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investment thesis
Adobe Corporation (NASDAQ: ADBE) had an impressive first-quarter performance, but the company’s shares fell as investors lost patience with the company’s efforts to monetize its artificial intelligence products.In this post, I’ll discuss why the company’s AI roadmap Still on track, and why investors should be patient with a company that could still be a major beneficiary of the artificial intelligence revolution. I introduced ADBE before In June 2023, it was given a hold rating.
Adobe first quarter results overview
The company’s first-quarter results were impressive, with ADBE generating record revenue of $5.1 billion, up 11.3% year over year and beating analysts’ expectations of $36.6 million. Non-GAAP earnings per share were $4.48, $0.10 higher than analysts’ expectations. The company also achieved an impressive 16% year-over-year growth in its remaining performance obligations, driven by strong momentum across its Creative Cloud, Document Cloud and Experience Cloud segments.
The company more or less reiterated its guidance for fiscal 2024. In addition, the company now expects second-quarter total revenue of $5.3 billion to $5.3 billion and non-GAAP earnings per share of $4.35 to $4.40. The guidance was lower than analysts’ expectations, which were for revenue of $5.31 billion and earnings of about $4.38 per share. This quarter, the board also authorized $25 billion in new stock repurchases. Lower-than-expected guidance and concerns about the timeline for monetizing artificial intelligence sent shares down nearly 14%.
Adobe is on the right path with artificial intelligence, investors need to be patient
Although the artificial intelligence revolution has brought about a large amount of shareholder wealth creation, it has also made investors extremely impatient. ADBE fell victim to this impatience when it announced that it would take some time to increase monetization of artificial intelligence.
While this extreme impatience should come as no surprise, since it was the irrational exuberance that caused investors to push ADBE’s stock higher in the first place, when one patiently analyzes the company from a long-term perspective, I think: There’s no reason to ring a bell Alarm bell.
First, even without any revenue from ADBE’s artificial intelligence product Firefly, the company easily beat the first-quarter guidance set by management in the fourth quarter of last year, and as I mentioned before, the company also set a record income. Second, residual performance obligations (RPO) grew 16% year-over-year, and the company’s Creative Cloud applications are widely adopted “in every field.”Geographic location and customer base. “ This shows that even without artificial intelligence, the company’s underlying business remains strong and intact.
Additionally, although Firefly does not currently generate any revenue, the AI tool remains extremely popular. According to the earnings call, “Firefly driver tool adoption rate highest in Photoshop in first quarter”, these features are available on a range of devices, including desktop, web and most recently iPad devices. ADBE’s AI products also led to a new record for Creative Cloud commercial subscriptions in the first quarter. Document Cloud also saw strong growth this quarter.
Management now expects the Firefly service and the AI assistant in Acrobat to deliver strong ARR growth in the second half of fiscal 2024. To date, Firefly has generated over $6.5 billion in assets. Additionally, Firefly allows customers to build their own custom models using their own proprietary data sets, which puts it in the same category as CRM’s Einstein Copilot and Oracle’s AI services. With the company planning to launch expanded Firefly service offerings and new AI assistants in the ADBE Experience Platform during the Adobe Summit later this month, the number of AI products that can monetize the company will only continue to grow.
ADBE is slowly making progress in improving the monetization of its artificial intelligence products. That could be a pain in the butt for short-term-focused investors, especially those who drove the stock price higher when the company first launched Firefly. But if you take a broader, longer-term view, then one can clearly see that despite no revenue from artificial intelligence, the company’s business remains strong across all areas. Furthermore, as mentioned in my last article about ADBE, Analysis by Market.us The study found that in the next eight years, generative artificial intelligence in the fashion field is expected to grow at a compound annual growth rate of 36.9%. This is a long-term prediction, not a short-term prediction, which makes the impatience with ADBE’s AI work even more bizarre to me.
Furthermore, the company isn’t just biding its time without taking any action. Behind the scenes, there is a lot of innovation going on. Firefly’s added benefits of increased privacy and trust also suggest there will be demand when it’s ready to monetize the product. Adobe’s AI story has only completed the first few chapters, and I think the best part is yet to come. Therefore, patience is necessary.
The Figma deal termination is unlikely to cause any long-term issues
As mentioned, one of the main reasons the company’s earnings per share took a hit in the first quarter was a $1 billion termination charge due to the company’s failure to complete its acquisition of Figma.
December 2023, ADBE finally cancels $20 billion acquisition plan Figma announced its exit after European regulators blocked the deal. Figma’s design software has become More popular than ADBE’s XD app The acquisition is seen as the right move for the company to once again seize control of the sector.However, regulators are now becoming more stringent and scrutinizing more heavily than ever before due to concerns about mergers creating monopolies (just ask Microsoft and Activision), the acquisition was viewed as a strategy to stifle competition rather than innovate.
In a way, this termination is a blessing in disguise. For a company with fiscal 2023 revenue of $6.9 billion and cash and cash equivalents of $7.84 billion, the decision to pay $20 billion for an acquisition seems odd to me. Additionally, ADBE plans to fund 50% of the acquisition in cash, which means it will have to take on more debt. ADBE currently has $3.65 billion in long-term debt, which is reasonable, according to LSEG Workspace (formerly Refinitiv). The acquisition of Figma would increase these debt levels. Additionally, the company announced a new $25 billion buyback program during its earnings call. Acquiring Figma would make future buybacks for the company, such as the recent one, quite difficult.
ADBE doesn’t need Figma for its long-term growth, especially since its AI roadmap is on the right path. and, Figma makes nearly $600 The ARR for fiscal year 2023 is $1.91 billion, and ADBE’s digital media division has an ARR of $1.91 billion for the same period, so ADBE does not urgently need Figma. So, all things considered, the $1 billion termination fee appears to be a short-term blip and less likely to cause ADBE any trouble than paying $20 billion.
Valuation
|
forward price to earnings ratio method |
|
|
price target |
$561.00 |
|
Estimated forward price-to-earnings multiple |
$27.5x |
|
PEG ratio (NTM) |
1.89 |
|
Expected earnings growth |
14.5% |
|
Estimated FY25 EPS |
$20.38 |
Source: Company’s first-quarter earnings, Refinitiv, Seeking Alpha, and author’s calculations
Management more or less reiterated its fiscal 2024 EPS target range of $17.60 to $18.00 on the earnings call. Although the company beat its first-quarter EPS target, the cancellation of the termination fee paid for the Figma acquisition had a negative impact on EPS of $2.19. As a result, management also saw the impact of the termination fee on full-year earnings per share. So, given all these numbers, I’m assuming FY24 EPS of $17.8, the midpoint of management’s guidance.
The company currently trades at a forward price-to-earnings ratio of 27.5 times, making it cheaper than some peers such as Autodesk (30.95 times) and Salesforce (30 times), according to data from LSEG Workspace (formerly Refinitiv). Furthermore, the stock is cheap even relative to its trailing P/E ratio of 32 times. Therefore, I assume in my calculations that the company has a forward P/E of 27.5x. This estimate is slightly lower than the estimate I used the last time I wrote about ADBE (28.2x). Given that AI monetization is only expected to accelerate in the second half of this year, I think the lower multiple is a reasonable estimate.
According to data from Seeking Alpha, the company currently trades at a forward PEG ratio of 1.89x, below its 5-year average of 2.27. While it will still take time for the company’s AI products to have an impact on the bottom line, I still believe the company could be a major beneficiary of AI. Therefore, I’m assuming a current PEG ratio of 1.89 because I do believe the company will deliver strong earnings growth. A forward P/E ratio of 27.5x and a PEG ratio of 1.89 would result in an EPS growth rate of 14.5%. This results in fiscal 2025 earnings per share of $20.38.
The forward price-to-earnings ratio is 27.5x, earnings per share are $20.38, and the price target is $561, which implies an upside of about 12% from current levels.
Additionally, the stock has some near-term catalysts that could push the price higher. Later this week, the company will host the Adobe Summit, which will also include an investor meeting. Any positive developments from the summit could push prices higher.
risk factors
One of the main risk factors for ADBE is OpenAI’s video generator Sora. Despite its limitations and ethical concerns, and the fact that it will only launch later this year, reviews of the tool have been glowing, TechRadar thinks it has huge sci-fi potential. When asked, ADBE management was quick to identify Sora as a major threat, with CEO Shantanu Narayen arguing: “To truly take advantage of generative AI, online video will increasingly need editing applications. “ Whether he’s right or wrong, only time will tell, but Sora’s launch is certainly a risk that investors should consider.
There is always a risk that monetization of the company’s AI products may not proceed as planned. This will be a significant blow to the company’s future growth, and while I’m bullish on ADBE’s AI roadmap, it’s definitely a risk that investors need to consider.
concluding thoughts
ADBE shares fell nearly 14% as investors lost patience as monetization of the company’s artificial intelligence products was slower than expected. I’m very confused by this reaction because it seems to me that if one takes a long-term view, one sees that this is a company where the underlying business is still strong and the AI roadmap is actually on the right path , privacy has also been enhanced. Related to the company’s artificial intelligence tools are expected to spur demand once the company is ready to monetize it.
Furthermore, ending the Figma acquisition might actually be a good thing in the long run. The fact that ADBE doesn’t need Figma to grow, and investors avoided a $20 billion loss that would have raised the company’s debt levels and hampered its buyback strategy, is something to cheer about. The company ultimately looks attractive from a valuation perspective, and I think the stock’s recent weakness provides an excellent buying opportunity. ADBE’s artificial intelligence story has only just begun, so it’s time to be patient, not panic.
