Adobe Aims At 22% EPS Growth From Markets Worth $147 Billion
As an Adobe ADBE investor, I am not thrilled that its shares trade nearly 10% below their peak — especially after a third quarter earnings report that beat expectations and raised guidance.
I see three reasons its stock could rise. Adobe
- Targets large fast-growing markets
- Is judged to be an industry leader
- Has strengths that should enable it to keep growing fast
Third Quarter Results Beat And Raise
Adobe has a track record of beating expectations and raising guidance. As I wrote in April, that’s what it did in the first quarter of 2021 during which its revenue rose 26% to $3.91 billion and it forecast 2021 growth of 20% to $15.45 billion.
As CEO Shantanu Narayen said then, “Adobe drove record Q1 revenue and we are raising our annual targets based on the tremendous opportunity across our business and our continued confidence in our global execution.”
On September 22, Adobe beat and raised when it reported third quarter results. As Investor’s Business Daily reported, Adobe sales in the third quarter rose 22% to $3.94 billion — $50 million more than analysts expected while earnings rose 21%.
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What’s more, Adobe raised its forecast for the fiscal fourth quarter. The company estimated that revenues would rise 20% to $4.07 billion — $30 million more than analysts modeled while Adobe expects earnings per share to rise 22% to $3.18 — 10 cents a share higher than the consensus.
Yet its stock fell 3.1% in the wake of the report and by October 15, Adobe traded 5.6% below its price the day before its third quarter earnings report.
Investors dumped its shares because Adobe did not grow as quickly in two of its business units as analysts had expected. How so? The company “missed expectations for annual recurring revenue in its core Digital Media business and experienced more adverse seasonality than expected in its Creative Cloud business last quarter,” reported IBD.
Targets Large, Fast-Growing Markets
Has Adobe peaked out? It is targeting very large and rapidly growing market opportunities.
Adobe has three cloud computing businesses. Its largest, Creative Cloud, includes software for creative professionals such as Photoshop and Illustrator. Document Cloud includes its Acrobat and e-signature offerings. Experience Cloud provides marketing software and services.
These business target markets that Adobe expects to be worth $147 billion by 2023. The Creative Cloud targets a total addressable market (TAM) expected to grow at a 32% annual rate to $41 billion by 2023, according to an Adobe Financial Analyst Meeting Presentation. Document Cloud’s TAM is sprinting at a 62% annual rate to $21 billion by 2023 and Experience Cloud’s TAM is increasing at a 15% annual rate to $85 billion by 2023.
These cloud businesses are benefiting from strong tailwinds that keep propelling their growth.
The Creative Cloud is driven by the proliferation of story telling. As Anil Chakravarthy, Adobe Executive Vice President and General Manager, Digital Experience Business and Worldwide Field Operations, told me in an October 11 interview, “As the leader of the field organization that sells all three products, I see what is driving growth. Content is growing constantly because everyone — individuals and business communicators — has a story to tell and new media makes it possible. This is what drives Creative Cloud.”
Adobe’s Document Cloud grows because people who use paper are still making the transition to the digital economy. As he said, “Mortgages, health care claims, and many government forms are still paper-based. The Document Cloud is helping them make the transition to digital. It is hard to quantify how much of our potential market has made the transition to digital; but one of our customers tracks the number of faxes it receives — they still get hundreds of millions a year.”
Adobe’s Experience Cloud aims to enable its business customers to sell at a price premium. How so? Companies are increasingly trying to match the high quality customer experience provided by companies like Amazon.
As Chakravarthy explained, “Every company — whether BTB or BTC — aspires to provide customers with a good digital experience. If you can’t differentiate yourself through a better customer experience, you can’t charge a price premium. We offer tools that enable businesses to deliver the right digital experience — using data to [optimize] an operating model of discover, try, buy, use, and renew.”
Judged an Industry Leader
While I have been unable to find data on Adobe’s market share and rank in its three lines of business, analysts deem Adobe to be an industry leader.
For example, Forrester FORR dubs Adobe a leader in digital experience platforms, enterprise marketing software, and digital asset management for customer experience. Gartner IT picked Adobe as a leader in digital commerce, marketing automation, and ad tech.
In my book, Disciplined Growth Strategies, I discussed how companies become market leaders and stay there. The short answer is they do two things:
- Outdo rivals in satisfying customer purchase criteria (CPC)
- Operate capabilities needed to provide customers consistent, superior value
Adobe has keen insight into the CPC of its Experience Cloud customers. As Chakravarthy explained, “[Customers choose among competing vendors based on who has] the needed product capabilities, how well integrated they are. whether the company will be a good long-term partner, and [which vendor has the most favorable] total cost of ownership and return on investment (ROI).”
Customers measure the Experience Cloud’s ROI concretely. As he said, they assess whether it helps them boost revenue, retain customers, enhance loyalty — as measured by the net promoter score, and lower their service costs.
Wells Fargo WFC Securities analyst Michael Turrin is optimistic about Adobe’s future. He wrote, “We view Adobe as one of the crown jewels of software” due to its solid positioning as the “de facto toolkit for creatives” and [it benefits from] tailwinds tied to digital experiences,” reported IBD.
Capabilities Should Keep Adobe Growing Fast
Adobe also has the capabilities needed to compete in its current markets and to create new growth opportunities.
According to Chaktavarthy, Adobe satisfies the CPC of its Experience Cloud customers by deploying product features including
- A content management system that provides product information through a website and a mobile app
- A digital storefront that enables companies to sell goods and services to consumers and businesses
- A customer experience system that tracks how users interact with the company
- Software to manage an omnichannel customer journey — through email, the web, mobile apps, or call centers; and
- Automated processes to manage workflow
Adobe’s long-term success depends on its ability to reinvent itself. Narayan — who has been CEO since 2007 — has presided over the increase in Adobe’s market capitalization from $24 billion to $276 billion, according to the Economist.
Early in his tenure, Narayen realized that with the rising popularity of smartphones and the cloud, Adobe should reinvent itself. As he told the Economist, “Software follows a sort of S curve: performance eventually moves sideways if you do not invest in the right opportunities.”
Adobe has done this through what strike me as unique approaches to product innovation and leadership style.
Adobe uses what it calls a data-driven operating model which gets feedback on how customers are using its digital services and harnesses the resulting insights to improve its products, the Economist reported.
In addition, Narayan manages differently. Rather than telling his direct reports exactly what to do, he sets a specific performance goal and leaves it to leaders of the three clouds to figure out how to hit the targets he sets.
For example, Narayan set a goal that “Adobe’s data platform must be able to serve up content in less than one-tenth of a second.” He challenged Adobe’s engineers to achieve that target, the Economist reported.
I think this approach works well because it blends Narayan’s insights into the specific performance levels that will delight Adobe’s customers while inspiring his engineers’ technical creativity.
In the last decade, Adobe stock has risen at a 36.5% compound annual rate — exceeding the S&P 500’s 13.8%. I am holding on to Adobe stock because I think it will continue to outperform over the long term.