Dying Business or Generational Opportunity? Adobe Stock Explained

The Stock Drop and AI Concerns [00:00]

• Adobe's stock has fallen 57%, a significant drop not explained by deteriorating financials or a bear market; revenues are up 10% and operating profits 29%.
• The primary driver for the stock's decline is the perceived risk from Artificial Intelligence (AI).
• Investors are scrutinizing investments for AI disruption, drawing parallels to companies like Chegg, which experienced a near 99% stock drop due to AI.
• Unlike Chegg, Adobe's financials show growth, not decline, indicating AI's impact is not yet reflected in its core business performance.

The stock is being priced in as such. It right now trades at just 14 times trailing earnings.

Adobe's Business Segments: Digital Media [03:01]

• Adobe's business is divided into two main segments: Digital Media (75% of revenue) and Digital Experience (25% of revenue).
• Digital Media is what most people associate with Adobe, encompassing creative tools like Photoshop, Illustrator, Premiere Pro, and Lightroom, as well as PDF solutions through Acrobat.
• This segment has a high gross margin of 95% and includes the Creative Cloud subscription, which accounts for about 80% of Digital Media revenue (60% of total revenue).
• The Document business, centered around Acrobat and PDF editing, represents about 20% of Digital Media revenue (15% of total revenue).
• Adobe's creative products are considered industry standards, with clients often requiring files in Adobe's native formats (e.g., PSD) for editing.

They have many, many different products, but those are kind of their key products that they put out.

Competitive Landscape in Digital Media [08:51]

• Competition in the creative space comes from low-end solutions like Canva, which offers a more intuitive user interface, and specialized tools (point solutions) like Figma for UI/UX design.
• Other competitors in video editing include Apple's Final Cut Pro, DaVinci Resolve, Avid Media Composer, and CapCut.
• Despite competition, Adobe's Premiere Pro holds a significant market share in video editing (around 35-40%).
• Adobe's strategy includes integrating with competitors, such as Figma, to maintain its platform's relevance.
• The Slack and Microsoft Teams analogy illustrates how an integrated suite can often overcome a superior point solution due to broader ecosystem benefits.

Adobe basically said, "We can't compete with them." And instead, now they integrate with them.

Adobe's Digital Experience Segment [14:27]

• The Digital Experience segment, comprising 25% of revenues (approximately $5.4 billion), has lower gross margins (around 72%) but contributes significantly to overall gross profit.
• This segment is crucial for enterprise clients, managing digital assets and customer journeys through products like Adobe Experience Manager and Adobe Experience Platform.
• Key value propositions include Content Management Systems (CMS) for cross-device content adaptation, Digital Asset Management (DAM) for brand-approved assets, Customer Data Platforms (CDP) for audience segmentation and personalization, and Analytics for performance measurement.
• This segment was built through significant acquisitions, including Workfront, Marketo, Magento Commerce, and Omniture, aimed at embedding Adobe deeper into enterprise workflows.
• Competitors like SAP, Oracle, and particularly Salesforce are encroaching on this space with their own analytics and audience segmentation tools.

So, the creative cloud creates the assets. The digital experience segment basically manages all of these assets.

AI's Impact and Adobe's Defense [24:29]

• AI is viewed as both a significant enabler and a potential threat to Adobe's business.
• The core question for AI's impact is whether it will become commoditized; if so, Adobe's distribution advantage becomes paramount.
• While Adobe doesn't have a leading-edge proprietary AI model, it integrates various AI models from partners like Google (e.g., Nano Banana) and OpenAI into its platform.
• AI's current limitations, such as generating imperfect images (e.g., "six-finger" issues), necessitate human editing, thus maintaining the need for Adobe's tools.
• Adobe's own AI model, Firefly, trained on Adobe Stock, offers commercially safe generative AI capabilities, a critical advantage for enterprises concerned about legal risks.

And so, it looks like Adobe's going to be fine with AI because they have these 25 different AI models that are already on their platform.

Business Model Transition and Future Risks [29:40]

• A key risk is "seat dilution," where AI efficiency reduces the number of users (seats) a company needs, impacting Adobe's per-user subscription revenue model.
• To counter this, Adobe is introducing generative AI credits, shifting towards a hybrid subscription and usage-based model.
• This transition is reminiscent of Adobe's earlier, successful shift from a perpetual licensing model to a Software as a Service (SaaS) subscription model, overseen by CEO Shantanu Narayen.
• Another risk involves Meta and Google leveraging AI for automated ad creation and distribution, potentially bypassing traditional creative workflows, though this primarily impacts smaller businesses rather than Adobe's enterprise focus.
• Brand ads, focusing on awareness rather than immediate response, are less susceptible to generative AI disruption as they are harder to measure and require strong brand control.

Now, at the time though, and this is key to remember, many people thought this would be a worse business model.

Valuation and Investor Considerations [38:50]

• Adobe's current market capitalization is $112 billion, with the stock down over 60% from its peak.
• In the last 12 months, Adobe generated $7.1 billion in net income and $7.9 billion in free cash flow.
• The company also repurchased $9.5 billion of its shares.
• Despite fears, revenues are still growing, with analysts considering a 20-25 times free cash flow multiple potentially fair, suggesting significant upside from the current 14 times multiple.
• Key considerations for investors include the CEO's ability to manage business model transitions, the perceived AI risks, and the future growth trajectory.

And so at At a $272 stock price, their market cap is $112 billion.