Earlier this year, I made the tough decision to close out my position in Adobe (NASDAQ: ADBE). The stock has been on a tear after a severe slump during the bear market of 2022. Shares have rallied 7% so far in 2023 and are up more than 30% from early-October 2022 lows, though they remain nearly 50% off of all-time highs.
The company is a dominant force in creative software and document management, but I believe some challenges lie ahead. Here's why I'm not buying, even as a new bull market might be getting rolling again.
Are inflation and competition eroding the Adobe advantage?
Adobe reported total revenue of $4.66 billion in its fiscal 2023 first quarter (ended March 3, 2023). That represented a year-over-year increase of 9% -- or 13% in "constant currency revenue," which excludes the nasty effects of a strong U.S. dollar on international sales.
Within the total, Creative Cloud (the suite of content-creation software used by movie creators, video game developers, and more) sales were up 13% to $2.76 billion on a constant-currency basis. Constant currency sales of Document Cloud -- which is like a well-rounded competitor to DocuSign (NASDAQ: DOCU) -- were up 16% to $634 million. Experience Cloud, which often goes head-to-head with products from Salesforce(NYSE: CRM) to help businesses market and manage an online presence, saw constant currency sales increase 14% to $1.18 billion. Given macroeconomic headwinds and the threat of recession, it was by no means a bad quarter.
Guidance for full-year 2023 was also slightly raised. Revenue outlook was unchanged and is expected to be in a range of $19.1 billion to $19.3 billion, up about 9% year over year. GAAP earnings per share (EPS) is now expected to be between $10.85 and $11.15, compared to between $10.75 and $11.05 before. On an adjusted basis, EPS should be between $15.30 and $15.60, compared to original estimates of between $15.15 and $15.45 before.
My beef with this early mock-up of 2023 is that GAAP EPS is expected to be up about 9% year over year, or up about 13% on an adjusted basis. A persistently strong dollar, inflation (yes, even cloud computing costs are going up), and lots of competition appear to be hampering Adobe's ability to leverage its earnings at a greater rate of increase. I hoped for more of a pop in earnings after some profit margin compression the last year or so.
What about the Figma acquisition?
In September, Adobe announced plans to acquire Figma, the collaborative design tool, for $20 billion. Though numerous upstart competitors are nipping at its heels, Adobe has a stranglehold on creativity software -- which has led some creatives to complain of the high costs (and resulting high profit margins) for Adobe products.
Regulators might be listening and attempting to apply the brakes to the proposed acquisition. According to Adobe CEO Shantanu Narayen on the last earnings call:
We have completed the discovery phase of the U.S. [Department of Justice's] second request and are prepared for next steps, whether that is an approval or a challenge. Adobe remains confident in the facts underlying the case, and based on current process timing, we believe the transaction continues to be on track for a close by the end of 2023.
When I was still an Adobe shareholder, I had mixed feelings about the company buying Figma for a massive premium. On one hand, Figma is growing fast, and the acquisition would help reaccelerate revenue growth, not to mention eliminate a new key competitor. But on the other hand, acquiring Figma won't help profit margins (it was likely losing money last year) -- at least not in the short term.
As my colleague Billy Duberstein pointed out, if Adobe does purchase Figma, it's all about the long game. But if and when it gets the go-ahead to pay for the acquisition, doing so will reverse a couple years' worth of Adobe's stock repurchases, since Adobe will pay half in stock and half in cash.
Why I'm not buying
Given the ongoing slowdown in growth of revenue and profit, as well as some short-term uncertainty introduced by Figma, I don't think Adobe stock -- at 33 times expected 2023 EPS (or 24 times on an adjusted basis) -- is all that great a deal. After a big rally off of lows last autumn, I'm happy to hold off for now and wait for a better price. I think there are some better creative software stock deals to be had if a new bull market is indeed just beginning.
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Nicholas Rossolillo and his clients have positions in Salesforce. The Motley Fool has positions in and recommends Adobe, DocuSign, and Salesforce. The Motley Fool recommends the following options: long January 2024 $420 calls on Adobe, long January 2024 $60 calls on DocuSign, and short January 2024 $430 calls on Adobe. The Motley Fool has a disclosure policy.