. While Creative Cloud contributed nearly 56% to Adobe’s revenue in the first quarter of 2017, we estimate that the total addressable market (TAM) for Adobe’s creative products stood at 21 million users in 2017. We also estimate that the TAM will grow to close to 25 million by the end of our forecast period in 2023. For 2017, we expect Adobe to exit with 11.2 million subscribers for its CC services, which translates into a growth rate of 27% over 2016’s 9.37 million. We estimate that the subscriber base will continue to grow at a robust CAGR of 10.5% through 2023 and add close to 7 million subscribers. This figure represents 78% of the 24 million TAM.

The company’s average revenue per subscriber (ARPS) consists of a blend of subscribers that have enrolled in 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 $27.85 in 2016. The recent trend in subscriptions indicates that users are subscribing to de-itemized versions of the software of CC instead of the full version of Creative Cloud. Accordingly, we expect the ARPS to decline in the coming years to $26 by the end of our forecast period. However, the company also reported solid growth in its enterprise term licensing agreements (ETLA), which have tenure of three years. This should mitigate the decline in ARPS to some extent in the future.

Adding Features To Adobe Marketing

Adobe’s Cloud Marketing division is the second biggest division and makes up 28% of its value. Over the past few years, Adobe has built a comprehensive digital marketing platform, scaling up its functionality and product offering through both organic growth and acquisitions. The Adobe Marketing Cloud generated over $1.6 billion in annual revenues in 2016, and has seen a compound annual growth rate (CAGR) of 28% over the last five years.

Adobe is aiming to increase its revenues from cloud-based marketing solutions by expanding in new geographies and verticals. Recently, it completed that assimilation of TubeMogul, which has strengthened its foothold in the digital marketing industry. Furthermore, over the past few years, mobile has emerged as a key revenue driver for the digital marketing vertical. Adobe reported that mobile data transactions grew to 56% of total Adobe Analytics transactions in Q1 2017. Total data transactions in Q1 grew to $41.3 trillion, and in the trailing four quarters, data transactions with Marketing Cloud solutions exceeded $100 trillion.

According to the company, Marketing Cloud is easily a $10 billion opportunity. Well-positioned in a growing market, this division is likely to witness robust growth in the coming years. Currently, we project revenues from the division to reach nearly $5 billion by the end of our forecast period.

Acrobat Cloud To Boost Document Services Revenue

The Acrobat family is Adobe’s third largest division and makes up around 14% of our price estimate for the company’s stock. In the past few years, revenues from the division have been declining, primarily due to an increase in revenues from Document Cloud services, which have subscription fees spread over the period of usage. The company continues to add functionality to Document Cloud; for example, in February, in conjunction with the Cloud Signature Consortium, Adobe unveiled an open cloud-based digital signature standard as well as new functionality in Adobe Sign including advanced document routing and online collaboration. These incremental additions to the product have helped the company to improve its subscriber base. The company has amassed over 5.21 million subscribers for the Document Cloud service. We expect this trend to continue, and forecast the subscriber base to grow to 13 million by the end of our forecast period. Furthermore, as the service gains momentum, we expect the ARPS to increase from around $6.90 in 2016 to $11 by the end of our forecast period.

Transition to Cloud Services to Negatively Impact Smaller Divisions

Adob’s smaller divisions, such as Adobe Packaged Software, LiveCyle software and Print & Publishing, make up just 2% of our valuation for the company. The adoption of Creative Cloud will likely negatively impact Adobe’s Print & Publishing vertical, while up-selling to Adobe Marketing Cloud will pressure LiveCyle Software revenues. We expect revenues from these divisions to decline in the future.

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