Adobe Stock: Embracing AI In Digital Design (NASDAQ:ADBE)

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by Samuel Pordengerg Mar 19, 2023 News
Adobe Stock: Embracing AI In Digital Design (NASDAQ:ADBE)

Mar. 19, 2023 12:54 AM ETAdobe Inc. (ADBE)CRM8 Comments
MM Research profile picture
  • There are two primary components to the value of a Tech company: the network effect and the industry standard.
  • Adobe has embedded its products in Microsoft Edge and Galaxy S-23.
  • I believe Adobe is currently trading right around its intrinsic value and is worth buying.

R_Type/i Stock.

A Wonderful Business

What distinguishes a visionary company? The business book Built to Last: Successful Habits of Visionary Companies was written by Jim Collins and Jerry Porras. An ideology that extends past'maximizing profitability' is the first. "We deliver tools and services to empower individuals to create, collaborate and express their vision, transform businesses with compelling, personalized experiences in streamlined workflows and connect communities with new levels of collaboration," said Adobe in their annual report.

Adobe also has a component called Big Hairy Audacious Goals.

"[on the Digital Media segment] Our goal for our Digital Media business is to be the leading platform for creativity and digital document solutions, where we offer a range of products and services...to design and deliver content seamlessly."

"[on the Digital Experience segment] Our goal is to be a leading provider of cloud-based solutions for delivering digital experiences and enabling digital transformation."

It's clear, concise, and simple, but not easy. It's foolish to make investment decisions based on what management thinks is the best opportunity. Adobe is well-equipped to benefit from the next big steps in tech: Digital transformation and Artificial Intelligence.

What Makes a Tech Company Valuable?

There has been a rise in the study of the economics of information as the internet has become ubiquitous. The network effect is what makes the internet so valuable. There were serious concerns about the decline of American industries before big tech came along. On the one hand, globalization has kept inflation low for 40 years, but on the other hand, manufacturing has moved out of the US, which has caused severe economic damage to many major industrial cities. There were serious concerns about US economic dominance in the early 1980s, but they were burnt to a crisp by the fire of the internet.

The internet fundamentally changed the US economy. It has changed the lives of almost every person alive today and anyone who will be in the future. The internet is proving that technological progress is unstoppable. The internet was expensive in the beginning, but progress increased at an increasing rate. Progress is richly rewarded in the US. The rise of the modern service-driven US economy can be traced back to the combination of internet technology and the US economic system.

The network effect is a big part of the internet's value. The network effect states that the value of software is a function of how many people use it. Imagine you are the first person to open a PDF. No one else has access to this file since you are the first one to use it. When you try to share a book on the internet, you can't because no one has the ability to access it. How much is this software worth? There's nothing. The other user buys your book for $10. The economic activity stimulated by the software is what drives the value. The effect is not linear. The output of the function - economic activity caused by the software - grows as users are added to it. The rise of US tech could be traced back to this mechanic.

The industry standard is one of the important pieces of the puzzle. Many early internet companies focused on becoming the industry standard. There are many stories of bad business practices by tech businesses. The internet has been sued by the US government over anti-competitive behavior, but it was the Wild West for a long time. Software companies focused on market share in order to drive brand value. In which their product became the default, many of the companies earned industry-standard status.

The rapid destruction of software products is possible due to intellectual property protection. The beginning of a descent to worthlessness was caused by Apple. Steve Jobs was unhappy with the security and efficiency of the flash platform for creating advanced graphics on the internet and removed it from the apple platform by 2010 The network effect's exponential growth function was reversed in order to make it decay until the end of 2020. Disruption to its network effect and fundamental cybersecurity flaws caused the collapse and replacement of the industry standard for delivering video based web content. The driver of value is the fundamental risk. Aggressive pursuit of becoming an industry-standard in the most competitive industry is a challenge.

The network effect and industry standard are the two primary components to the value of a tech company.

The Next 10 Years

The next generation of American technology is what Adobe is focused on. The ability to embrace the digital age is provided by Adobe. Many companies are leaning into the Adobe productecosystem to modernize their business, and with almost all products offering recurring revenue streams for Adobe, the business looks set to consistently grow in the coming years.

PDF files allow for a consistent presentation of documents. The PDF was published as an open standard by Adobe. It is now a standard format for online communication. Adobe can't make a lot of money from the monopoly of its patents on the PDF file. Adobe Acrobat is the leading PDF reader and editor. More than 400 billion PDF's were opened in Adobe products. Acrobat is the default PDF viewer in Microsoft Edge, which has an estimated 1 billion yearly users. Microsoft is pushing the frontier in its own way, with the recent implementation of ChatGPT. If more traffic goes to Bing, more traffic will go to Edge, and any PDF opened in Edge will use Adobe software. One of the strongest information networks in the world has Adobe's product embedded into it, which should lead to a lot of new business in the future.

According to Adobe, over ninety percent of the world's creative professionals use the program. Adobe has a photo editor for the S-23. The management team noted a few key generative AI developments in the Digital Experiences segment, which will be shown in further detail at Adobe Summit. The next shock to American innovation and growth is expected to be provided by Artificial Intelligence. The threat of artificial intelligence displacement is one of the main concerns of many industries. Many professions feel a threat of being replaced by this technology. Tools that replace the creative process are not part of Adobe's focus. Creative professionals make up Adobe's core customer base and they want to develop tools that will help amplify the volume and quality of their work. Adobe is well-equipped to enhance its product offerings on the back of this revolutionary technology, despite the fact that it is a huge risk to the company.

Adobe is making it easier for new customers to use their products. Adobe management noted threats to non-critical business expenses. One of the first functions that gets defunded in the face of financial uncertainty is marketing. Management is seeing a different development in the uncertainty. The cost advantages of getting products from a variety of vendors is why businesses are decreasing their spend. Customer relationship management software is one of the core products of a company likeSalesforce. Adobe has a competitive offering to this with Adobe Experience Manager, and management believes they will not see a material weakness in this segment because many customers will consolidate vendors Adobe is a strong contender to be the sole provider of marketing and digital transformation technology for businesses that want to cut down on marketing spend and complexity by finding a single vendor to provide a full suite of applications.

Risks

There is risk in good investments. Adobe has a solid business model and strong fundamentals, but that doesn't mean I'm happy with it. Since the beginning of the year, stock-based compensation has increased by 5x. This equates to 1% dilution annually. A hefty financial commitment on a yearly basis is one of the reasons management combats this with aggressive share purchases. It's not a big deal if stock-based compensation is being used as a way to motivate employees. If this is a way for management to line their pockets, it will put downward pressure on Adobe's value.

Adobe's core customer is at risk of mass displacement due to the use of artificial intelligence. Adobe's business model is at risk if fears of major job losses in the digital creative industries are true. The Adobe ship may see a glacier on the horizon. Predicting the impact of technological innovation is just that: a prediction. We know that it will have major ripple effects, but we don't know the full range of effects. Adobe is positioning itself to be at the forefront of artificial intelligence-enhanced product offerings, which should drive shareholder value.

Valuation

The value of Adobe is currently estimated by me. Adobe is currently trading at a multiple of 26x levered free cash flow and has a 10-year CAGR of 36% for free cash flow. I think the growth rate will increase, which will result in a 5% growth of levered free cash flow a year. Adobe is using key growth opportunities across business transformation and artificial intelligence-assisted digital design to drive stability and growth of free cashflows. The current interest rate environment shouldn't put downward pressure on levered free cash flow because Adobe has more cash on hand. The margin of safety price is $350.61 if I discount these cashflows at 15% and estimate a conservative price/free cash flow multiple of 10x.

Free Cash Flow to Equity Valuation
2022 FCF $6,272,300,000.00
Est. Growth Rate Discount rate
Est Future FCF 1.05 15%
2023 $6,585,915,000.00 $5,726,882,608.70
2024 $6,915,210,750.00 $6,013,226,739.13
2025 $7,260,971,287.50 $6,313,888,076.09
2026 $7,624,019,851.88 $6,629,582,479.89
2027 $8,005,220,844.47 $6,961,061,603.89
2028 $8,405,481,886.69 $7,309,114,684.08
2029 $8,825,755,981.03 $7,674,570,418.28
2030 $9,267,043,780.08 $8,058,298,939.20
2031 $9,730,395,969.08 $8,461,213,886.16
2032 $10,216,915,767.54 $8,884,274,580.47
Terminal Value (P/FCF multiple * 2032 est. discounted cashflow) 10.00 $88,842,745,804.66
Intrinsic Value (Sum of discounted cashflows and terminal value) $160,874,859,820.54
Shares outstanding 458,580,000
Current Discounted Equity Value $160,874,859,820.54
Current Discounted Equity Value/share $350.81

This is slightly different from my previous valuation.

Adobe is currently trading around its intrinsic value and is a good buy. Adobe will richly reward investors over the next 10 years at its current valuation, even though I will be somewhat stubborn with my cash and wait for atrigger price of $350. 81. Adobe stock is a Buy because it's a wonderful business with a really positive long-term outlook and many opportunities to drive consistent growth.

The article was written by someone else.

MM Research profile pictureI identify outstanding businesses through value investing principles and economic analysis. Whether you're a seasoned investor or just getting started, I'm committed to equipping you with the knowledge to make well-informed and profitable investments.

I have a beneficial long position in the shares of ADBE either through stock ownership or options. This article was written by me, and it expresses my own thoughts. I am not getting paid for it. I don't have a business relationship with companies whose stock is mentioned.

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