This global software company is expected to grow at an annual rate of 22.65% over the next five years, and four analysts have increased their earnings forecasts for the company in the past 30 days.
Adobe Inc. (ADBE)
From Canaccord Genuity Research
We have been saying all year that Q4 could be rocky and that investors should allocate more of their portfolio to typically more conservative Growth + Profit stocks. Based on our projections, and supported by last night’s results, Adobe Inc. (ADBE) fits in the former category with a top decile G+FCF Margin sum now set for C19E of 63%. Indeed, ADBE is one of our favorite five stocks.
Even so, we always consider how we could be wrong, because in fact, great investment returns are not built by awesome upside picks, but by avoiding debilitating losses. Where could we be wrong on Adobe?
In the short-run, it is certainly possible that POTUS baiting the Fed could produce the opposite effect, and the Fed could tip us into an inverted yield curve and recession if it lets emotion overcome the agency’s guesswork statistics. Despite the narrative from marketing tech companies, if a recession hits, spending money to convince customers to buy things they’re not going to buy anyway is a waste of money—and that means MarTech companies such as ADBE, CRM, HUBS, and SHOP could feel the pinch.
Beyond macro risks, Adobe has its plate full integrating the half dozen acquisitions it has made, including the $6.5 billion spent to buy Magento and Marketo. Meanwhile, we have yet to meet a management team that tells us that integrating utterly different workflows and data schemas is anything other than just a bit of developmental elbow grease—and unfortunately, that statement is fiction, as even with a building full of the best coders money can buy, it takes at least two years to fully integrate the architecture of a major acquisition (UI/UX is faster, but that is veneer only). While integrating, it is like putting the clutch in on a stick shift car, which is another way of saying that firms that have integrated stacks pull ahead.
We continue to believe that Adobe, working in partnership with Microsoft, will begin to win a greater share of marketing digital transformation bake-offs, but it will be at least 24 months until those wins have the potential to be material.
Circling back to our main point, Adobe remains one of our favorite stocks because the stock is valued at about 1x EV/FCF/G based on normalized earnings growth, the company is exceptionally well-positioned for digital content creation, the marketing effort is quite promising, and management has proven that the firm can integrate material acquisitions. We addressed Adobe’s fundamental risks because we believe it is irresponsible to do otherwise.
Adobe reported total revenue of $2.46B, which was ahead of our estimate by ~$40M and marked 23% y-o-y growth. Non-GAAP EPS of $1.83 came in below our estimate, however non-GAAP EPS excluding the financial impact of Marketo came in above at $1.90. FCF of $3.8B beat our estimates by ~$60M. Digital media ARR ended the quarter at $6.8B, for a sequential increase of $400M, ~$45M ahead of our estimate.
Guidance for FQ1/19 is mixed due to the incorporation of Marketo into the model. Revenue guidance of $2.54B is ~$20M above our initial estimate, while EPS guidance of $1.60 is $0.26 below. By Segment, Digital Media growth expectations are slightly below our estimates while digital experience growth expectations are significantly above, with upside driven by the incorporation of Marketo.
ADBE provided preliminary F2019 financial targets at its Analyst Day on October 15, prior to its acquisition of Marketo. Changes to these targets reflect the acquisition of Marketo and adverse changes in global currency rates since last updated. ADBE now expects total F2019 revenue of $11.15B, with digital media segment revenue up 20% y-o-y and digital experience segment revenue up 34% y-o-y. Digital media ARR is expected to be $1.45B while digital experience annual subscription bookings are expected to be up 25% y-o-y. Non-GAAP EPS is expected to be $7.75.
Our unchanged $290.00 is based on a 27x EV/FCF multiple applied to our updated F2020 estimate of $5.32B plus roughly $1.5B in prospective net cash and assumes ~493M fully diluted shares outstanding. Buy.
Richard Davis, CFA, David Hynes Jr., and Luke Morison, Canaccord Genuity Research, www.canaccordgenuity.com, December 14, 2018