Adobe, Figma, and AI Drivers

We featured Adobe back in December, after Goldman analysts picked the stock as a ‘best in class’. The Adobe share price briefly rallied but has since fallen back to that December pricing. Do Goldman’s assumptions still hold true?

Let’s quickly recap Adobe’s recent journey. Back in October 2022, Goldman Sachs analysts zoomed in on stocks to include in a basket of ‘Best-in-Class Cash Returns at Reasonable Cash Flow Valuations’. Adobe was included.

They defined these stocks as having…

“a solid track record of generating superior financial returns (measured using cash returns on cash invested or CROCI) that our analysts expect will continue into 2023E alongside valuation support (in the form of attractive debt-adjusted cash flow yields) — characteristics that should make them favourably positioned across market environments.”

This came in the wake of a big selloff after Adobe decided to acquire Figma for around $20 billion, a price that many analysts said was excessive…

Nevertheless, the share price rallied from those October lows, closed the ‘Figma gap’ and spent a little time back above the 200 day moving average, before falling again. Ironically, news a couple of weeks ago that the Figma deal could be blocked by US/UK/EU antitrust regulators also saw a selloff in response.

If ever there was evidence for the age-old claim that “markets prefer certainty’...

Anyway, Adobe is set to report earnings this week.

• Exp. Quarterly EPS (USD) 3.68
• Exp. Quarterly Revenue (USD) 4.62bln
• Exp. FY EPS (USD) 15.31
• Exp. FY Revenue (USD) 19.26bln Source: Newsquawk

As usual, a miss or a beat on those numbers could drive the short-term action, but how about new drivers?

AI - The Next Big Thing?

Adobe has been adding AI features to their services suite over time, especially in their creative products.

Bank of America analysts say that “many of these new AI features, especially for Creative Cloud products, represent a potential paradigm shift in the day-to-day workflow of content creators and could also lower the barrier to entry for basic content creation.”

The analysts add that

Adobe looks well positioned to continue gaining share across its product suite given its competitive advantages:

1. large Creative Cloud subscriber base
   
2. distribution channel of 4,900+ sales & marketing personnel
   
3. breadth & depth of the digital content and experience software suite.

The bank maintains a neutral rating on Adobe, primarily due to uncertainty over the Figma acquisition which they believe will weigh on shares in the near-term.

However, their $400 Price Objective (PO) is far from neutral.

Our $400 PO is based on 19x our C24E FCF. This represents 1.3x our C24E FCF growth rate of 15%, in line with the large cap GARP (growth at reasonable price) software group average of 1.1x.

Obviously, the macro environment could render all of this speculation moot. Or maybe AI isn’t the big valuation driver that sell-side analysts think.

Which is where the Goldman analysis comes back to the foreground. Is Adobe still capable of driving those cash returns, and will the share price valuation become less reasonable in future?