On Wall Street, growth and value are anything but joined at the hip. Stocks are typically split into two groups: growth and value. When a growth stock gets hammered down, it becomes a “real bargain” growth stock; when a value stock drops in price, it is a “better value” at the lower price.
So, is Adobe a real bargain, a better value, or a pass?
With 80% market share and a new word in our vocabulary (“googled”), it is safe to say that Google is the internet. I can’t remember the last time I met someone who didn’t know what Google was.
Such is the case with Adobe. Even if you don’t know the company’s name or product line, you have seen and/or used their stuff. You probably have Adobe® Reader® to view and interact with PDF documents. If you’ve ever visited YouTube (e.g., to watch Rick Santelli yelling at Jim Cramer), you’ve seen Adobe® Flash® because you, like 99% of all internet users, have the Flash plugin in your browser.
Adobe equals Design
Photoshop and Illustrator are the standards for photo editing, and hence web image design (pictures don’t get doctored, they are “photoshopped”); Dreamweaver is the standard for drag-and-drop web design; After Effects is the movie-editing tool of choice for web developers and is used in Hollywood for both traditional and animated movies (watch the credits for “After Effects editor”); Acrobat is the tool of choice for creating portable business documents. The list goes on and on.
Suffice it to say, Adobe has a very durable and competitive moat. One of the truly amazing things about this moat is that developers have crossed the moat, and yet their products never truly compete because every non-Adobe design/animation software is seen as a poor man’s fix. (This doesn’t include super high-end, specific software used in video games or movies. Adobe owns the personal and casual market and have decent market share in the super-niche market as well.)
It’s practically an ATM
Adobe generates cash. It’s tough to figure out how much cash it will generate simply because the gigantic Macromedia acquisition from a few years back is still working its way through the financials. Still, Adobe generated about $980 million in owner earnings last year, up from $580 and $540 million in 2006 and 2005, respectively.
When a new Adobe product comes out, people want it – and they pony up the cash. After all, you aren’t going to get an FWA award without After Effects video work or some stunning Photoshop design thrown into Flash.
It is financially sound (some other ratios to look at)
For every dollar of tangible long-term assets, Adobe has just $0.36 of long-term liabilities(1) . The company has no long-term debt (could be good or bad, but “none” is better than “too much”) (2) and generated 21% owner earnings on its equity last year(3).
What does all this mean?
- Management is doing a great job of managing the balance sheet and helping secure our claim in the company;
- If management doesn’t believe that additional debt will fuel growth, it shouldn’t assume any. In Adobe’s case, this “growth” company seems to realize that rapid growth doesn’t have to be highly leveraged.
- The company is utilizing assets well and seems to be well positioned (and durable) should it experience some difficulties.
Price versus Value; Growth versus Value
Though Adobe is typically considered a growth stock, its financial position, dominance, and ability to generate dependable (and perhaps predictable) excess cash makes it look more like a value stock. Of course, why buy “value” stocks if you don’t expect them to grow, and why buy “growth” stocks if their businesses have no value? Buffett said it best:
Growth and value investing are joined at the hip.
Right now, some kids are banging away at computer code, trying to become the next Google. In 10 years, Google went from nobody to leader. Who will be the leader in another 10? But Adobe? This is one of those rare technology companies that have such a durable and broad moat that any competition is going to have to be extremely well funded and large, and will have to survive many years of losses during the software development stages, all while trying to keep up with Adobe’s products, innovations, and possible buy-out attempts.
You can run through the price on your own (see How to Value a Business), but I come up with a value around $44 a share. I was extremely conservative (in my mind, at least) by using a 14% growth rate for 3 years, followed by 12% for 3, followed by 10% for the next 4. And so, throughout 2007, Adobe traded right around its intrinsic value. As the markets tumbled, so did Adobe, and now it appears to be about 25% underpriced.
Is it a steal? Personally, I know the company well and I think my assumptions are on the conservative side. As Buffett said,
It is far better to buy a wonderful business at a fair price than a fair business at a wonderful price.
I’d be happy to buy Adobe today and hang on to it for the long term. Any mistake I made in my valuation will likely work itself out in my margin of safety and through the company’s aggressive stock buyback program. (If I made a valuation mistake and the company was constantly increasing its outstanding shares, I’d be up a certain creek without a paddle.)
Sound business. Largely insulated. Fair price. What are your thoughs?
Sorry for the late post
And I’m sorry for the late post. Today’s snow storm slowed or completely paralyzed the city and knocked me offline for the entire morning.
(Before you load up on Adobe, take a look at this post.)
Filed under: Companies Analyzed (Generals)
Related Stocks: ADBE
The problem I see with Adobe is the inability I have to predict where the company will be in a few years. If I can’t do that, I can’t (personally) come up with any reasonable estimate as to its intrinsic value.
15% per year growth sounds great, but you have to have confidence that Adobe will continue to hold and grow its market share. I don’t have that confidence and i know that simply being ubiquitous (and well know) does not translate into earnings.
Granted, they have a lot of things going for them…They have Adobe Reader which is impressive because there are many free ways to view PDF’s (and pdf support is built into the Mac). So I am impressed at the stickiness of this product – Photoshop and Flash are industry norms (along with other products in their software suite). With the recent acquisition of buzzword they have also entered what seems like the online office race with MS, Google, etc.
Their business model is envious, like most ‘knowledge’ companies, they can make a product once and sell it (or license it) as many times as they want with little incremental costs to the company. Sales growth requires little incremental capital and they generate lots of cash flow. All of these benefits also serve to encourage competition. Youtube came from nowhere (well a garage i suppose) and grew into a billion dollar idea in less than a year — part of the reason this was possible is that start up costs for a lot of knowledge companies are pretty close to zero.
Before google hit the scene altavista was the main search engine and in a few years google not only overtook them but made them obsolete. Now they are one of the largest companies in the world. Car companies started out with a bang in the early 1900’s when it was new and novel. In a rather short period of time cars became ubiquitous and industry profitability started to go down (few people predicted this in advance).
Your right, Buffett said, “It is far better to buy a wonderful business at a fair price than a fair business at a wonderful price.” But you have to remember, especially when quoting him, Buffett knows millions of people analyze every word he says so he is careful with what he says. Often there is a disconnect between what he says and what he does (he’s still buying and selling derivatives despite calling them financial weapons of mass destruction).
Buffett has made few investments in technology companies because he cannot predict what the company will look like in 5-10 years.
Cheers,
NFI
http://www.noisefreeinvesting.com/blog/
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I have been on this blog for sometime, and really have found it a wonderful learning experience, and want to real thank Joe and everyone for taking the time to explain and give great advice and commentary to ideas shown here especially to novices such as me. Please don’t let this end.
For once, here is a subject I know well, Adobe is very much part of my working life, as a designer and developer I can feel I can add a little to this discussion. These of course are mainly my opinions and are just observations I have had in my industry. Adobe, is huge in design, even if I choose to use another piece of software, the odds are that my friends or clients output will at somepoint have to live inside an Adobe tool. So things like native formats are important, especially when you might have to reporduce assets in another tool otherwise.
I see this as a huge barrier to resistance to change, not to mention the moat value designers place on Adobe is strong. Just look at any design studio and ask why they use Apple macs, when the PC alternative is equal to any Mac and exceeds on price. Cool is Cool. And PC’s are just not cool.
Additionally I have noticed very much recently that Adobe is in fact looking to target the online application space with thier AIR concept. Now as a designer developer I have been recently using Microsoft’s Expression Suite very much aimed at developers more than designers, and I can say I honestly miss Adobe products on the design side, Microsoft at this point just doesn’t get design and worflow. However of course Microsoft is “development” so they need to push harder on the design to get the winning formulae.
Certainly Silverlight is a fair competitor to Flash. Winning hearts and minds is the challenge on Microsoft right now. On the otherhand,however, Adobe isn’t development orientated, actionscipt and Flash are not true development it is dwafed by .NET a platform plus the size, influence and power of Microsoft in this space. So in summary from my point of view, Adobe is design to designers the World over the way Nike is Sports. However, no one is infallible and all it takes is someone like Microsoft to upset the apple cart to change things. I personnally do not believe such a company can over throw Adobe for a long time, just because of loyality to the tools Adobe has, however if clients start asking for alot of heavy code behind the scenes then something like Silverlight looks very promising. Of course worst case for Adobe is to support a new format into their existing technology.
Anyhow just my two cents I am certainly very interested in Adobe, they have a huge strong hold, but I do believe they will not hold this position indefinately. MY big watch signs of things changing will be when clients start asking for something other than Flash, for their Online/Desktop presence……
Thanks for listening
Stuart
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Interestingly enough, in this same position I believe Autodesk(ADSK) lives. They have a huge moat, owning 3D Max, and Maya, used for Game and Movie 3D design(Most major Blockbusters have used their software), there are other 3D apps but few people use them in high end design. Not to mention Autodesk owns AutoCAD an Architectural Standard. I wonder if any one on this forum has any view on this company also, which I have had my eye on for about the samer time as Adobe. They too are trading low right now to my calculation.
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The PDF format has no moat, especially if things go the way of ODF or some other open document format.
Their photo editing s the best. It truly is amazingly good stuff.
Flash can be replaced any time over the next 5 years. I’d go as far as to say that it will be replaced.
What I’m getting at is that it is obvious that 2 of the 3 areas mentioned have no moat. And the Photoshop moat is even questionable.
While the numbers are good, I always have to think of moat and Adobe doesn’t have it. When it comes to technology, it is always easy to punch holes in products when moat is brought up as a topic. The fact is that hte only thing with a barrier is the photo editing software.
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I don’t know about anyone else, but I see one common theme in the comments: uncertainty. Will Adobe hang on to its moat? Will it continue to be the dominant company?
That’s precisely why I’m not super-excited even though the business appears to be at a slight discount.
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Adobe generated about $980 million in owner earnings last year, up from $580 and $540 million in 2006 and 2005, respectively.
Joe – are these your own calculations, or are these figures published somewhere? How do your owners earnings estimates relate to the free cash flow values as published on the Morningstar financial screens?
http://quicktake.morningstar.com/StockNet/cashflow10.aspx?Country=USA&Symbol=ADBE
As always, thanks!
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Free cash flow is a guide to determining whether or not the business is consistent. It is the starting point for many valuations and can often be used as the “future cash” component of the valuation.
For a company like Adobe (or any other company that issues a ton of stock options), where $150 million was expensed in stock options, you should go to the cash flow reports and back out any “non-negligible” charges that might affect the valuation.
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Nelson wrote in his post “Adobe being a niche player maybe a target”. In my mind, and humble opinion, the answer is fairly simple and reasonably obvious. Just ask yourself Nelson, if you were the CEO of a successful corporation and had a mountain of earned cash to invest (remembering that shareholders need to be both entertained and financially satisfied) and given all of the possible investment options available to you (something tells me you will not be putting all your hard earned dollars into bonds), would you be considering the acquistion of Adobe? If it were me, I would. Perhaps such an acquisition would be based on savvy business reasons. Perhaps , simply because as CEO of a successful corporation I have the resources available and wield enough influence to indulge my own greed and desire for more power. Ever since Joe mentioned the strength of Adobe (cash flow, moat) to me several months ago, my personal instinct is that Adobe is an attractive target. Do I jump in now? Do I wait until Adobe is in play? Decisions, decisions. My own evaluation of Adobe suggests an intrinsic value of around $35/share and although we are below that level now and it justifies acquisition of the stock, I think for the time being I shall continue to follow Joe’s lead and not back the truck up just yet. I may change my mind if the stock price continues to fall for I need to remember that I am not the only one who is using the intrinsic value to guide investment decisions. Mr. CEO is also sharpening his pencil.
Glenn
Glenn
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I’m not aware of a single resource for market share data. The company’s reports usually have a good amount of information, and Google is a great resource.
If you know the industry and the company inside and out, you should have a good grasp on market share. It may not be an exact science, but you’ll know if your company is the company.
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Hi Joe,
Just finished reading your book, it was great and very educational when it comes to valuing a business as a business owner. Your book also brought me to this site and through this site i came across Sanjay Shetty i believe and thru her blogs i came across the FWallStreet_model.xls. Based on this excel model, ADBE is valued around 49.42. At $29.06, price as of today, its trading at a 41% discount. Based on the excel sheet, the median FCF growth since 99 to present has been 17.8%. Shareholders equity has even done better with a median growth over the same period of 32.2% and the CROIC of 35.2%.
the model has it valued at around 27.084 billion by 2028. since ADBE is fairly steady i used a 25% MOS, which gives a buy under price of $37.07.
Lets say i use the same 14% FCF growth instead of 17.8, i would get a fair value of $41.47, at $29.06, this is a 30% MOS. This seems like a good long term play still. i am going to go ahead and nibble at it.
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The issue I find with software companies in general is feature bloat – take MS Office for an example. There are only so many features that are really necessary, newer releases just add cosmetic improvements while the free competition (Open Source) slowly catches up crimping growth. Adobe is also very militant in enforcing licensing to the point of alienating their legitimate customers (from personal experience). Their moat may not be as wide as permanent as it appears.
Growth in the tech companies seem to be driven by acquisitions, MS buying Yahoo, Cisco buying anything that moves, Google with youtube, Oracle with peopleSoft etc. Adobe being a niche player maybe a target.
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