Cloud Magic – ADBE

by Dan March 24, 2017 9:28 am • FREE ACCESS

Last week, the cloud software provider Adobe Systems (ADBE) reported better than expected results and guidance, per Barron’s Online:

Revenue in the three months ended in February rose 12%, year over year, to $1.68 billion, yielding EPS of 94 cents, excluding some costs. Analysts had ben modeling $1.645 billion in revenue and 87 cents per share in earnings. Adobe said its “annualized recurring revenue” was 4.25 billion, which it said rose by $265 million from the prior quarter.

CFO Mark Garrett said that “solid execution and business momentum combined with strong market tailwinds” had given the company “confidence in our ability to continue to deliver strong financial results.”

“We remain bullish about our prospects for the rest of 2017 and beyond.”

“Outlook for this quarter is for revenue of “approximately $1.73 billion,” and EPS of “approximately 94 cents.” That compares to consensus for $1.71 billion and 91 cents.

In the after market the stock was trading up nearly 7%, closed the next day up 4% and nearly filled in the entire earnings gap:

Bloomberg

Pretty impressive price action for a stock that is up 23% year to date, and 40% from its post-Brexit 52-week lows made in late June, especially when you consider the stock trades 31x expected 2017 eps and nearly 9x sales.  But valuation for growth stocks, especially ones that have been in a multi-year business model change to catch a fast moving secular shift in their industry, are more of an art than a science, from my ADBE earnings preview on March 16th:

The stock trades 32x expected EPS growth of 26% in 2017, and 25x expected 2018 eps growth of about the same. It all seems fairly reasonable when you consider current consensus is calling for 20% sales growth in 2017 and 2018. While its multiple to sales is hefty for a company expecting to book $7 billion in sales, I would add that there are very few large cap tech companies growing sales at 20% off of that sort of base. For instance, SalesForce.com (CRM) grew sales 26% last year to $8.4 billion, with GAAP eps of only 26 cents, vs ADBE’s eps of $2.32 on $5.85 billion. Not all SaaS company’s profitability are created equal! If we were playing would you rather, I think it’s fairly clear that ADBE is a better bet on valuation, relative to growth and profitability.

But for now, despite PE to Growth that is attractive, and obviously relative valuation, ADBE shares are priced to perfection, with fairly bullish sentiment.

About that secular shift, back in 2012 and 2013, ADBE moved away from selling licenses to some of their most popular software applications and started selling seats, here for an example from May 2013 on their Creative Cloud:

Adobe also announced that the company will focus creative software development efforts on its Creative Cloud offering moving forward. While Adobe Creative Suite® 6 products will continue to be supported and available for purchase, the company has no plans for future releases of Creative Suite or other CS products. Focusing development on Creative Cloud will not only accelerate the rate at which Adobe can innovate but also broaden the type of innovation the company can offer the creative community.

Sales and earnings from Licensing desktop software was slowing, and the push towards recurring revenues from selling seats to cloud-based apps and services appeared to be an obvious play to refocus investors on potential growth of the new business model in a rapidly changing computing landscape.

It didn’t take long for investors to get the memo after the stock languished between the mid $20s and high $30s for the better part of 2010 through 2012, the stock started to take off in early 2013:

Bloomberg

And look at EPS, 2013 saw a massive hit, down 42% in 2013 and 4% in 2014 with the model change, and then off to the races off of a much smaller base, with the company posting record eps in 2016, with a 30% surge expected in 2017:

Bloomberg

And sales, fairly similar, I think it is safe to say there are not too many other companies the world over with trailing 12-month sales of $6 billion (that is wildly profitable) that are expected to grow 22% for the second consecutive year:

Bloomberg

This morning Credit Suisse’s Software analyst upgraded shares of ADBE to a Buy from Neutral with a $150 12 month price target, you guessed it, on “momentum in Creative Cloud”, per Bloomberg:

Says growth in the highly profitable creative cloud business will lead to stronger than expected cash flows
Expects investors to increasingly gravitate towards software vendors with strong growth and cash flow profiles
Nemeroff attended Adobe’s Summit Digital Marketing conference this week and says it highlighted ADBE’s large breadth of digital marketing solutions

For a business and computing shift that was identified years ago by many in both the computing and financial worlds, I’d say it makes a little sense to views today’s upgrade as new news. This is not a knock on the analyst, there were plenty in the last few years to upgrade ADBE at an all-time high after a strong report, who have been very right, this guy may also be in the months to come, my point here is that there is nothing fundamental about an upgrade and price target raise.  Maybe the most important takeaway is that some trees really can grow to the clouds.