Adobe Inc. (ADBE, Financial) is one of the largest technology companies and one of the leaders in the global digital content creation market. Headquartered in San Jose, California, the company operates in three business segments: Digital Media, Digital Experience and Publishing and Advertising.
Source: Author's elaboration, based on quarterly securities reports
Thesis
The first investment thesis we highlight is the growth of Digital Media revenue, which is a key segment of the company, contributing about 73.5% of its total revenue for the third quarter of fiscal 2023. We think that content is becoming a more crucial component of marketing strategies and in creating successful businesses.
Adobe products also play a key role in creating quality content that helps attract consumers and allows people worldwide to share unique and valuable knowledge with millions of users through various social networks.
The Digital Media segment has an extensive portfolio of products, including world-renowned software and cloud-based services such as Adobe Acrobat Sign, Acrobat, Photoshop, Illustrator, Premiere Pro and many others. These products provide powerful functionality for advertising agencies, merchandisers, content creators, data scientists, and other users.
Meanwhile, the Digital Media segment has seen steady revenue growth in recent years, thanks partly to the launch of Adobe's artificial intellligence-based software products. It amounted to $3.59 billion for the third quarter of fiscal 2023, an increase of 11.2% compared to the previous year.
Source: Author's elaboration, based on quarterly securities reports
At the same time, despite the increase in the cost of subscription revenue, the company's operating income margin amounted to 34.7% for the three months ended Sept. 1. This financial metric is higher than the company's competitors in the technology sector, such as Salesforce (CRM, Financial), Oracle (ORCL, Financial) and SAP (SAP, Financial).
Source: Author's elaboration, based on Seeking Alpha
However, considering the potential risks, such as the deterioration of the geopolitical situation in the Middle East and the possible blocking of the deal to acquire Figma by Adobe, we initiate our coverage of the company with a "market perform" rating.
Adobe's third-quarter financial results and outlook for 2024
Before diving into Adobe's financial results for the third quarter of fiscal 2023 and our expectations for fiscal 2024, we would like to direct your focus toward its institutional investors.
Adobe's five largest shareholders, including such well-known companies as Blackrock, Vanguard Group, State Street, FMR and Morgan Stanley, collectively own 25.42% of the company's shares.
Adobe, being a growth stock, always trades at high multiples. The company's management continues to pursue an active merger and acquisition policy to increase the growth rate of its revenue.
However, in early August, European antitrust regulators resumed an in-depth investigation into Adobe's $20 billion acquisition of Figma. Despite the growing likelihood of the deal collapsing and, as a result, Adobe will not be able to acquire the leader in the global user interface and user experience design software market, the percentage of its shares owned by institutional investors has remained stable in recent months.
This significant ownership by the Wall Street titans underscores their strong belief in the company's promising future, even as the hype around artificial intelligence wanes.
Source: Fintel
The third quarter of fiscal 2023 delivered excellent results as Adobe's total revenue continues to grow year over year and, more importantly, the company continues to beat analysts' consensus earnings per share estimates in all of the last 10 quarters. A key factor contributing to the company's continued improvement in its financial position is the growing demand for its subscription offerings. So Adobe's subscription revenue for the three months ended Sept. 1 amounted to $4.63 billion, an increase of 12.2% compared to the previous year.
Source: Author's elaboration, based on quarterly securities reports
Adobe is expected to release its financial report for the fourth quarter of fiscal 2023 on Dec. 13. According to Seeking Alpha, Adobe's revenue for this quarter is expected to be $5 billion to $5.09 billion, up 10.8% year over year and 3.1% higher than analysts' expectations for the prior quarter.
Source: Author's elaboration, based on Seeking Alpha data
In addition, according to our model, the company's total revenue will be above this range and reach $5.11 billion, an increase of 11.5% year over year.
Source: Created by author
We expect Adobe's quarterly revenue growth will be driven by higher pricing for certain Creative Cloud plans, an increase in the company's new customers and raised demand for its Document Cloud subscription offerings.
Source: Author's elaboration, based on Adobe press release
Moreover, we predict Adobe's operating income margin will reach 34.1% by fiscal year 2023. At the same time, by fiscal year 2024, this financial metric will increase to 35.5%, thanks to the expansion of the portfolio of products and services, an increase in the number of new Creative Cloud subscribers and optimization of labor costs.
In addition, the improvement in the company's operating income margin will occur due to the Federal Reserve's interest rate cut, which, according to our expectations and CME Group data, will be in 2024. This event is one of the most important in the financial world and is poised to boost the global economy's growth rate.
Source: CME Group
According to Seeking Alpha, Adobe's fourth-quarter earnngs per share are expected to be $4.11 to $4.18, up 3.8% from the consensus estimate for the third quarter of fiscal 2023. On the other hand, according to our model, Adobe's earnings will be higher than this range and amount to $4.20 per share.
The company's trailing 12-mont non-GAAP price-earnings ratio is 32.97, 91.71% higher than the sector average and 17.11% lower than the average over the past five years. On the other hand, the forward non-GAAP price-earnings ratio is 34.46, which is one factor indicating that financial market participants are too optimistic about Adobe's prospects as the euphoria around AI continues to fade.
Source: Author's elaboration, based on Seeking Alpha data
Besides strong demand for Adobe Creative Cloud, the other key contributor to Adobe beating consensus earnings per share is its share repurchase program. In recent years, the amount of cash flow directed toward this purpose has continued to remain stable, averaging approximately $1.42 billion per quarter.
For the three months ended Sept. 1, Adobe repurchased about $1.12 billion worth of its shares. At the same time, at the beginning of September, the remaining authorization to buy back Adobe shares amounted to $3.48 billion. In our assessment, this will partially minimize the impact of short sellers in the event of the outbreak of war between Israel and Hezbollah, an event that could interrupt the upward trend of the Nasdaq-100 index (^NDX, Financial).
Source: Author's elaboration, based on Seeking Alpha data
Conclusion
As one of the largest technology companies and one of the leaders in the global digital content creation market, the key risks for Adobe's financial position are the deterioration of the geopolitical situation in the Middle East, which could lead to an oil embargo by Iran and other Arab countries, as was the case due to the Yom Kippur War. In this case, this will lead to rising inflation worldwide and central banks will have to raise interest rates again, ultimately increasing downward pressure on the major market indexes and the price of Adobe shares. So, from October 1973 to October 1974, the price of the Dow Jones (DJI) decreased by more than 40%.
Source: TradingView
In addition, we highlight as a risk the possible blocking by regulators of the Adobe acquisition of Figma, which will lead to a termination fee of $1 billion.
Source: Author's elaboration, based on 10-K filing
On the other hand, thanks to Adobe's strengthening position in the global artificial intelligence software market and improving its margins quarter over quarter, the company's share price has increased by more than 50% year to date.
Source: Author's elaboration, based on Seeking Alpha
We initiate our coverage of Adobe with a "market perform" rating for the next 12 months.
