Here's a deep dive into Adobe Inc (NASDAQ: ADBE) business.
Here at MoneyWiseSmart, we did a deep dive into Adobe, and this full comprehensive report is part of our Multibagger Research Series.
The research report spans numerous pages and includes the following topics and more:
Business Overview and Competitive Advantages
Financial Summary
Management Team
Growth Prospects
Risks
Valuation
The full report is only available to our Multibagger Research Series subscribers, but we are releasing a free preview for everyone’s benefit as below. If you wish to subscribe to our Multibagger Research Series for the full report, do check out the details at the end of this blog post.
Part 1: Business Overview
Introduction
Adobe Inc (NASDAQ: ADBE) was founded in 1982 and is one of the world’s largest and most diversified software companies, providing products and services used by creative professionals, communicators, and consumers worldwide.
Almost every one of us would’ve used Adobe’s products, especially Adobe Acrobat Reader, to open a document in the Portable Document Format (PDF) format, an evolution of its original product, PostScript.
In fact, this report you are reading right now is also saved in PDF format.
Apart from Adobe Acrobat Reader, other famous products under its stable include Photoshop, Illustrator and Premiere Pro.
Photoshop is the world’s most advanced digital imaging and design app, which features powerful editing and effects tools to transform photos.
Adobe Illustrator is an industry-standard vector graphics app used by designers of all types who want to create digital graphics and illustrations for all kinds of media.
Adobe Premiere Pro is a top video editing app used by filmmakers, TV editors, YouTubers and videographers.
Source: Adobe website
Adobe’s products run on desktop and laptop computers, smartphones, tablets, other devices and the web, depending on the product.
And the company has operations in many parts of the world, such as the United States, Europe, the Middle East, Africa, and the Asia Pacific.
Business Model
Next, let’s explore Adobe’s business further and how it makes money.
Adobe offers many of its products via the software-as-a-service (SaaS) model or a managed services model (both of which are referred to as hosted or cloud-based), as well as through term subscription and pay-per-use models.
It licences its products to end-users through app stores and its own website.
For those who may not know, SaaS is an online software distribution model where a third-party provider hosts applications for customers.
For that service, the customer pays a subscription cost on an ongoing basis, and the upfront cost is much lower than with the traditional software model where users purchase a perpetual licence to the software that costs much more.
The advantage of having a SaaS business model for companies is that there’s a recurring revenue element and companies are better able to predict their future sales.
Adobe transitioned into the subscription business model in 2012, where it moved away from selling its products through physical, shrink-wrapped products to be deployed at customers’ sites under a perpetual license – where customers pay once and can use the software indefinitely (more on that later under the “Management Team” section).
Adobe also distributes certain products and services through a network of distributors, value-added resellers (VARs), systems integrators (SIs), independent software vendors (ISVs), retailers, software developers and original equipment manufacturers (OEMs).
In addition, the company also licenses its technology to hardware manufacturers, software developers and service providers for use in their products and solutions.
Business Segments
Adobe’s business is organised into three reportable segments:
• Digital Media;
• Digital Experience; and
• Publishing and Advertising.
Under Adobe’s Digital Media segment, it provides products, services and solutions that enable individuals, teams and enterprises to create, publish and promote their content anywhere and accelerate their productivity by modernising how they view, share, engage with and collaborate on documents and creative content.
Adobe’s Digital Media segment is centred around Adobe Creative Cloud and Adobe Document Cloud, including products such as Creative Cloud Express, Photoshop, Illustrator, Lightroom, Premiere Pro, Acrobat, and Adobe Sign.
This is the core of what Adobe has delivered to users for decades, and it has continually evolved and expanded its business model to provide customers with a range of flexible solutions.
Source: Adobe financial analyst meeting presentation
Source: Adobe financial analyst meeting presentation
Under its Digital Experience segment, Adobe provides an integrated platform and set of applications and services through Adobe Experience Cloud to enable brands and businesses to create, manage, execute, measure, monetise and optimise customer experiences that span from analytics to commerce.
The foundation of its offering is Adobe Experience Platform. It provides businesses and brands with an open and extensible system for customer experience management that transforms customer data into robust customer profiles that update in real-time and uses insights driven by artificial intelligence (AI) to enable the delivery of personalised digital experiences across various channels.
Source: Adobe investor datasheet
Adobe’s legacy products and solutions are contained within the third segment of Publishing and Advertising.
Source: Adobe investor datasheet
Most of Adobe’s revenue is from its subscription or SaaS business, as seen from the table below for its fiscal year 2021 (FY2021) ended 3 December 2021:
Adobe’s subscription revenue consists mainly of fees it charges for its subscription and hosted service offerings and related support.
The company mainly recognises subscription revenue over time according to the term of agreements with its customers, beginning with the commencement of service. More specifically, subscription revenue related to certain offerings (where fees are based on a number of transactions and invoicing is aligned to the pattern of performance, customer benefit and consumption) are recognised on a usage basis.
Here’s a breakdown of Adobe’s largest chunk of revenue, Subscription, for FY2021:
We can see that almost 99% of Adobe’s subscription revenue comes from Digital Media and Digital Experience.
Next, let’s take a look at Adobe’s business segment revenue breakdown for FY2021:
Under Adobe’s Digital Media segment, majority of its revenue – at around 83% – came from Creative Cloud while the remaining 17% came from Document Cloud.
In terms of geography, this is how Adobe’s revenue breakdown looked like for FY2021:
Americas (consisting mainly of the United States) contributes to the bulk of Adobe’s business, followed by Europe, Middle East and Africa (EMEA), and Asia-Pacific (APAC).
Competitive Advantage
Premium content that includes details of Adobe’s competitive advantages to fend off its competitors.
Part 2: Financials
Premium content that analyses Adobe’s financial performance.
Part 3: Management Team
Management Team
Adobe was co-founded by Dr John Warnock and Dr Charles Geschke in 1982. Their aim was to build a company where they would like to work, and that would deliver better results than its competitors while maintaining a strong corporate culture.
True to what they set out to do, Adobe is widely recognised as being a great place to work while at the same time creating industry-leading products and a business with broad-based innovation and strong financials.
(On a side note: Warnock continues to serve on Adobe’s board of directors, but Geschke passed away in April 2021, leaving behind a legacy.)
Fast forward to 40 years later, Adobe is still one of the best companies to work for. Out of the 7,400 reviews of Adobe on Glassdoor, 91% will recommend the company to a friend, and 96% approve of Adobe’s chief executive officer (CEO), Shantanu Narayen, who’s 58 years young. Overall, the company received 4.4 stars out of five, which is highly commendable.
Source: Glassdoor
Adobe’s leader was also ranked second in Glassdoor’s Top CEOs for 2021, with a 99% approval rating.
Source: Glassdoor
Shantanu Narayen joined Adobe in 1998 as vice president and general manager of its engineering technology group. He then became president and chief operating officer (COO) in 2005, CEO in 2007 and chairman of the board in 2017.
As Adobe’s CEO, Shantanu transformed the company into an industry leader by pioneering a cloud-based SaaS model for its Creative Suite (which housed Photoshop and other products) back in 2012, establishing the global standard for digital documents and creating and leading the explosive Digital Experience category.
In its fiscal year 2011 annual report, Adobe explained how the transition to a subscription-based model would help propel its business (emphases are ours):
“Our Creative Cloud offering, marketed as a subscription model with attractive monthly pricing, is expected to be available in 2012 and we believe it will be a catalyst for revenue growth in the coming years. By increasing the value we provide to our core creative customers with Creative Cloud services, we anticipate we can grow our revenue per customer over time as they begin to use additional features available to them in the offering. We also believe the monthly pricing model will be attractive to users of older versions of our products who desire to use our latest releases and services, but who have not been willing to upgrade to newer versions due to their price sensitivity, and, therefore, will increase our revenue potential with them. Similarly, we anticipate we can drive significant new user adoption for our creative tools business over the next several years in markets outside of our core creative professional targeted market because of the attractive monthly subscription pricing combined with the strong brand of our creative tools and the broad value proposition that our Creative Cloud offering will provide.”
As predicted by Adobe, in an interview with McKinsey in 2015, its ex-chief financial officer Mark Garrett and its ex-vice president of corporate strategy Dan Cohen said that the move to the cloud was paying off, explaining:
“Our research showed that we were bringing in a lot of new users under the subscription model, which addressed one of the problems we had been facing—growing the base. Meanwhile, many existing users told us they would not have upgraded without the subscription offering."
The move by Adobe to a subscription-based business model, albeit painful in the short term, was a great decision over the long run.
So Adobe, under Shantanu Narayen’s guidance, has done really well in terms of execution and transformation into the SaaS space.
With regard to stock ownership, Narayen owns less than 1% of Adobe’s stock. While we prefer the CEOs of companies to have high insider ownership to have skin in the game, it’s typical for non-founders to have little share ownership in the company they are managing.
Other senior executives worth mentioning are Daniel Dunn (Adobe’s chief financial officer or CFO), Anil Chakravathy (president of Adobe’s Digital Experience business), and David Wadhwani (president of Adobe’s Digital Media business).
To understand more about the breadth and depth on Adobe’s executive bench, it’s worthwhile watching the question-and-answer session at Adobe’s Virtual Financial Analyst Meeting that happened on 16 December 2021. Daniel Dunn, who joined Adobe in October 2021, especially stood out for us for knowing the financial intricacies of Adobe’s business at his fingertips. As a CFO, he’s also responsible for the company’s capital allocation decisions, which is something we heavily scrutinise.
Compensation Structure
Adobe has a pay-for-performance policy for its executives’ total compensation.
For instance, around 92% of its CEO’s total compensation in FY2021 was made up of equity awards.
A large portion (70%) of these awards are based on Adobe’s relative total shareholder return (compared against the companies in the Nasdaq 100 Index) measured over a three-year performance period (although we would prefer a longer time frame of five years and beyond) issued under its 2021 Performance Share Program.
The balance of equity value is granted as time-based restricted stock units (RSUs) that vest over a four-year vesting schedule.
The following table shows the compensation of key executives of Adobe for FY2021:
Source: Adobe 2022 proxy statement
In FY2021, Shantanu Narayen earned a total compensation of US$36.1 million, which was just 0.2% of Adobe’s total revenue for the year.
Adding up the compensation of the other key executive officers, as shown above, the amount comes up to less than 1% of FY2021 total revenue.
Adobe updated its 2022 Performance Share Program to include performance based on a new financial metric called the net new sales, which combines the Digital Media segment’s net new annual recurring revenue (ARR) and subscription revenue growth in Digital Experience, over three one-year periods.
Adobe said that adding the net new sales metric will help ensure its key executive officers’ financial incentives align with its strategic priorities and continued growth.
Part 4: Growth
Premium content that looks at Adobe’s growth prospects.
Part 5: Risks and Valuation
Risks
Premium content that discusses Adobe’s risks.
Valuation
Premium content that analyses Adobe’s capital requirements and valuation.
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