Adobe facing challenges with slowing growth and rising competition, leading to a negative outlook.
March 30, 2024 Adobe (ADBE), arguably has some significant short-term and long-term obstacles surfacing on the horizon. I embraced the endeavor of purchasing considerable shares of Adobe during the initial half of 2022. The appeal was largely due to the resilience of its digital media offerings, the constant traction of its subscription model, consistent growth indicators, and fair valuation metrics.
Nonetheless, my stance shifted following the release of Adobe’s first-quarter earnings report on March 14, compelling me to downsize my holdings last August and subsequently liquidate the remaining shares, being fortunate to secure a marginal profit. My outlook of this industry-leading cloud services provider was fundamentally influenced by five paramount concerns.
- Diminishing Growth Trajectory
Approximately 75% of Adobe’s revenue stream is derived from its Digital Media division that encompasses popular services like Photoshop, Illustrator, and Premiere Pro. The remaining portion is fulfilled by its Digital Experience services tailored for enterprise clientele. Over the past couple of fiscal years, both these business segments have been wrestling with decelerated sales growth. For instance, Digital Media’s revenue growth plummeted from 25% in FY 2021 to 11% in FY 2022 and FY 2023. Analogously, the Digital Experiences segment saw a dip from 24% in FY 2021 to 14% in FY 2022 and then down to 11% in FY 2023. Consequently, Adobe’s total revenue growth fell from 23% in FY 2021 to 12% in FY 2022 and further to 10% in FY 2023. Adobe forecasts a meager 9%-10% year-over-year revenue growth for the first quarter of the fiscal 2024 that kicked off last December. Market analysts even anticipate an underscore of just 11% growth for the entire year. - Escalating Competitive Pressures
Adobe attributes part of its growth impediment to macroeconomic influences but also acknowledges the rapidly evolving competitive scene. Figma has been gradually encroaching upon Adobe XD’s market share in the UI and UX software design industry. On a similar note, Canva, known for its online image editing tools, recently acquired Affinity, thereby widening its spectrum of digital media editing services and posing a tangible threat to Photoshop. Microsoft (NASDAQ: MSFT) after incorporating OpenAI’s generative AI capabilities into its Bing Image Creator and Designer platforms, has also pivoted to become a budding competitor with its text-to-image creation offerings.
Adobe’s counteractions to these looming threats have been less than convincing. Its abortive attempt at acquiring Figma in September 2022, derailed by regulatory obstructions, not only led to the termination of the $20 billion deal in the following December but also cost Adobe a hefty $1 billion termination penalty payable to its competitor cum rival. Adobe’s subsequent move to adapt to the generative AI shift by extending its Firefly platform for generating images and digital models hasn’t substantially augmented its revenue.
- Threat of Stagnancy
In an effort to compensate for the sustained slowdown, Adobe has resorted to cost-cutting measures, price increments, and share buybacks to augment its earnings per share (EPS). Yet, such measures cement Adobe’s resemblance to a stable, slower-growth tobacco company, straying from its original characterization as a fast-paced tech giant. Adobe amplified the prices of its Creative Cloud services by nearly 10% in late 2023. Consequently, it’s plausible that most of this year’s growth will be credited to price escalations for existing patrons as opposed to organic growth by expanding its customer base.
During Adobe’s most recent earnings announcement, management unveiled a new $25 billion buyback plan. While this initially appears an appeasement strategy following the failure of the Figma acquisition, the decision raises eyebrows when considering the need for more aggressive and substantial investments for widening Adobe’s competitive advantage.
- Regulatory Concerns for the Core Business
Adobe’s aspiration for future growth is heavily reliant on the effectiveness of its subscription model. However, recent revelations detailing a probe by the U.S. Federal Trade Commission (FTC) into Adobe’s subscription cancellation policies have surfaced. The FTC’s examination has been focused on Adobe’s practice of levying prorated fines on clients who opt to cancel their subscriptions past the 14-day threshold. Adobe concedes the possibility of incurring “significant monetary costs or penalties” to settle this investigation, while the FTC could undermine the appeal of Adobe’s cloud services by barring its cancellation charges. - Inflated Valuation
Analysts foresee that Adobe’s adjusted earnings will witness a 12% growth this year. Given this projection, a layman investor might perceive Adobe’s shares as reasonably priced at 28 times this year’s earnings. However, a comparative analysis reveals that Microsoft, exhibiting a faster growth pace, trades at 31 times forward earnings. Likewise, Salesforce (NYSE: CRM), another competitor in the enterprise software industry, also shows a faster growth pattern and trades at 31 times forward earnings. Therefore, it’s arguably imprudent to invest in Adobe’s floundering business when the option to assign a marginally higher multiple to Microsoft or Salesforce exists. Possibly reflecting this sentiment, Adobe’s insiders offloaded more shares than they purchased over the past 12 months, even as the board authorized another buyback plan equivalent to 11% of its market cap.
Given these red flags, Adobe’s stocks might recover if the overall business strategy rejuvenates, but for the time being, the warning signals are too pronounced to dismiss. Hence, I’ve chosen to withhold engagement with this struggling company until there are more signs of recovery.
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