Adobe Systems Incorporated (NASDAQ:ADBE) is a less talked about tech name, but its product is ubiquitous and used daily by droves of office workers across all industries.
Making PDFs of documents may have less sex appeal than some app on your glossy, sleek new iPhone, but Adobe developed the much-needed software to share formatted documents electronically. That product has set the stage for a very impressive stream of recurring income and built the foundation for ADBE to extend its product lines to mobile and the cloud.
From a business model standpoint, it’s super attractive given that recurring aspect to its annual revenues. Document security is a prime concern for businesses, and ADBE’s products are the first that come to mind. There’s an incredible level of brand equity already that doesn’t require additional investment to spread the word.
In fact, from a best practices standpoint, making a PDF has become the norm — it’s expected.
ADBE’s Gravy Stream
A good place to start a deeper dive into the recurring revenue stream is the creative cloud. Business momentum should widen the gap between annualized recurring revenue and revenue as time progresses. ARR overtook revenues during the 2015 fiscal year, and since then, ADBE has been successful in driving that trend.
The revenue mix for the 2017 fiscal year is expected to be $4 billion attributed to subscription revenue and $0.2 billion in perpetual and OEM. Compare that to the 2014 fiscal year. Then, of a total $1.8 billion in revenue, subscriptions were just $1.1 billion. Management has been very successful in driving that shift in just a few years.
And even though it may feel like everyone and their company may already use ADBE, the market is still huge. ADBE estimates its total available market, or TAM, for the creative cloud to be at $24.2 billion. For the document cloud, the TAM estimate comes to $5.3 billion. The current fiscal year revenue estimates are just $0.8 billion. So, there’s plenty of room for sustained growth.
The focus on driving ARR is intense, and there are multiple levers for ADBE to pull to get there. Actionable ways to continue that ever lucrative stream of recurring revenue include new user acquisition, Acrobat/Creative Suite migration, value expansion via services, and upselling.
So with that quick primer on a couple important pieces of the business, let’s look to what shareholders can expect in 2018: In short, a lot of growth.
All major business segments are expected to grow in double digits: digital media 23% year-over-year and Experience Cloud total revenue 15% year-over-year. (Experience Cloud subscription revenue broken out will do 20% growth.)
That makes for full year GAAP EPS of $4.40, meaning an implied forward P/E multiple of 42x. The current trailing P/E is 58x, which is by no means cheap. It doesn’t feel grossly overpriced, but it also doesn’t strike me as a screaming buy.
For some context, on a trailing basis Microsoft Corporation (NASDAQ:MSFT) trades at 29x and Apple Inc. (NASDAQ:AAPL) at 19x. And admittedly AAPL isn’t a great comp, but it’s just a point of reference.
Keep in mind too, that ADBE has benefitted from the overall ebullience for the tech sector. ADBE stock has had an 80% run-up year-to-date. There’s a significant degree of transparency for future earnings. It’s clearly a well-run company with an entrenched product. But future gains may be capped given the significant outperformance this year.
As of this writing, Luce Emerson was long AAPL.