4. Adobe Inc. (NASDAQ: ADBE)
Value: $83,770,000
No. of hedge Fund Holders: 114
Adobe Inc. (NASDAQ: ADBE) is a U.S-based company with a solid reputation for its solutions used in animation, photography, graphics, and multimedia. However, its operations now include the provision of software for digital marketing management.
Adobe recently secured a partnership through which it will integrate its digital commerce platform with the ShopRunner e-commerce expedited delivery platform owned by FedEx Corporation (NYSE: FDX). The integration will make it possible for sellers on Adobe’s platform to provide free two-day shipping and other logistics perks. Adobe will also provide extra sales data to sellers who select FedEx, allowing them to streamline their operations.
Adobe Inc. (NASDAQ: ADBE) generated $3.91 billion revenue in the first quarter of its fiscal 2021 after a 26% YoY gain. Its GAAP diluted earnings per share for the same period was $2.61, while the Non-GAAP EPS was $3.14. Creative revenue soared to $2.38 billion during the quarterly period, while the digital media segment generated $2.86 billion in revenue. The document cloud segment’s revenue figure for the same period was $480 million, which was 37% higher YoY.
Palm Capital, in their Q1 2021 investor letter, mentioned Adobe Inc. (NASDAQ: ADBE). Here is what Palm Capital has to say about Adobe Inc. in their letter:
“Adobe has a near-monopoly in content creation software with dominant applications including Photoshop, Lightroom and Illustrator that are critical in the lives of creative professionals. These applications are not only the best in the industry but also have high switching costs as it takes designers many years to become adept at using them. This investment of time is a sunk cost and makes it costly for designers to switch to an alternative. Additionally, as most creative professionals use Adobe’s suite of products it also has a network effect advantage – creative professionals use it because most other creative professionals do.
This creates stickiness of revenue, the visibility of which is enhanced by the fact that more than 90% of Adobe’s overall revenue is subscription-based and a large portion of this is paid in advance.
As Adobe’s programs have already been developed and they are now largely distributing this over the internet, the company’s gross profit margins are a towering 85%.
Adobe also has great economics. It is capital light. This means that it does not need physical assets like machinery, property, or stock to operate. As its assets are intangible, it does not need to take on debt to finance them. And its marginal cost of serving additional customers is minimal. The company is highly cash generative, not only because some of its revenue is received upfront, but also because it pays a large portion of salaries with shares and share options. This is evident from its balance sheet – it has had a large net cash position for seven of the past ten years. Furthermore, investments in its intangible assets are expensed rather than capitalized resulting in a low tax burden relative to typical capital-intensive businesses.
Finally, Adobe has lots of room for growth. The shift to digital creates a strong underpin for demand growth over the long term. And Adobe’s switching costs give it the power to grow revenue by increasing prices. Additionally, the subscription model is growing Adobe’s market in several ways. Firstly, it makes it affordable for small businesses, opening a new market to Adobe. Secondly, by freeing up IT capex and fixed costs, the model also makes it more affordable for large businesses, incentivizing them to take on pricier options. Thirdly, as the company is not updating its products that were sold under the licence model, the subscription model is beginning to capture many non-compliant users.
Over the next ten years, we expect Adobe’s sales to more than double and its free cashflow margin to expand to almost 40%.
These characteristics make Adobe an exceptional business and it is one half of the reason we have been invested for nearly three years.
This example as well as our examples of the aggregators earlier illustrates the impact that the internet has had in not only creating more profitable, less capital-intense businesses but also in allowing businesses to grow to much larger sizes at a much faster pace than before. It partly explains the pace with which new businesses are reaching $100bn valuations whether on public or private markets.”
