Adobe's (ADBE 1.29%) stock sank 17% to its lowest levels in nearly three years on Sept. 15 following its report for the third quarter of fiscal 2022, which ended on Sept. 2. Revenue at the digital media software company rose 13% year over year to $4.43 billion, missing analysts' consensus estimate just slightly. Its adjusted net income rose 7% to $1.6 billion, or $3.40 per share, which beat the consensus forecast by $0.06.
Adobe's headline numbers looked fairly stable, but management's light revenue guidance and the announcement of plans for an unexpected acquisition rattled investors. Let's consider what the bears and bulls think about those recent developments, and weigh the question of whether or not Adobe's post-earnings plunge has created a good buying opportunity.
Image source: Getty Images.
What the bears will tell you about Adobe
During the quarter, Adobe generated 73% of its revenue from its Digital Media segment, which houses its Creative and Document Clouds. Another 25% came from its Digital Experience segment, which houses its enterprise-oriented marketing, analytics, and digital workflow services.
Adobe bears will point out that after generating more than 20% year-over-sales growth across both segments in 2021, its revenue growth decelerated significantly in the first nine months of fiscal 2022.
|
Adobe Segment |
Q3 2021 |
Q4 2021 |
Q1 2022 |
Q2 2022 |
Q3 2022 |
|---|---|---|---|---|---|
|
Digital Media Revenue |
23% |
20% |
17% |
16% |
16% |
|
Digital Experience Revenue |
26% |
21% |
20% |
18% |
15% |
|
Total |
22% |
23% |
17% |
15% |
15% |
Data source: Adobe. YOY =Year over year. *On a constant-currency basis, and excluding an extra week in the prior-year quarter. **On a constant-currency basis.
Currency exchange headwinds exacerbated that slowdown, and Adobe notably started to report its growth in constant currency terms to reflect the impact of a rising dollar at the beginning of fiscal 2022.
On a reported basis (which isn't displayed in the constant currency terms shown in the chart), Adobe's 13% revenue growth in the third quarter of fiscal 2022actually represented a deceleration from its 14% growth in the second quarter. Management expects that slowdown to persist, forecasting just 10% revenue growth in the upcoming fourth quarter, compared to analysts' recent expectations of 12%, as it grapples with macro headwinds and a strong dollar.
Adobe's margins are also slipping as its growth cools off. In the first nine months of 2022, its gross margin dipped by 60 basis points year over year to 87.8%, and its operating margin dropped by 170 basis points to 35.1%. Faced with that pressure, it would have made sense for Adobe to rein in its spending.
Instead, Adobe abruptly announced that it would buy the design software start-up Figma for $20 billion in a half-cash, half-stock deal. That's a staggering 50 times the $400 million in annual recurring revenue Adobe expects Figma to generate this year. Figma's gross margins are similar to Adobe's, but it was unprofitable back in 2020 and is still likely bleeding red ink. Therefore, this unexpected deal could compress Adobe's operating margins when it closes in 2023.
What the bulls will tell you about Adobe
Those who are bullish on Adobe will point out that its business has weathered numerous economic downturns, that its cloud-based ecosystem is sticky, and that its creative programs such as Photoshop, Illustrator, and Premiere Pro are still industry standard tools for media professionals.
They'll also argue that Adobe's takeover of Figma, which competes against the Adobe XD service in the user interface (UI) and user experience (UX) design markets, eliminates a disruptive competitor. Many large enterprise customers, including Microsoft, have been using Figma alongside Adobe's other services -- and that fragmentation could have caused long-term headaches for the company. Figma's net dollar retention rate (or the percentage of revenue it retains from its existing customers on an annual basis) currently exceeds 150%. If Adobe keeps its rate in that neighborhood, its annual revenue could potentially surpass $1 billion in just a few years.
Adobe spent $4.8 billion on stock buybacks in the first nine months of 2022, which reduced its outstanding share count by nearly 2% year over year. It still has $8.3 billion remaining in its current buyback authorization, which will last through 2024. Those repurchases should boost its earnings per share (EPS) while offsetting some of the dilution from the Figma deal. It expects additional buybacks to reduce its outstanding share count by another 3% year over year in the fourth quarter.
That's why Adobe's guidance for 9% year-over-year adjusted EPS growth in the fourth quarter still exceeded analysts' expectations for 8% growth. That stable profitability arguably makes Adobe a more reliable investment in the current bear market than higher-growth cloud companies that are still unprofitable.
Lastly, Adobe's stock has gotten a lot cheaper. At $300 per share, it trades at just 22 times next year's expected earnings and 7 times next year's expected sales. Those aren't bargain-bin valuations yet, but they could make Adobe more appealing than other pricier cloud stocks.
Do Adobe's weaknesses eclipse its strengths?
Adobe clearly faces some near-term hurdles. Macro headwinds could continue to throttle its sales growth and squeeze its margins, and investors will continue to question the value of the Figma acquisition. But over the long term, Adobe's business should stabilize and overcome its cyclical challenges.
Therefore, I don't think investors should sell Adobe right now. Indeed, at its current level, the stock might be a compelling long-term buy for investors who believe the company can continue to dominate in its niche.
