I bought a lot of shares of Adobe (ADBE 3.02%) throughout the first half of 2022. At the time, I admired the strength of its digital media products, the stickiness of its subscriptions, its stable growth rates, and its reasonable valuations.
However, I trimmed my position last August and sold the remaining shares for a slight profit following the release of its first-quarter earnings report on March 14. These are the five core issues that changed my opinion about the cloud services giant.
Image source: Getty Images.
1. Its growth is slowing down
Adobe generates nearly three-quarters of its revenue from its Digital Media segment, which houses its flagship Photoshop, Illustrator, and Premiere Pro services. The rest comes from its Digital Experience services for enterprise customers. Both business divisions grappled with slower sales growth over the past two fiscal years.
|
Metric |
FY 2021 |
FY 2022 |
FY 2023 |
|---|---|---|---|
|
Digital Media Revenue Growth |
25% |
11% |
11% |
|
Digital Experience Revenue Growth |
24% |
14% |
11% |
|
Total Revenue Growth |
23% |
12% |
10% |
Data source: Adobe.
For the first quarter of fiscal 2024 (which started last December), Adobe expects its revenue to only rise 9%-10% year over year. For the full year, analysts anticipate 11% growth.
2. It faces clear competitive threats
Adobe blames some of that slowdown on the macro headwinds, but the competitive landscape is also evolving. Figma has been gaining ground against Adobe XD in the user interface (UI) and user experience (UX) software design markets. Canva, which had already been chipping away at Photoshop with its online image editing tools, recently acquired Affinity to expand its suite of digital media editing services. Microsoft (MSFT 0.80%), which integrated OpenAI's generative AI tools into its Bing Image Creator and Designer platforms, is evolving into a competitor with its text-to-image creation services.
Adobe's responses to these threats aren't reassuring. It initially tried to buy Figma in Sept. 2022, but regulatory hurdles forced it to abandon the $20 billion deal last December -- and forced it to pay its growing competitor a $1 billion termination fee instead. Adobe responded to the seismic shift toward generative AI by expanding its own Firefly platform for creating images and digital models, but that effort hasn't meaningfully boosted its revenue yet.
NASDAQ: ADBE
Key Data Points
3. It's acting like a tobacco company
To offset its persistent slowdown, Adobe is cutting costs, raising its prices, and buying back shares to boost its earnings per share (EPS). Yet those tactics make it more similar to a slow-growth tobacco company instead of a high-growth tech giant.
Adobe raised the prices of its Creative Cloud services by about 10% in late 2023. Therefore, most of its growth this year will likely be driven by price hikes for its existing customers instead of the organic expansion of its customer base.
And during Adobe's latest earnings report, its management announced a new $25 billion buyback plan. That seemed like a move to appease investors after it failed to buy Figma, but earmarking all that cash for buybacks doesn't make much sense when it should be making bigger and bolder investments to widen its competitive moat.
4. Its core business faces regulatory challenges
Adobe's future growth relies heavily on its ability to lock customers into its subscriptions. However, it recently disclosed that the U.S. Federal Trade Commission (FTC) had launched a probe into those subscription cancellation policies.
The FTC has been investigating Adobe's policy of charging prorated penalties to customers who cancel their subscriptions after the first 14 days. Adobe admitted that it could incur "significant monetary costs or penalties" to settle that investigation, while the FTC could reduce the stickiness of its cloud services by banning its cancellation fees.
5. It's not cheap anymore
Analysts expect Adobe's adjusted earnings to grow 12% this year. Based on that forecast, its stock might seem reasonably valued at 28 times this year's earnings.
But Microsoft, which is growing at a faster rate, trades at 31 times forward earnings. Salesforce (CRM 2.46%), which competes against Adobe in the enterprise software market, is also growing faster and trades at 31 times forward earnings. Therefore it doesn't make much sense to invest in Adobe's troubled business when you can pay a slightly higher multiple for Microsoft or Salesforce. That might be why Adobe's insiders sold more shares than they bought over the past 12 months, even as its board greenlit another buyback plan equivalent to 11% of its market cap.
Adobe's stock might bounce back if it gets its act together, but the red flags are too bright to ignore. So for now, I'm staying away from this struggling company until a few more green shoots appear.
