` Krause Fund Research Spring 2017
Technology Adobe Systems Inc. (NYSE: ADBE)
Recommendation: SELL April 17, 2017
Current Price: $129.05 Analysts Target Price Range: $110 - $120 Ryan McCuskey [email protected]
Jiaying Cao [email protected] Adobe’s Future and Overvaluation Joshua Farmer [email protected] • Extremely large growth in subscription revenue: Subscription revenue in the application software
industry has increased significantly over the last Company Overview decade, since companies are moving towards Adobe Systems Inc. (ADBE) is a leading application subscription based revenue models. This large growth software company. Adobe provides digital media software, has been one of the primary reasons Adobe’s stock has digital marketing software, and printing & publishing been performing so well. However, subscription services. The segment that has driven growth is digital revenue growth is beginning to mature and slow down, media, which includes Creative Cloud and Creative which is very impactful on Adobe and other Document software. Moreover, Creative Cloud application software companies who have adopted a subscriptions have grown to 8 million in 2016 are expected subscription based revenue model. to surpass 9 million in 2017. We expect Adobe’s growth to continue due to its Creative Cloud business and • Optimistic management team: Adobe’s management subscribers; however, we do not believe the growth will be team is very optimistic going forward, due to their sustainable in the next 5 years. Our estimate is that overall cloud software business1. However, subscription growth will fall to 2.9% in 2022. revenue continues to fall. Management may have a positive outlook, but their recent financial performance Stock Performance Highlights may suggest otherwise. 52-Week High $131.33 52-Week Low $90.35 • Intense competition in the application software Equity Beta 1.03 industry: Competition in the application software Average Daily Volume $2.395 M industry is very intense. In fact, many firms are making efforts to steal Adobe’s customers, and Share Highlights capitalize on perpetual license based models. Market Capitalization $63.84 B
Shares Outstanding $494.7 M One Year Stock Performance Book Value per share $8.42
EPS (ttm) 2.62 P/E Ratio (ttm) 49.27
Company Performance Highlights ROA 9.57% ROE 16.20% Sales 5,854,430 Growth in Subscription Revenue
Financial Ratios Current Ratio 2.08 Debt to Equity 0.71 Source: Yahoo! Finance
1 Important disclosures appear on the last page of this report.
Employment Executive Summary The employment rate is a measure of the amount of people Adobe Systems Inc. is one of the leading firms within the in the workforce that are actively able and are willing to application software industry, designing and producing work. Employment rates are sensitive to economic cycles state of the art digital media and digital marketing software and are a good indicator of the strength of the economy. products. In this analysis, we cover a wide array of The employment rate metric is important to Adobe company-specific information, ultimately to understand Systems Inc., and the technology sector as a whole the value drivers of Adobe. Moreover, we believe that because as high-level talent becomes scarce, and other Adobe is a SELL right now, given their continuous drive technology firms are competing for the same talent, it to innovate, their strong financial performance, and their increases labor costs. current position in the application software industry. The current unemployment rate in the U.S. is 4.5% according to the March 2017 employment data, down Macroeconomic Outlook 5.5% from the peak of 10% unemployment in 2009. This is the lowest the unemployment rate has been since April of 2007.4 Gross Domestic Product Real GDP is a measure of how well a country is producing goods and services adjusted for inflation. GDP is calculated by aggregating all of the production of an economy using a specific year’s prices. It is a good indicator of strength within the country and can be used to compare growth of global economies. Since the 2008 recession, the economy has recovered in terms of real GDP production with the help of the Fed’s quantitative easing policy and since 2010, the annual growth of real GDP on average has fluctuated between 1.5-2.5%. 2
Source: U.S. Bureau of Labor Statistics
We see the unemployment rate remaining steady between 4.4% - 4.7% throughout the remainder of the 2017 year. However, we believe that full-employment will be hard to maintain moving forward due to an increasing participation rate in the workforce compounded with lower Real GDP growth. Due to this we see the unemployment rate increasing to 5.5%-7% by the year 2020.
With a large amount of technology firms located in a Source: U.S. Bureau of Economic Analysis specific region in San Francisco, we find it important to note the significance of unemployment and wage growth Given the market conditions, we predict a Real GDP in Santa Clara County, CA. Santa Clara is home to growth of 2.1% in 2017 and predict a lower range growth Alphabet Inc, and various other technology firms including range in the future between 1.5-2% given the but not limited to Apple, Microsoft, Adobe and Intel (3). strengthening of the dollar and international trade The various amount of technology firms in the same uncertainty. Also, with the current interest rate levels geographical location competing for the same talent beginning to raise from historic lows, we see the cost of pushes the cost of labor for these firms. According to the capital financed with debt lowering in the future, U.S. Census, the median household income in Santa Clara depressing Real GDP growth from consistently being over (2011-2015) was $96,310, which is 78.7% higher than the 2%. With the Dow Jones Industrial Average and S&P 500 U.S. average of $53,889.5 We predict this income to grow hitting an all-time highs on 3/1/17 of $21115.55 and to over $100,000 in 2020 due to the growth of technology $2395.96, we see the continual growth off historical highs companies and the need for talent, continuing to hard to sustain for the U.S. economy going forward.3 increase labor expense in the industry.
2 Important disclosures appear on the last page of this report.
Exchange Rates USD to JPY Rate
Exchange rate can suggests how much a dollar worth in other currencies. Exchange rate is not only important for firms operating in the global, but also essential for domestic companies, because domestic companies also need to compete with foreign companies in the US. We focus on the US dollar index, and several major foreign currency exchange rates, based on Adobe’s global market.
Besides America, Adobe has 28% revenue in EMEA Source: Marketwatch.9 (Europe, the Middle East and Africa) and 14% revenue in APAC (Asia-Pacific). The United States has only 53% of Adobe has 7% of its revenue in Japan, so USD to JPY rate the total revenue in 2016. So almost half of their revenue is important for revenue in APAC. USD to JPY rate is comes from overseas market, which is affected by the raising with small waves, but decrease in first 6 month in exchange rate. As the US dollar strengthens, their overseas 2016. It came to a peak at the end of 2016, and is now revenue shrinks, Adobe has hedged their currency risks, decreasing. We forecast a USD to JPY rate of 120/$ in 6 which partially offset the negative effect.6 month due to the strengthening dollar and weakening Yen. We forecast a rate of 113/$ in 2-3 years. Because the Bank of Japan will have a policy to control the currency market and revalue the Yen.10
EUR to USD Rate
Source: Adobe 10-K Source: Marketwatch.11
The US Dollar Index (DXY) Euro and British pound has the biggest effect in Adobe’s revenue. They together had over 86 million dollars negative effect on total foreign market in 2016.12
EUR to USD exchange rate stay high since 2015, means dollar is appreciating recently. Besides, Brexit has also caused Euro to depreciate. We forecast a EUR to USD rate of $0.9524/Euro in 6 month as dollar continue increase value, and a $0.9804/Euro in 2-3 years.
GBP to USD Rate
Source: Marketwatch.7
The US Dollar Index (DXY) is measures the US dollar with a basket of foreign currencies (Euro, Japanese Yen, Canadian Dollar, Swedish Krona, Swiss Franc).8 However it ignores some currencies that have become more important recently. The DXY suggested that the US dollar is appreciating in general in recent 5 years. We forecast a 105 in 6 months and 110 in 2-3 years, since dollar is strengthening. Source: Marketwatch.13
3 Important disclosures appear on the last page of this report.
British pound has effect of negative 36.2 million on Adobe’s foreign revenue.14
GBP to USD rate has increasing since 2015. It change from 0.7 dollar per pound to 0.8 dollar per pound since Brexit, and now maintain around 0.8 dollar per pound. As the Brexit processing going, we forecast a rate close to 0.82 to 0.84 dollar per pound in 6 month. After the process settled down, we assume the range will go back to near 0.7 dollar per pound in 2-3 years.
Industry Analysis
Adobe Systems Inc. falls into the application software Source: ZDnet.com15 industry, within the technology sector. The application software industry is a sub industry in the technology sector, where companies develop software for either The SAAS market has become the most used and accepted individual or corporate users that helps them perform in the application software space due to the easy adoption various tasks, such as managing their relationship with without companies changing their IT infrastructure. We their customers, maintaining finances, to helping with see this showing tremendous value as more and more daily operations. companies are implementing software services within their company. Additionally, we believe that growth of Application software companies have recently been application software companies will primarily stem from primarily driven by their subscription revenue and cloud their cloud based products. software businesses. Moreover, subscription based revenue models are dependent on users who renew their Cloud Revenue Growth subscriptions each year. Firms that dominate this industry are Microsoft, SAP SE, Oracle, and Adobe. Many firms Within the application software industry, revenue streams within this industry have seen large growth, especially from software products and services, through either a Adobe with their large growth in cloud subscribers. subscription or perpetual licensing model. In fact, Adobe has shifted its business model towards a subscription based model rather than a license based model.
Business Segments
Product Lines for this industry include software products for business functions, big data collection, and financial performance. These lines serve almost all industries from automotive to healthcare.
More specifically, one of the major business segments in the application software industry is has recently been cloud Source: Statista (5). software. The cloud based market is comprised of three main segments: Infrastructure-as-a-service, Platform-as-a- As the chart shows, software-as-a-service revenue has service, and Software-as-a-service. Moreover, the increased significantly from 2010 to 2016. The increase has been related to the demand of new features and software-as-a-service segment comprises most of the companies forcing consumers to pay for subscriptions to market spending as shown below. The SAAS market is get the latest features.16 We see the cloud segment expected to continue to grow at an expected rate of 19% maturing in the near future, since it has seen very large per annum until 2019. growth recently. This maturity is illustrated by one of the leading firms in the cloud segment, Adobe, whose profits are starting to fall.
4 Important disclosures appear on the last page of this report.
Developments and Trends A big trend, that has been in the software industry for a while is the strength of competition. From startups to established firms, the industry faces new competition regularly.
Although the strength of competition is high, it is important to note that of the 39 companies in the S&P 1500 software industry, only 1 has been founded since 1999 (Salesforce). This is due to the importance of established relationships that the companies with large market caps have with clients and their larger budgets for top talent, advertising and research. Source: Bloomberg
As the pie chart below illustrates, firms such as Microsoft, The growth cycle of the “smart” application is entering SAP, Oracle, IBM, and Salesforce.com have a large maturity, meaning normalized growth and companies will presence in the application software industry. start having to relying on artificial intelligence for growth in the application software industry. The “other” classification is comprised of many different smaller firms within the industry. Artificial intelligence is in products such as Google Furthermore, the degree of market share is based on each Assistant, Amazon Alexa and IBM Watson. firm’s revenue from application software.
Another trend is the shift towards a subscription based Catalysts for Growth/Change model rather than a license model, as mentioned earlier. Subscription models that application software firms are There are several factors that drive Application Software starting to implement will be useful in smoothing out industry growth. Hardware demand, upgrade cycles and cyclical fluctuations with the economy and providing a transition to cloud based applications will be the most constant revenue stream. important drivers in the Application Software industry.
The long-term value the constant revenue stream however Hardware Demand means that there will be a short-term fallout of cash. Software is always bound with hardware, if new hardware Market and Competition is introduced, software also needs to be updated with the operating system. The more hardware sold, the more The best firms positioned in this industry are ones that software demand is generated. As tablets become a have prominent market share and have a competitive edge convenient and popular choice to gradually replace laptops, Adobe’s team developed application for tablet on their peers. users.
Furthermore, many firms have also merged or acquired Upgrade Cycle others to gain exposure to different markets. For example, Salesforce.com acquired Demandware to increase its Application software is more user based. The operating customer platform. system is always updating to adapt to user’s needs and brings better user experience with new features. Software
needs to follow both hardware and operating system Additionally, regarding Salesforce.com, it is ones of the upgrades. For example, when Apple updates its iOS largest customer relationship management companies in system, other application software also needs to update. the industry (Salesforce.com). However, with regard to Currently, as the technology develops at a high speed, and overall market share in the application software industry, the upgrade cycle will also speed up. salesforce.com has a relatively small presence compared to its peers. Moreover, upgrade cycles are increasing with the innovative nature of the technology industry. For example, Microsoft tends to abandon old operating systems after 5 years, which means that older programs may not be supported anymore.17 These upgrade cycles are the result
5 Important disclosures appear on the last page of this report.
of consumer demand for new products with unnecessary Bargaining Power of Suppliers: Low features. As the upgrade cycles continue to increase, consumers will be forced to upgrade. We see the upgrade The bargaining power of suppliers in the application cycle continuing to grow significantly as technology firms software industry is very low. Application software continue to innovate and release new software. companies are reliance on their software development, but not so much the purchase and supply of physical Transition to Cloud Based Applications goods. In fact, application software companies are often their own suppliers. As more information generate, users are not satisfied with hard disks to transmit and store data. Cloud based Industry Rivalry: High application will be more acceptable in the future.18 With cloud based application, people can work anywhere and in The competition is very high in the application software any device, which reduce the data transport and occupation industry. Firms are constantly trying to maintain an edge in their own hardware. Adobe did a great transition from on their competitors and sustain a large market presence. single application to cloud services, and you can easily For example, many customers have become angry about change your work from any device close to you. Adobe’s switch to subscription model, so firms like Quark Inc has gained attraction with it QuarkXPress layout Mergers and Acquisitions software products.21 New Initiatives for companies in this subindustry include mergers and acquisitions in order to diverse products Key Investment Positives & Negatives through acquiring pure-play businesses. For example, Positives Oracle purchasing Net Suite and Salesforce acquiring Demandware. Another initiative for firms in this industry Software has the most weight in the technology industry, is the transition to implementing artificial intelligence in and also one of the most competitive industries in the their products as the “smart” product or app is maturing in world. Although it is also very concentrated, the 4 largest the product life cycle. companies dominate 73.96% of the market.22
For the sub-industry, Application Software has almost Porters Five Forces limitless opportunities to develop. Every new task can
generate a set of software potentially.23 Threat of New Entrants: Low
Negatives The competitive nature of the application software industry makes it difficult for new firms to sustain Software in general is relatively mature in the technology success. In fact, if a new firm does not maintain a sector. For example, most other software operates on technological or marketing edge on its competitors, or Windows and iOS systems, Adobe has covered most if the firm can’t reach a large enough scale, then it will design area, etc. Unless new areas are developed, new be an acquisition target for its competition.19 investments in big companies will only be a strategy of maintaining current performance. There is not much room Threat of New Substitutes: Low for new growth.24
Most firms in the application software industry have a niche market, and produce their own unique products. Company Analysis Substituting between application products, such as Creative Cloud, is not very likely since Adobe provides its own unique services. General Information Adobe Systems Incorporated is a pure play company in Bargaining Power of Customers: Moderate Application Software. It provides digital media and digital marketing products, and services for users on creating, The bargaining power of customers is moderate, due to managing, delivering, measuring, optimizing and engaging the fact that customers can pressure application with different content via various media, devices and software companies to release newer versions of their operating systems. applications. However, firms can also utilize subscription models to force customers to Adobe’s products and services cover digital media, digital continuously renew their subscriptions, if they want to marketing, and print and publishing business segments. use new features, giving firms some leverage over customer bargaining power.20 6 Important disclosures appear on the last page of this report.
As it first promoted in 1983, it began with the Adobe PostScript technology and was licensed to printer manufacturers over the world. Later, it stepped into desktop software applications and launched Adobe Illustrator, Photoshop, and Acrobat desktop software. Aside from developing and releasing its own software solutions, it also acquired different software, and worked on technology collaboration or agreement with other companies, in order to develop a more complete work suite.
Adobe’s products face a competitive environment with short product life cycles and frequent changing in industry Source: Adobe 10-K 2016 standards and introduction of new products.
As the pie chart indicates, the main sources of revenue for This requires the company to discover new customer needs Adobe is digital media, which we expect to continue to and develop or acquire new product line frequently. grow significantly. We then believe growth will level off at a 2.9% growth rate in 2022. In fiscal year 2016, Adobe generated revenue of 5,854.4 million. Including 3,941 million in Digital media, 1,736.6 In Adobe’s income statement, however, the company million in Digital market, and 176.8 million in Print and reports their revenue by Subscription, Product Revenue, publishing. The total revenue has increased by 22% over and Service and Support Revenue. Since Adobe released FY2015. the Creative Cloud by subscription in 2012, subscription revenue growth rapidly and has become its major revenue (Sources: MarketLine25 and Adobe 10K 201626) stream, it will be easier for Adobe to report its revenue in this way.28 Products and Markets Subscription Revenue generated by the subscription of Key products and Brands Adobe Creative Cloud, which contains most of its major services design products, such as Photoshop, and Illustrator. • Digital media • Creative Cloud Product Revenue mainly comes from people who purchase solutions • Photoshop • Digital imaging • Illustrator its old version of single products, which can be used for software • InDesign the rest of the life, once they purchase them. Since • Vector graphics • Adobe Premiere Pro Creative Cloud is provided on subscription basis, once you software • After Effects subscribe it, you can use all products it provide in the • Professional page • Dreamweaver suites, beyond the restriction of device, it is a trend that layout software • Animate people move from single product to a more convenient • Video editing tool • Adobe Digital Publishing Suite cloud suites. This reflect people’s demand for transiting to • Animation and • Typekit cloud based application in the whole industry, as the creative compositing • Behance diversification of devices. software • Acrobat and Document Cloud • Digital publishing • Adobe Analytics solution • Adobe Target • Portable document • Adobe Social format (PDF) • Adobe Media Optimizer creation and • Adobe Experience Manager conversion • Adobe Campaign • Digital marketing • Adobe Audience Manager solutions • Adobe Primetime
(Source: MarketLine27)
Adobe’s revenue generates from: - Digital media (67% of the total revenues in FY2016) - Digital marketing (30%) Source: Adobe Valuation Model - Print and publishing (3%)
7 Important disclosures appear on the last page of this report.
Earnings Analysis
For fiscal year 2016, Adobe reported their revenue to be $5.85 million, which represents a 22% growth year-over- year. The revenue and net income growth was driven by the strong performance and growth of Creative Cloud revenue, Adobe document cloud subscriptions, and strong revenue for Adobe Marketing Cloud.
Source: Adobe Valuation Model
The first chart above shows the growth rate by segment in subscription. We can see their subscription revenue suddenly increase after their switch to a subscription-based model, especially in Digital Media and Printing and Publishing. At the end of fiscal year 2016, the subscription revenue gradually enters a more steady growth trend, but the growth rate is still as high as 50%. Digital Marketing Source: Statista29 kept growth at a rate close to 20%. So in our forecasting, we keep the Digital Marketing growth rate at 20%; for As the chart illustrates, Creative Cloud subscriptions have both Digital Media and Printing and Publishing, we grown significantly since 2013. It is estimated that applied a steady reducing growth rate, from 33% to 8%. subscribers will surpass 13 million in 2017. We believe short term growth will be primarily driven by the rapid From the second chart, we can see the overall revenue increase of subscribers. growth rate for Subscription, Product, and Service & Support. We noticed that Product revenue has a negative The company achieved record Creative Cloud revenue of growth rate, and has been decreasing rapidly since 2012. $886 million in Q4, while also achieving annual Creative After the release of Creative Cloud, the amount of people Cloud revenue of $3.2 billion; furthermore, this equates to purchasing single products decrease. In our model, we 38% year-over-year growth in Creative Cloud revenue. build a -41.7% (in 2016) decrease of percentage of total Similarly, Document cloud revenue for the quarter was revenue into forecasting, and at the CV year 2022, the $191 million, while the annualized recurring revenue was percentage of Product Revenue in total revenue will be $475 million. close to 0%. The Service and Support revenue is growing steadily every year, so in the model, we forecast it as a 7% Furthermore, Digital media also generated $4 billion of of total revenue. After taking out the percentage of Product annualized recurring revenue. Moreover, there was an and Service, we get the percentage of Subscription, and increase of $316 million in net ARR from Q3 to Q4, use the total Subscription revenue divided by the because of the adoption and retention of Creative Cloud percentage of Subscription, we forecasted the total revenue and Document cloud across various customer segments (See Revenue Decomposition). (Earnings Call Script).
Geography: Managerial Guidance
The success of Adobe has been the result of manager’s ability to predict the future accurately. Moreover, in the 4Q earnings call, it was stated that Adobe has been utilizing artificial intelligence technology and machine learning. 30
Additionally, management has been able to create a unique corporate culture. They have achieved this through increasing diversity among their employees.
Source: Adobe 10-K 2016
8 Important disclosures appear on the last page of this report.
Competition Research & Development Overall, Adobe faces intense competition. With high industry standards, products are updated in short life Research and development expenses were $976.0 million, cycles, resulting in new products that are entering $862.7 million and $844.4 million for 2016, 2015, and frequently. 2014, respectively.
In the digital market segment, the company’s competitors They develop their software internally, and acquire including Apple, Autodesk, Corel, Microsoft, etc., and products and technology by others by investing in their lower-end offerings via app stores at smart devices. In the stock. The increase in research & development costs digital marketing segment, Adobe Marketing Cloud is between 2016 and 2015 was primarily due to an increased competing with Google, IBM, Oracle, Salesforce.com, headcount, which increased the costs related to SAP, etc., in various market areas. The print and compensation and benefits for more people. publishing offerings also compete with large-scale electronic and web publishing systems, XML-based The research & development expenses consist primarily of publishing firms and lower-end desktop publishing salaries and benefits for software developers and expenses products.31 related to facilities and computer equipment used in software development. To compete in the market, Adobe is focusing on develop cloud-based offerings available on subscription basis. The corporate headquarters, research and development Although the development of smart devices provides activities, data centers, and other significant facilities are opportunities to a lot of low-end offering competitors, this conducted in the San Francisco, which is near a major is also an opportunity for Adobe to develop its products in earthquake faults, where future operating results can be smart devices. Through the launch of Adobe Creative severely hindered if a catastrophic event occurred. Cloud in digital media, Adobe realized its transition from computer desktop to cloud-based applications, through In-process research and development of acquired which users can shift conveniently from one device to companies is integrated into their tangible and intangible another without interruption. Similarly, Adobe Marketing assets based on the estimated fair value at acquisition. Cloud is the solution for the digital market. Foreign Sales and Earnings: Besides pushing out cloud-based products, Adobe will also enhance and integrate existing products, provide new Outside of the United States, Adobe engages in business products time, meet customer needs, protect customer transactions in U.S. dollars and other currencies. information, extend core technology into new products. Moreover, they utilize foreign exchange derivatives to (Source: MarketLine32) hedge foreign currency revenue, which reduces their foreign exchange risk.
Financial Metrics of Competitors When the dollar strengthens and the hedged foreign currency assets decrease, and thus their overall market Market Cap Share Price Sales Net Income EPS P/E P/S P/B Adobe (ADBE) 64.31B 129.99 5,854,430 1,168,782 2.62 49.47 10.42 8.45 value of their financial hedging instruments increases. SAP SE (SAP) 115.48B 96.57 23,270,000 3,833,000 3.24 29.82 4.92 4.12 Salesforce.com (CRM) 59.29B 83.8 8,391,984 179,632 0.26 322.31 7.06 7.9 Oracle (ORCL) 182.61B 44.38 37.047,000 8,901,000 2.11 20.99 4.88 3.61 The company has decided to primarily use forward Microsoft (MSFT) 504.92B 65.29 85,320,000 16,798,000 2.12 30.75 5.89 7.34 contracts in the future, rather than option contracts, Source: Yahoo! Finance33 ultimately to hedge their revenue in foreign currencies more efficiently. Moreover, at the end of 2016, all of the Furthermore, we gathered various multiples that we view company’s foreign exchange contracts were worth $891.2 are most relevant in the application software industry. We million (Adobe 10K 2016). If the dollar strengthens, given only gathered the data for top firms in the industry, the current economic status of European and Asian ultimately to gain a better understanding of Adobe’s countries, then it can drastically benefit Adobe. relative value compared to its competitors. Major Stockholders Overall, we believe that competitors within this industry will continue to put pressure on each other to The major stockholders in Adobe are individual investors. innovate in order to sustain longevity. There are roughly 1,125 holders of Adobe’s common stock. However, it is difficult to estimate how many total shareholders there are because many of the shares are held Other Topics by brokers or institutions, on behalf of stockholders.34 9 Important disclosures appear on the last page of this report.
Moreover, major holders are institutions and mutual fund Opportunities owners hold about 92.30% of common stock; on the other hand, 0.38% are held by insiders and 5% by owners. - Growth in demanding of the market
Dividend Payout Policy The increasing of demand from new devices provide great opportunity for Adobe to develop its mobile terminal- They did not declare or pay out any cash dividends for based products. As they has already move to cloud-based FY2016 and FY2015. Moreover, they do not anticipate to subscription, they embraced this big opportunity and a part pay out any dividends in the foreseeable future. of their growth will generate just from this natural growth of demanding. So there growth will be optimistic in the Significant Real Estate near future.
The most relevant real estate information, with regard to - Opportunity in digital marketing recent transactions, is that they sold a building and land with a total carrying value of $36.3 million, at the end of The market has an increasing demand for optimize 2015. customers experience, and Adobe’s digital marketing is focus on provide this solutions. Their solution focused on S.W.O.T. ANALYSIS features for both “web and mobile analytics, social marketing, targeting, advertising and media optimization, Strengths digital experience management, cross-channel campaign management, audience management, advertising and real- - Strong growth in subscription revenues time bidding technology, premium video delivery and monetization.”35 During 2015-2016, their digital Adobe’s subscription growth rapidly since it release advertising has increased about 76%.36 Creative Cloud, although the growth rate is decreasing, it still close to 50% at 2016. In the feature, we forecast it will Threats gradually enter a steady growth stage, and in our model, we built a gradually decreasing growth rate into it. - Intense competition
In Digital Media, the increasing amount of digital image In Digital Media, device, hardware and camera and video demand leads by more access of digital camera manufactures try to bundle their own software for free. As and other new devices bring more users to their imaging Adobe transfer to cloud-based offering, they also face and video offerings. competition in other smart phone and tablet applications. Since the cost of developing applications on mobile - Broad offering for products and services terminal is much cheaper than on computer, a lot of new photo and video editing offerings from small business Adobe has developed a lot of products by themselves, but provide a much cheaper or free price for users. For also acquire other companies and merge their product into unprofessional designers, there are a lot of substitutes in Adobe’s own cloud-based suites. Once users subscript the mobile device market. cloud suites, they have access to all of them in the suites. This provide a great deal for people who need a lot of In Digital Marketing, the Adobe Marketing Cloud also them, and also keep the loyalty from users. If they has faced competition from big companies like Google, IBM, subscribe it, they will be less likely to turn to another Marketo, Oracle, salesforce.com, SAP, SAS, Yahoo!, company’s product, they will be more likely to use Verizon, and Teradata. Companies offer product and products already provided in the suite. Besides, it will be services together can bundle them together as well. easier for them to move from one software to another, from Photoshop to Illustrator, for example. - Limited room for future growth
Weaknesses The biggest switch Adobe did is shifting from product- base to cloud-base, but their products didn’t change that - Debt obligations much. In fact, they just put every related product they have into Creative Cloud or Marketing, so that different Adobe has a high leverage. They have a debt ratio of 0.42 software can have a better compatibility. The increasing of in 2016. They have 1.9 billion senior notes outstanding at their subscription revenue partially comes from the the end of 2016, 900 billion dues in 2020 and 1 billion original product revenue, rather than new growth. Before dues at 2025. Although it will bring tax benefits, it also this transition in 2011, it has a product revenue of 3.4 means risk. billion. Although the subscription revenue in 2016 has 10 Important disclosures appear on the last page of this report.
exceeded this number already, we still need to consider from 48.84% in 2016 to 33% in 2017, gradually falling what actually creates new value for Adobe. As a result, we to 8% in 2022. Our logic behind estimating a decrease estimate the revenue in a more conservative way. We in high growth to a steady growth is because digital suggest that after 2019, it will get into a more steadily media revenue has fallen significantly over the last 3 growth stage. Their market is nearly mature in digital years. We believe gradually decreasing the growth will market. Without introduce new product, they will probably capture the overall maturity of Adobe’s digital media maintain it performance, and their growth will only come business, as well as the industry competitive nature from the natural growth of demand from market. that is steering customers away from Adobe’s subscription model. Since 2014, Adobe’s digital media - Foreign exchange currency fluctuations subscription revenue has fallen from 168.76% in 2014 to 48.84% in 2016. Overall, we estimate this high Since Adobe have nearly 50% of its revenue comes from growth to decline to a lower, steady rate in the next 5 oversea market, without appropriate hedging, their foreign years. revenue will shrink as dollar strengthening. They also need to prepare for any economic changing in foreign market. Digital Marketing
Digital marketing has shown consistent, steady growth Valuation Discussion over the last 4 years. Digital marketing is driven by Adobe’s Marketing Cloud software subscriptions with corporate users. We estimate that this growth will Through our economic and industry outlook, and current remain constant throughout our forecast period, since company specific factors, we implemented various it has remained stable since adobe’s move to a assumptions regarding Adobe’s future financial subscription model in 2013. Moreover, we expect performance and its intrinsic and relative stock price; our growth to remain at 20% throughout our forecast rating is a SELL due to the results of our valuation model period. This estimate is optimistic with regard to and assumptions we have going forward for Adobe. Adobe’s digital marketing business; however, digital Moreover, we used a discounted cash flow model, marketing seems more stable than digital media, which economic profit model, dividend discount model, and a is why we assumed growth would remain stable for the relative valuation. next 5 years.
Revenue Decomposition Printing and Publishing
Adobe’s revenue growth has primarily stemmed from In our outlook for printing and publishing subscription its subscription revenue, which is divided into three revenue, we used the same intuition that we used in segments: digital media, digital marketing, and forecasting digital media subscription revenue. printing and publishing. The digital media segment has Overall, printing and publishing subscription revenue primarily driven revenues through Adobe’s innovation has fallen significantly since Adobe’s switch to a in its Creative Cloud and Creative Document subscription based model. In fact, printing and businesses. We believe that revenue growth will publishing subscription revenue has fallen from a primarily stem from Adobe’s digital media and digital 272% growth rate in 2014 to a 51% growth in 2016. marketing segments, while it’s printing and publish We decided to decrease printing and publishing segment will eventually decline. revenue at the same rate as digital media, slowly decreasing revenue growth from 33% in 2017 to 8% in Subscription Revenue 2022. We believe that the maturity of Adobe’s subscriber growth, and recent performance of digital Digital Media media, illustrates an overall trend in how well printing and publishing will perform going forward. By slowly The growth of the digital media segment has been decreasing growth by about 10% each year until it driven by Adobe’s Creative Cloud and Document reaches a more sustainable growth of 8%, we can Cloud subscriptions. Subscribers have grown from capture the overall trend of subscriber growth 1.44 million in 2013 to a projected 13 million in 2017. maturing. This large growth has been the result of Adobe’s shift from a perpetual license based model to a subscription Product Revenue model in 2013.37 Moreover, we expect growth to slowly fall overtime, as Adobe’s digital media Product revenue is revenue that is driven by their business starts to mature. We expect growth to fall perpetual and term-based software products.38 We
11 Important disclosures appear on the last page of this report.
ultimately see product revenue, as a percentage of total administrative expenses rose to 39% and 10%, revenue, falling to almost 0%. More specifically, we respectively. Recently they have normalized and have product revenue falling from 7.97% of sales in decreased back to historical percentages. Therefore, 2017 to 0.54% of sales in 2022. This decline is due to we assumed that keeping both accounts as a constant the fact that Adobe is shifting all of its focus on its percentage of sales, based on a historical average, is subscription revenue. most logical going forward. Moreover, we expect sales & marketing to be 34.25% of sales, and general & Services & Support Revenue administrative to be 7.60% of sales going forward.
Services & Support revenue is driven by Adobe’s Research and Development consulting, software maintenance, and technical support of their cloud solutions and licensed Research and development costs are related to the products.39 Overall, services and support revenue has salaries of software developers, research facility costs, performed very consistently throughout the last 4 and expenses related to computer equipment used by years, since Adobe adopted a new business model. In developers. Moreover, research and development costs forecasting services and support revenue, instead of have gradually risen in value over time, however, as a looking at the year-over-year revenue growth, we percentage of sales, it has remained stable. We instead looked at the average historical percentage of therefore forecasted research and development as a revenue that is from services and support, which we constant percentage of sales going forward. More calculated to be 7%. Given the consistency of this line specifically, we estimated that research and of revenue, we estimated that services and support development will remain 5.7% of sales throughout our revenue will remain a constant 7% of total revenue forecast period. through the forecast period. Given that this line of revenue stems from Adobe’s support of their Capital Expenditures application software products, we believe that services and support revenue will remain stable going forward. In our forecast of capital expenditures, we looked at managerial guidance regarding future property, plant, Cost of Goods Sold and equipment investments. Moreover, management has stated that capital expenditures will decrease Adobe breaks down cost of goods sold by its three slowly over time as their investments towards streams of revenue: subscription, product, and services property, plant, and equipment decreases. These & support. Cost of goods sold has slightly changed in decreases are due to debt obligations that are due in recent years due to the increase of data center costs, 2020 and 2025. Moreover, we estimated an average which resulted from an increase in transaction volume historical value of capital expenditures to be $157,317. of cloud services.40 However, COGS has remained We then slowly decreased the value of capital stable over the last decade. In order to forecast cost of expenditures from 2016 to 2022 by $10,000 goods sold, we took an average of cost of goods sold throughout the forecast period, until we arrived at a as a percentage of sales, and then kept cost of goods more normal level of capital expenditures, according sold as a constant percentage of sales going forward. to historical levels. Moreover, we estimate that cost of goods sold will remain at 14.21% of sales going forward. Keeping Continuing Value Growth Assumptions COGS as a constant percentage of sales will maintain consistent profit margins going forward, and will Our CV growth for NOPLAT and EPS are estimated at account for the increases in costs associated with 2.9%, which is where we see long-term growth of revenue growth going forward. GDP in our macroeconomic outlook. We believe that Adobe is very profitable in the short-term, with Selling and Administrative Expenses revenue growth equaling 10% in 2022; however, we know that Adobe’s growth will slow significantly and Adobe divides sales and administrative expense into won’t grow faster than the economy in the long-run. two accounts: sales & marketing and general & administrative. Both accounts have not had much In the continuing year, we estimated ROIC to be fluctuations at all over the last decade. In fact, we 25.02% and ROE to be 22.13%. Our ROIC is a noticed a trend where sales & marketing and general & function of NOPLAT and Invested Capital administrative expenses were around 32% and 7% of calculations, which primarily stem from our growth sales, respectively; moreover, when Adobe shifted to a assumptions. Additionally, our ROE is a function of new model in 2013, sales & marketing and general & our net income and stockholders’ equity. One
12 Important disclosures appear on the last page of this report.
important thing to note is that Adobe does not pay Adobe. Given the assumptions that we built into our dividends, nor does it plan on paying any in the future, model, we calculated an adjusted intrinsic stock price therefore retained earnings grows significantly; with of $119.32. We believe this price most accurately retained earnings growing, as a symptom of a non- reflects the true value of Adobe’s stock. Adobe is dividend paying company, our stockholders’ equity trading at $129.99 as of April 18, 2017, thus we grows significantly as well. However, our revenue also believe Adobe is overvalued. In fact, we were grows steadily, and thus our ROE remains between conservative in our equity risk premium assumption, 20.55% and 23.41% in our forecasting years. which lowered the WACC; if the WACC was higher, Adobe’s stock price would be even lower, thus further WACC supporting our SELL rating.
We estimated the weighted average cost of capital Dividend Discount Model through using the capital asset pricing model for the cost of equity, and analyzing long-term default Since Adobe does not pay out dividends, the dividend premiums of companies rated similar to Adobe to discount model is not an adequate model to use for estimate the cost of debt. Furthermore, we calculated a valuation. However, we calculated an adjusted stock WACC of 7.40%. We also used an effective tax rate of price of $93.33. Though we believe that Adobe’s stock 24.1% in our WACC calculation, as well as the yield is overvalued, the dividend discount model is not what on the 30-year Treasury bond as the risk-free rate. Our lead to this conclusion. WACC of 7.40% is the product of our assumptions relating to our cost of equity and cost of debt. We Relative Valuation believe our relatively low WACC is a symptom of our low cost of equity, which is due to our conservative In our relative valuation model, we estimated the 2017 outlook for the expected market returns over the risk- and 2018 P/E and PEG ratios for various comparable free rate. firms, and used those ratios to back out a relative stock price. In choosing our comparable firms, we choose Cost of Equity based on industry, growth, and size. Moreover, we believe these variables are most important in finding a As stated earlier, we used the capital asset pricing relative value for Adobe. model to estimate the cost of equity. First off, we used the current yield on the 30-year Treasury bond as our Our relative valuation backed out an estimated stock risk-free rate, since we are discounting long-term price of $110.42 and $110.48 for 2017 and 2018, cashflows. Secondly, we extracted our equity beta respectively. With regard to our PEG ratio analysis, from Bloomberg, which was 1.026. Lastly, we used we backed out stock prices of $172.43 and $158.99 for Damodaran’s estimate for the equity risk premium, 2017 and 2018, respectively. Furthermore, we believe which is 4.51%. We believe that a 4.51% equity risk the most accurate measure of relative value for Adobe premium captures the geometric historical average of are stock prices we backed out from the industry P/E equity risk premiums. The cost of equity we calculated ratios. We believe this value is an accurate measure of is 7.55%. Adobe in the application software industry.
Cost of Debt Sensitivity Analysis In estimating the cost of debt, Adobe did not have any long-term bonds outstanding that captured the enough CV Growth of NOPLAT and Beta risk. Therefore, we used Bloomberg to calculate the default-premium on long-term bonds that have similar We analyzed our stock price based on the CV growth ratings to Adobe. We calculated the cost of debt to be rate of NOPLAT and beta. We believe these two 4.285%. factors are very important in our cash flow estimation
and discount rate, thus we wanted to see the effects of
both. In short, we found that the highest stock price
resulted from a low beta and high CV growth of
NOPLAT, which was $131.30. In contrast, we found Discounted Cash Flow and Economic Profit Model that the lowest stock price was when beta was the
highest and CV growth of NOPLAT was lowest, We utilized a discounted cash flow and economic which was $109.85. We concluded that a high CV profit model to estimate an intrinsic stock price for
13 Important disclosures appear on the last page of this report.
growth rate of NOPLAT will mitigate the changes in beta.
Equity Risk Premium and Cost of Debt
Given the assumption we made about our equity risk premium, and since Adobe did not have any long-term bonds outstanding, we decided to test the equity risk premium and cost of debt. We noticed as the equity risk premium grew, the stock price fell significantly. This is indicative of the capital asset pricing model. In contrast, we also noticed that the cost of debt did not have much influence on the stock price, whereas the equity risk premium impacted the price significantly.
Risk Free Rate and Beta
Though we had tested beta against the CV growth rate of NOPLAT, we also wanted to see the effects beta had compared to the risk free rate. Beta had a much higher influence on the stock price against the risk free rate, than it did against the CV of NOPLAT. Additionally, the risk free rate also influenced the stock price significantly. We concluded that the implications of the cost of equity are very large on our valuation, thus our WACC assumptions are very sensitive.
Subscription Growth and COGS as % of Sales
We tested the subscription growth against COGS as a % of sales, essentially to see how growth and cost of goods sold affect our valuation. We found that the stock price was impacted by the COGS as a % of Sales to an extent, but subscription growth had a significant impact on the stock price. For example, if subscription growth would have been 43% and COGS at 6.6% of sales, as we forecasted COGS, then our stock price would have been $184.72. Thus, our valuation is very sensitive to growth.
Subscription Growth and CV ROIC
Additionally, since we save the effects of subscription growth compared to COGS as a % of sales, we wanted to see subscription growth against CV ROIC. Our CV of ROIC is dependent on our NOPLAT and invested capital calculations. In short, we found that CV ROIC does not affect the price very much either. As we saw earlier, our growth assumption significantly impacted the stock price once again. We concluded that growth is one of the most influential assumptions we have made in our model.
14 Important disclosures appear on the last page of this report.
Important Disclaimer
This report was created by students enrolled in the Security Analysis (6F:112) class at the University of Iowa. The report was originally created to offer an internal investment recommendation for the University of Iowa Krause Fund and its advisory board. The report also provides potential employers and other interested parties an example of the students’ skills, knowledge and abilities. Members of the Krause Fund are not registered investment advisors, brokers or officially licensed financial professionals. The investment advice contained in this report does not represent an offer or solicitation to buy or sell any of the securities mentioned. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Krause Fund may hold a financial interest in the companies mentioned in this report.
15 Important disclosures appear on the last page of this report.
References https://www.cnet.com/news/adobe-competitors-pounce-after- 1 Adobe Software Inc. (2017). Earnings Call Script: Adobe Q4 subscription-backlash/ and FY2016 Earning Results. Retrieved February 14th, 2017 22 NetAdvantage (October 2016) Software; Industry Overview. from Retrieved February 3rd, 2017 from S&P Capital IQ. http://wwwimages.adobe.com/content/dam/Adobe/en/investor- 23 Erne, B., & Teufel. A. (2010). Fisher Investments on relations/PDFs/51216102/2sm4RkL45bvq.pdf Technology. Hoboken, NJ: John Wiley & Sons, Inc. P76. 24 NetAdvantage (October 2016) Software; Industry Trends. 2 Bureau of Economic Analysis. National Income and Product Retrieved February 3rd, 2017 from S&P Capital IQ. Accounts, Gross Domestic Product: Fourth Quarter and Annual 25 MarketLine. (2015). Adobe Systems Incorporated: Company 2016 (Third Estimate), Corporate Profits: Fourth Quarter and Profile. Retrieved February 14th, 2017 from Annual 2016. Retrieved April 17th, 2017, from https://drive.google.com/file/d/0B1kfnvY_Na3vR25uQW5iSk5 https://www.bea.gov/newsreleases/national/gdp/2017/gdp4q16_ EWEk/view?ts=58a24231 3rd.htm 26 Adobe Software Inc. (2017). Form 10-K. Retrieved 3 Yahoo Finance. February 14th, 2017, from 4 Bureau of Labor Statistics. Databases, Tables & Calculators by http://wwwimages.adobe.com/content/dam/Adobe/en/invest Subject. Retrieved April 17, 2017, from or-relations/PDFs/ADBE-10K-FY16-FINAL- https://data.bls.gov/timeseries/LNS14000000 CERTIFIED.PDF 5 Yahoo! Finance. (2017). ADBE: Statistics. Retrieved February 27 MarketLine. (2015). Adobe Systems Incorporated: 14th from Finance.Yahoo.com Company Profile. Retrieved February 14th, 2017 from 6 Adobe Software Inc. (2017). Form 10-K. Retrieved February https://drive.google.com/file/d/0B1kfnvY_Na3vR25uQW5i 14th, 2017, from Sk5EWEk/view?ts=58a24231 http://wwwimages.adobe.com/content/dam/Adobe/en/investor- 28 Shankland, S. 2012. Adobe launches Creative Cloud relations/PDFs/ADBE-10K-FY16-FINAL-CERTIFIED.PDF subscription service. Retrieved April 17, 2017, from 7 MarketWatch. U.S. Dollar Index (DXY). Retrieved April 17, https://www.cnet.com/news/adobe-launches-creative-cloud- 2017, from http://www.marketwatch.com/investing/index/dxy subscription-service/ 8 Marotta, D.J., 2015. What Is The US Dollar Index? Retrieved 29 Statista. Adobe's Creative Cloud individual and team April 17. 2017, from subscriptions from 2013 to 2016 (in millions). Retrieved April https://www.forbes.com/sites/davidmarotta/2015/01/17/what-is- 17, 2017, from the-us-dollar-index/#6af3c444701e https://www.statista.com/statistics/497176/adobe-creative-cloud- 9 MarketWatch. Japenese Yen. Retrieved April 17, 2017, from subscriptions/ http://www.marketwatch.com/investing/currency/usdjpy 30 Adobe Software Inc. (2017). Earnings Call Script: Adobe Q4 10 Financial Times. The Japanese economy at a glance. Retrieved and FY2016 Earning Results. Retrieved February 14th, 2017 April 17, 2017, from from https://ig.ft.com/sites/numbers/economies/japan http://wwwimages.adobe.com/content/dam/Adobe/en/investor- 11 MarketWatch. USD/EUR. Retrieved April 17, 2017, from relations/PDFs/51216102/2sm4RkL45bvq.pdf http://www.marketwatch.com/investing/currency/usdeur 31 Adobe 2016 10-K 12 Adobe 2016 10-K 32 MarketLine. 13 MarketWatch. USD/GBP. Retrieved April 17, 2017, from 33 Yahoo Finance http://www.marketwatch.com/investing/currency/usdgbp 34 Adobe 2016 10-K 14 Adobe 2016 10-K 35 Adobe 2016 10-K 15 Dignan, L. 2014. Cloud services spending to balloon through 36 MarketLine 2018. Retrieved April 17, 2017, from 37 Shankland, S. 2013. Adobe kills Creative Suite, goes http://www.zdnet.com/article/cloud-services-spending-to- subscription-only. Retrieved April 17, 2017, from balloon-through-2018/ https://www.cnet.com/news/adobe-kills-creative-suite-goes- 16 Pogue, D. 2015. Why the Upgrade Cycle Will Never End. subscription-only/ Retrieved April 17, 2017, from 38 Statista https://www.scientificamerican.com/article/why-the-upgrade- 39 Adobe 2016 10-K cycle-will-never-end/ 40 Statista 17 Pogue, D. 2015. 18 Bloomberg L.P. (2017) Global Application Software 2017 Outlook. Retrieved February 3rd, 2017 from Bloomberg database. 19 Value Line. Industry Overview: Computer Software and Services. Retrieve April 17. 2017, from http://www.valueline.com/Stocks/Industries/Industry_Overview __Computer_Software_and_Services.aspx#.WPVp2ojyuUk 20 Dudovskiy, J., Oracle Porter’s Five Forces Analysis. Retrieved April 17, 2017, from http://research-methodology.net/oracle- porters-five-forces-analysis/ 21 Shankland, S. 2013. Adobe competitors pounce after subscription backlash. Retrieved April 17, 2017, from 16 Important disclosures appear on the last page of this report. Adobe Systems Inc Key Assumptions of Valuation Model
Ticker Symbol ADBE Current Share Price $129.99 Shares Outstanding 494,698 Current Model Date 2017/4/18 Fiscal Year End Dec. 31
Cost of Equity 7.55% Pre-Tax Cost of Debt 4.285% Beta 1.026 Risk-Free Rate 2.920% Equity Risk Premium 4.51% CV Growth of NOPLAT 2.90% CV Growth of EPS 2.90% Current Dividend Yield 0.00% Marginal Tax Rate 11.8% Effective Tax Rate 24.1% WACC 7.57% CV ROIC 25.02%
17 Adobe Systems Inc Revenue Decomposition
Fiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021E CV 2022E Subscription Revenue Streams: Digital Media 1268300 2264700 3370800 4483164 5514292 6231150 6729642 7268013 7849454 Digital Media Growth Rate 168.76% 78.56% 48.84% 33.00% 23.00% 13.00% 8.00% 8.00% 8.00% Digital Marketing 797500 937000 1180400 1416480 1699776 2039731 2447677 2937213 3524656 Digital Marketing Growth Rate 20.27% 17.49% 25.98% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00% Printing and Publishing 10800 22200 33600 44688 54966 62112 67081 72447 78243 Printing and Publishing Growth Rate 272% 106% 51% 33% 23% 13% 8% 8% 8% Subscription Revenue 2076602 3223901 4584801 5944333 7269034 8332993 9244400 10277673 11452353 Growth rate 82.49% 55.25% 42.21% 29.65% 22.29% 14.64% 10.94% 11.18% 11.43% Percentage of Total Revenue 50.07% 67.23% 78.31% 85.03% 88.36% 90.29% 91.42% 92.08% 92.46% Product Revenue 1627800 1125100 800500 557091 382089 249798 159511 102616 66364 Growth rate -34.10% -30.88% -28.85% -30.41% -31.41% -34.62% -36.14% -35.67% -35.33% Percentage of Total Revenue 39.25% 23.46% 13.67% 7.97% 4.64% 2.71% 1.58% 0.92% 0.54% Services & Support Revenue 442700 446500 469100 489354 575891 646017 707821 781312 867000 Growth rate -1.01% 0.86% 5.06% 4.32% 17.68% 12.18% 9.57% 10.38% 10.97% Percentage of Total Revenue 10.67% 9.31% 8.01% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% Total Revenue 4147102 4795501 5854401 6990778 8227015 9228808 10111733 11161601 12385717 Total growth rate 2.27% 15.63% 22.08% 19.41% 17.68% 12.18% 9.57% 10.38% 10.97%
18 Adobe Systems Inc Income Statement
Fiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021E CV 2022E Revenue Subscription 2,076,584 3,223,904 4,584,833 5,944,333 7,269,034 8,332,993 9,244,400 10,277,673 11,452,353 Products revenue 1,627,803 1,125,146 800,498 557,091 382,089 249,798 159,511 102,616 66,364 Services & support revenue 442,678 446,461 469,099 489,354 575,891 646,017 707,821 781,312 867,000 Total revenue 4,147,065 4,795,511 5,854,430 6,990,778 8,227,015 9,228,808 10,111,733 11,161,601 12,385,717
Cost of revenue Subscription 335,432 409,194 461,860 459,993 541,338 607,256 665,352 734,433 814,980 Products 97,099 90,035 68,917 291,515 343,067 384,841 421,659 465,439 516,484 Services & support 189,549 245,088 289,131 241,881 284,655 319,317 349,866 386,191 428,546 Total cost of revenue 622,080 744,317 819,908 993,390 1,169,059 1,311,414 1,436,877 1,586,064 1,760,010
Gross profit 3,524,985 4,051,194 5,034,522 5,997,388 7,057,956 7,917,394 8,674,856 9,575,538 10,625,706
Operating expenses Research & development 844,353 862,730 975,987 1,031,618 1,090,420 1,152,574 1,218,271 1,287,713 1,361,112 Sales & marketing 1,652,308 1,683,242 1,910,197 2,394,341 2,817,752 3,160,867 3,463,268 3,822,848 4,242,108 General & administrative 399,132 385,619 420,110 531,299 625,253 701,389 768,492 848,282 941,314 Depreciation and Amortization 144,200 146,300 157,600 196,720 196,017 193,074 188,430 182,496 175,581 Restructuring & other charges 19,883 1,559 (1,508) 23,842 23,842 23,842 23,842 23,842 23,842 Amortization of purchased intangibles 52,424 68,649 78,534 60,089 68,784 69,541 70,306 71,079 71,861 Total operating expenses 3,112,300 3,148,099 3,540,920 4,237,909 4,822,069 5,301,287 5,732,609 6,236,259 6,815,819
Operating income 412,685 903,095 1,493,602 1,759,479 2,235,886 2,616,107 2,942,246 3,339,278 3,809,888
Non-operating income (expenses) Interest & other income (expense), net 7,267 33,909 13,548 139,030 157,729 205,442 262,173 327,971 407,578 Interest expense (59,732) (64,184) (70,442) (81,504) (65,716) (65,716) (65,716) (65,716) (65,716) Investment gains (losses), net 1,156 961 (1,570) ------Total non-operating income (expense), net (51,309) (29,314) (58,464) 57,526 92,013 139,726 196,457 262,255 341,862 Income before income taxes 361,376 873,781 1,435,138 1,817,006 2,327,900 2,755,833 3,138,703 3,601,533 4,151,750 Provision for (benefit of) income taxes 92,981 244,230 266,356 214,433 274,726 325,228 370,412 425,033 489,966 Net income (loss) $ 268,395 $ 629,551 $ 1,168,782 $ 1,602,573 $ 2,053,174 $ 2,430,605 $ 2,768,291 $ 3,176,500 $ 3,661,783 Weighted average shares outstanding-basic 497,867 498,764 498,345 498,555 498,450 498,502 498,476 498,489 498,482 Net income (loss) per share-basic $ 0.54 $ 1.26 $ 2.35 $ 3.21 $ 4.12 $ 4.88 $ 5.55 $ 6.37 $ 7.35
19 Adobe Systems Inc Balance Sheet
Fiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021E CV 2022E Assets Current Assets Cash & cash equivalents 1,117,400 876,560 1,011,315 1,542,205 3,063,501 4,890,357 7,024,327 9,627,750 12,780,346 Short-term investments 2,622,091 3,111,524 3,749,985 3,859,485 3,972,182 4,088,169 4,207,544 4,330,404 4,456,852 Trade receivables, net 591,800 672,006 833,033 964,727 1,135,328 1,273,576 1,395,419 1,540,301 1,709,229 Deferred income taxes 95,279 ------Prepaid expenses & other current assets 175,758 161,802 245,441 230,696 271,491 304,551 333,687 368,333 408,729 Total current assets 4,602,328 4,821,892 5,839,774 6,597,113 8,442,502 10,556,652 12,960,977 15,866,788 19,355,155 Property & equipment, gross 1,699,157 1,758,616 1,926,212 2,120,017 2,303,822 2,477,627 2,641,432 2,795,237 2,939,042 Less accumulated depreciation & amortization 914,034 971,195 1,109,948 1,306,668 1,502,685 1,695,759 1,884,189 2,066,685 2,242,266 Property & equipment, net 785,123 787,421 816,264 813,349 801,137 781,868 757,243 728,552 696,776 Goodwill 4,721,962 5,366,881 5,406,474 5,406,474 5,406,474 5,406,474 5,406,474 5,406,474 5,406,474 Purchased & other intangibles, net 469,662 510,007 414,405 474,373 479,591 484,867 490,200 495,593 501,044 Investment in lease receivable, non-operating 80,439 80,439 80,439 80,439 80,439 80,439 80,439 80,439 80,439 Other assets 126,315 159,832 149,758 251,668 296,173 332,237 364,022 401,818 445,886 Total assets 10,785,829 11,726,472 12,707,114 13,623,417 15,506,316 17,642,537 20,059,356 22,979,664 26,485,774
Liabilities and Stockholder's Equity Current Liabilities Trade payables 68,377 93,307 88,024 111,852 131,632 147,661 161,788 178,586 198,171 Accrued expenses 683,866 678,364 739,630 964,727 1,135,328 1,273,576 1,395,419 1,540,301 1,709,229 Income taxes payable 23,920 6,165 38,362 37,311 47,802 56,590 64,452 73,956 85,254 Deferred revenue 1,097,923 1,434,200 1,945,619 2,097,233 2,468,104 2,768,642 3,033,520 3,348,480 3,715,715 Total current liabilities 2,494,435 2,213,556 2,811,635 3,211,125 3,782,867 4,246,469 4,655,178 5,141,323 5,708,370 Debt & capital lease obligations 911,086 1,907,231 1,902,068 1,533,625 1,533,625 1,533,625 1,533,625 1,533,625 1,533,625 Deferred revenue 57,401 51,094 69,131 83,889 98,724 110,746 121,341 133,939 148,629 Income taxes payable 125,746 256,129 184,381 293,613 345,535 387,610 424,693 468,787 520,200 Deferred income taxes 342,315 208,209 217,660 244,464 278,805 319,458 365,760 418,889 480,135 Other liabilities 73,747 85,459 97,404 83,889 98,724 110,746 121,341 133,939 148,629 Total liabilities 4,009,924 4,724,892 5,282,279 5,450,605 6,138,280 6,708,654 7,221,938 7,830,503 8,539,587 Stockholder's equity Common Equity 3,778,556 4,184,944 4,616,392 4,626,552 4,633,360 4,633,360 4,633,360 4,633,360 4,633,360 Retained earnings 6,924,294 7,253,431 8,114,517 9,717,090 11,770,264 14,200,869 16,969,160 20,145,660 23,807,443 Accumulated other comprehensive income (loss) (8,094) (169,080) (173,602) (173,602) (173,602) (173,602) (173,602) (173,602) (173,602) Treasury stock, net of reissuances (3,918,851) (4,267,715) (5,132,472) (5,997,229) (6,861,986) (7,726,743) (8,591,500) (9,456,257) (10,321,014) Total stockholders' equity (deficit) 6,775,905 7,001,580 7,424,835 8,172,811 9,368,036 10,933,884 12,837,418 15,149,161 17,946,187 Total liabilities and stockholders' equity 10,785,829 11,726,472 12,707,114 13,623,417 15,506,316 17,642,537 20,059,356 22,979,664 26,485,774
20 Adobe Systems Inc Cash Flow Statement All numbers in Thousands Fiscal Years Ending Dec. 31 2017E 2018E 2019E 2020E 2021E CV 2022E Cash flows from Operating Activities Net income 1,602,573 2,053,174 2,430,605 2,768,291 3,176,500 3,661,783 Adjustments to reconcile net income to cash from operating activities Add Depreciation and Amortization 196,720 196,017 193,074 188,430 182,496 175,581 Add Amortization of purchased intangibles 60,089 68,784 69,541 70,306 71,079 71,861 Change in deferred taxes 26,804 34,341 40,654 46,302 53,129 61,246 Change in working capital accounts Trade receivables, net (131,694) (170,601) (138,248) (121,844) (144,882) (168,928) Prepaid expenses & other current assets 14,745 (40,796) (33,059) (29,137) (34,646) (40,396) Trade payables 23,828 19,780 16,029 14,127 16,798 19,586 Accrued Expenses 225,097 170,601 138,248 121,844 144,882 168,928 Income taxes payable 108,181 62,413 50,863 44,945 53,598 62,711 Deferred revenue 166,373 385,706 312,560 275,473 327,559 381,924 Net cash provided by operating activities 2,292,716 2,779,419 3,080,265 3,378,736 3,846,514 4,394,297 Cash flows from Investing Acticities Change in ST investments (109,500) (112,697) (115,988) (119,375) (122,860) (126,448) Change in LT investments ------Capital expenditures (193,805) (183,805) (173,805) (163,805) (153,805) (143,805) Capitalization of intangible assets (120,057) (74,002) (74,816) (75,639) (76,471) (77,312) Business acquisitions (change in goodwill) ------Change in Lease Receivable ------Change in other assets (101,910) (44,505) (36,065) (31,785) (37,795) (44,068) Net Cash Used for Investing Acticities (525,272) (415,009) (400,674) (390,604) (390,932) (391,633) Cash flows fom Financing Activities Proceeds from issurance of long-term debt (368,443) - - - - - Change in other liabilities (13,515) 14,835 12,022 10,595 12,598 14,689 Payments of dividends ------Proceeds from issuance of common stock 10,160 6,808 - - - - Repurchases of common stock (864,757) (864,757) (864,757) (864,757) (864,757) (864,757) Change in accumulated other comprehensive income ------Net cash provided by financing activities (1,236,554) (843,115) (852,735) (854,162) (852,159) (850,068) Net Increase (Decrease) in Cash 530,890 1,521,295 1,826,856 2,133,970 2,603,423 3,152,596 Cash & cash equivalents at the beginning of period 1,011,315 1,542,205 3,063,501 4,890,357 7,024,327 9,627,750 Cash & cash equivalents at the end of period 1,542,205 3,063,501 4,890,357 7,024,327 9,627,750 12,780,346
21 Adobe Systems Inc Common Size Income Statement
Fiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021E 2022E Revenue Subscription 50.07% 67.23% 78.31% 85.03% 88.36% 90.29% 91.42% 92.08% 92.46% Products revenue 39.25% 23.46% 13.67% 7.97% 4.64% 2.71% 1.58% 0.92% 0.54% Services & support revenue 10.67% 9.31% 8.01% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% Total revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Cost of revenue Subscription 8.09% 8.53% 7.89% 6.58% 6.58% 6.58% 6.58% 6.58% 6.58% Products 2.34% 1.88% 1.18% 4.17% 4.17% 4.17% 4.17% 4.17% 4.17% Services & support 4.57% 5.11% 4.94% 3.46% 3.46% 3.46% 3.46% 3.46% 3.46% Total cost of revenue 15.00% 15.52% 14.00% 14.21% 14.21% 14.21% 14.21% 14.21% 14.21%
Gross profit 85.00% 84.48% 86.00% 85.79% 85.79% 85.79% 85.79% 85.79% 85.79%
Operating expenses Research & development 20.36% 17.99% 16.67% 14.76% 13.25% 12.49% 12.05% 11.54% 10.99% Sales & marketing 39.84% 35.10% 32.63% 34.25% 34.25% 34.25% 34.25% 34.25% 34.25% General & administrative 9.62% 8.04% 7.18% 7.60% 7.60% 7.60% 7.60% 7.60% 7.60% Restructuring & other charges 0.48% 0.03% -0.03% 0.34% 0.29% 0.26% 0.24% 0.21% 0.19% Amortization of purchased intangibles 1.26% 1.43% 1.34% 0.86% 0.84% 0.75% 0.70% 0.64% 0.58% Total operating expenses 75.05% 65.65% 60.48% 60.62% 58.61% 57.44% 56.69% 55.87% 55.03%
Operating income 9.95% 18.83% 25.51% 25.17% 27.18% 28.35% 29.10% 29.92% 30.76%
Non-operating income (expenses) Interest & other income (expense), net 0.18% 0.71% 0.23% 1.99% 1.92% 2.23% 2.59% 2.94% 3.29% Interest expense -1.44% -1.34% -1.20% -1.17% -0.80% -0.71% -0.65% -0.59% -0.53% Investment gains (losses), net 0.03% 0.02% -0.03% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Total non-operating income (expense), net -1.24% -0.61% -1.00% 0.82% 1.12% 1.51% 1.94% 2.35% 2.76% Income before income taxes 8.71% 18.22% 24.51% 25.99% 28.30% 29.86% 31.04% 32.27% 33.52% Provision for (benefit of) income taxes 2.24% 5.09% 4.55% 3.07% 3.34% 3.52% 3.66% 3.81% 3.96% Net income (loss) 6.47% 13.13% 19.96% 22.92% 24.96% 26.34% 27.38% 28.46% 29.56%
22 Adobe Systems Inc Common Size Balance Sheet As percentage of Sales Fiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021E CV 2022E Assets Current assets Cash & cash equivalents 26.94% 18.28% 17.27% 22.06% 37.24% 52.99% 69.47% 86.26% 103.19% Short-term investments 63.23% 64.88% 64.05% 55.21% 48.28% 44.30% 41.61% 38.80% 35.98% Trade receivables, net 14.27% 14.01% 14.23% 13.80% 13.80% 13.80% 13.80% 13.80% 13.80% Prepaid expenses & other current assets 4.24% 3.37% 4.19% 3.30% 3.30% 3.30% 3.30% 3.30% 3.30% Total current assets 110.98% 100.55% 99.75% 94.37% 102.62% 114.39% 128.18% 142.16% 156.27% Property & equipment, net 18.93% 16.42% 13.94% 11.63% 9.74% 8.47% 7.49% 6.53% 5.63% Goodwill 113.86% 111.91% 92.35% 77.34% 65.72% 58.58% 53.47% 48.44% 43.65% Purchased & other intangibles, net 11.33% 10.64% 7.08% 6.79% 5.83% 5.25% 4.85% 4.44% 4.05% Investment in lease receivable, non-operating 1.94% 1.68% 1.37% 1.15% 0.98% 0.87% 0.80% 0.72% 0.65% Other assets 3.05% 3.33% 2.56% 3.60% 3.60% 3.60% 3.60% 3.60% 3.60% Total assets 260.08% 244.53% 217.05% 194.88% 188.48% 191.17% 198.38% 205.88% 213.84%
Liabilities and Stockholder's Equity Current liabilities Trade payables 1.65% 1.95% 1.50% 1.60% 1.60% 1.60% 1.60% 1.60% 1.60% Accrued expenses 16.49% 14.15% 12.63% 13.80% 13.80% 13.80% 13.80% 13.80% 13.80% Income taxes payable 0.58% 0.13% 0.66% 0.53% 0.58% 0.61% 0.64% 0.66% 0.69% Deferred revenue 26.47% 29.91% 33.23% 30.00% 30.00% 30.00% 30.00% 30.00% 30.00% Total current liabilities 60.15% 46.16% 48.03% 45.93% 45.98% 46.01% 46.04% 46.06% 46.09% Debt & capital lease obligations 21.97% 39.77% 32.49% 21.94% 18.64% 16.62% 15.17% 13.74% 12.38% Deferred revenue 1.38% 1.07% 1.18% 1.20% 1.20% 1.20% 1.20% 1.20% 1.20% Income taxes payable 3.03% 5.34% 3.15% 4.20% 4.20% 4.20% 4.20% 4.20% 4.20% Deferred income taxes 8.25% 4.34% 3.72% 3.50% 3.39% 3.46% 3.62% 3.75% 3.88% Other liabilities 1.78% 1.78% 1.66% 1.20% 1.20% 1.20% 1.20% 1.20% 1.20% Total liabilities 96.69% 98.53% 90.23% 77.97% 74.61% 72.69% 71.42% 70.16% 68.95% Stockholder's equity Common Equity 91.11% 87.27% 78.85% 66.18% 56.32% 50.21% 45.82% 41.51% 37.41% Retained earnings 166.97% 151.25% 138.60% 139.00% 143.07% 153.88% 167.82% 180.49% 192.22% Accumulated other comprehensive income (loss) -0.20% -3.53% -2.97% -2.48% -2.11% -1.88% -1.72% -1.56% -1.40% Treasury stock, net of reissuances -94.50% -88.99% -87.67% -85.79% -83.41% -83.72% -84.97% -84.72% -83.33% Total stockholders' equity (deficit) 163.39% 146.00% 126.82% 116.91% 113.87% 118.48% 126.96% 135.73% 144.89% Total liabilities and stockholders' equity 260.08% 244.53% 217.05% 194.88% 188.48% 191.17% 198.38% 205.88% 213.84%
23 Adobe Systems Inc Common Size Balance Sheet As percentage of Assets Fiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021E CV 2022E Assets Current assets Cash & cash equivalents 10.36% 7.48% 7.96% 11.32% 19.76% 27.72% 35.02% 41.90% 48.25% Short-term investments 24.31% 26.53% 29.51% 28.33% 25.62% 23.17% 20.98% 18.84% 16.83% Trade receivables, net 5.49% 5.73% 6.56% 7.08% 7.32% 7.22% 6.96% 6.70% 6.45% Prepaid expenses & other current assets 1.63% 1.38% 1.93% 1.69% 1.75% 1.73% 1.66% 1.60% 1.54% Total current assets 42.67% 41.12% 45.96% 48.42% 54.45% 59.84% 64.61% 69.05% 73.08% Property & equipment, net 7.28% 6.71% 6.42% 5.97% 5.17% 4.43% 3.78% 3.17% 2.63% Goodwill 43.78% 45.77% 42.55% 39.69% 34.87% 30.64% 26.95% 23.53% 20.41% Purchased & other intangibles, net 4.35% 4.35% 3.26% 3.48% 3.09% 2.75% 2.44% 2.16% 1.89% Investment in lease receivable, non-operating 0.75% 0.69% 0.63% 0.59% 0.52% 0.46% 0.40% 0.35% 0.30% Other assets 1.17% 1.36% 1.18% 1.85% 1.91% 1.88% 1.81% 1.75% 1.68% Total assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Liabilities and Stockholder's Equity Current liabilities Trade payables 0.63% 0.80% 0.69% 0.82% 0.85% 0.84% 0.81% 0.78% 0.75% Accrued expenses 6.34% 5.78% 5.82% 7.08% 7.32% 7.22% 6.96% 6.70% 6.45% Income taxes payable 0.22% 0.05% 0.30% 0.27% 0.31% 0.32% 0.32% 0.32% 0.32% Deferred revenue 10.18% 12.23% 15.31% 15.39% 15.92% 15.69% 15.12% 14.57% 14.03% Total current liabilities 23.13% 18.88% 22.13% 23.57% 24.40% 24.07% 23.21% 22.37% 21.55% Debt & capital lease obligations ------Deferred revenue 0.53% 0.44% 0.54% 0.62% 0.64% 0.63% 0.60% 0.58% 0.56% Income taxes payable ------Deferred income taxes 3.17% 1.78% 1.71% 1.79% 1.80% 1.81% 1.82% 1.82% 1.81% Other liabilities 0.68% 0.73% 0.77% 0.62% 0.64% 0.63% 0.60% 0.58% 0.56% Total liabilities 37.18% 40.29% 41.57% 40.01% 39.59% 38.03% 36.00% 34.08% 32.24% Stockholder's equity 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Common Equity 35.03% 35.69% 36.33% 33.96% 29.88% 26.26% 23.10% 20.16% 17.49% Retained earnings 64.20% 61.86% 63.86% 71.33% 75.91% 80.49% 84.59% 87.67% 89.89% Accumulated other comprehensive income (loss) -0.08% -1.44% -1.37% -1.27% -1.12% -0.98% -0.87% -0.76% -0.66% Treasury stock, net of reissuances -36.33% -36.39% -40.39% -44.02% -44.25% -43.80% -42.83% -41.15% -38.97% Total stockholders' equity (deficit) 62.82% 59.71% 58.43% 59.99% 60.41% 61.97% 64.00% 65.92% 67.76% Total liabilities and stockholders' equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
24 Adobe Systems Inc Value Driver Estimation
Fiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021E CV 2022E EBITA Calculation Operating Revenues 4,147,065 4,795,511 5,854,430 6,990,778 8,227,015 9,228,808 10,111,733 11,161,601 12,385,717 Less COGS (622,080) (744,317) (819,908) (993,390) (1,169,059) (1,311,414) (1,436,877) (1,586,064) (1,760,010) Less Sales and Marketing (1,652,308) (1,683,242) (1,910,197) (2,394,341) (2,817,752) (3,160,867) (3,463,268) (3,822,848) (4,242,108) Less General and Administrative (399,132) (385,619) (420,110) (531,299) (625,253) (701,389) (768,492) (848,282) (941,314) Less Amortization of Non-Goodwill Intangibles (52,424) (68,649) (78,534) (60,089) (68,784) (69,541) (70,306) (71,079) (71,861) Less R & D Expenses (844,353) (862,730) (975,987) (1,031,618) (1,090,420) (1,152,574) (1,218,271) (1,287,713) (1,361,112) Less Other Operating Expenses (19,883) (1,559) 1,508 (23,842) (23,842) (23,842) (23,842) (23,842) (23,842) Add Implied interest on Operating Leases 8,188 7,985 7,152 13,009 12,963 12,768 12,461 12,069 11,611 EBITA 565,073 1,057,380 1,658,354 1,969,208 2,444,866 2,821,949 3,143,137 3,533,842 3,997,080
Ajusted Taxes Marginal Tax Rates 23.03% 27.69% 11.80% 11.80% 11.80% 11.80% 11.80% 11.80% 11.80% Income Tax Provision 92,981 244,230 266,356 214,433 274,726 325,228 370,412 425,033 489,966 Add Operating lease interest 1,885 2,211 844 1,535 1,530 1,507 1,471 1,424 1,370 Add Tax on Restructuring 4,579 432 (178) 2,814 2,814 2,814 2,814 2,814 2,814 Add Tax shield on Interest & other income - - - Less Tax on Interest & other income (1,673) (9,391) (1,599) (16,408) (18,614) (24,245) (30,940) (38,705) (48,100) Add Tax shield on Interest Expense (13,755) (17,775) (8,313) (9,619) (7,755) (7,755) (7,755) (7,755) (7,755) Less Tax on Investment gains (266) (266) ------Add Tax shield on Investment Loss - - 185 ------Total Adjusted Taxes 83,750 219,441 257,295 192,756 252,700 297,548 336,001 382,810 438,295
NOPLAT Calculation EBITA 565,073 1,057,380 1,658,354 1,969,208 2,444,866 2,821,949 3,143,137 3,533,842 3,997,080 Less Adjusted Taxes (83,750) (219,441) (257,295) (192,756) (252,700) (297,548) (336,001) (382,810) (438,295) Add Change in Deferred Taxes (26,351) (38,827) 9,451 26,804 34,341 40,654 46,302 53,129 61,246 NOPLAT 454,971 799,112 1,410,510 1,803,256 2,226,507 2,565,055 2,853,438 3,204,161 3,620,031
Invested Capital Calculation Net Operating Working Capital Operating Current Assets: Normal Cash 8,880 8,984 5,320 ------Accounts Receivable 591,800 672,006 833,033 964,727 1,135,328 1,273,576 1,395,419 1,540,301 1,709,229 Prepaid Expenses and Other Operating Assets 175,758 161,802 245,441 230,696 271,491 304,551 333,687 368,333 408,729 Total Operating Current Assets 776,438 842,792 1,083,794 1,195,423 1,406,819 1,578,126 1,729,106 1,908,634 2,117,958 Operating Current Liabilities: Accounts Payable 68,377 93,307 88,024 111,852 131,632 147,661 161,788 178,586 198,171 Accrued Expenses 683,866 678,364 739,630 964,727 1,135,328 1,273,576 1,395,419 1,540,301 1,709,229 Deferred Revenue 1,097,923 1,434,200 1,945,619 2,097,233 2,468,104 2,768,642 3,033,520 3,348,480 3,715,715 Income Taxes Payable 23,920 6,165 38,362 37,311 47,802 56,590 64,452 73,956 85,254 Total Operating Current Liabilities 1,874,086 2,212,036 2,811,635 3,211,125 3,782,867 4,246,469 4,655,178 5,141,323 5,708,370 Total Net Operating Working Capital (1,097,648) (1,369,244) (1,727,841) (2,015,701) (2,376,047) (2,668,342) (2,926,072) (3,232,689) (3,590,412) Add Net PPE 785,123 787,421 816,264 813,349 801,137 781,868 757,243 728,552 696,776 Add LT Operating Assets Net Intangible Assets (Non-goodwill) 469,662 510,007 414,405 474,373 479,591 484,867 490,200 495,593 501,044 Present Value of Operating Leases 186,341 166,916 303,598 302,514 297,972 290,805 281,646 270,975 259,156 Other Operating Assets 126,315 159,832 149,758 251,668 296,173 332,237 364,022 401,818 445,886 Total LT Operating Assets 782,318 836,755 867,761 1,028,555 1,073,736 1,107,909 1,135,869 1,168,385 1,206,086 Less LT Operating Liabilities Deferred Revenues, non-current 57,401 51,094 69,131 83,889 98,724 110,746 121,341 133,939 148,629 Other Liabilities 73,747 85,459 97,404 83,889 98,724 110,746 121,341 133,939 148,629 Total LT Operating Liabilities 131,148 136,553 166,535 167,779 197,448 221,491 242,682 267,878 297,257 Invested Capital 6,815,455 7,474,450 8,947,871 10,003,411 11,346,831 12,421,516 13,356,841 14,468,304 15,765,705
NOPLAT 454,971 799,112 1,410,510 1,803,256 2,226,507 2,565,055 2,853,438 3,204,161 3,620,031 Begin IC 6,498,804 6,815,455 7,474,450 8,947,871 10,003,411 11,346,831 12,421,516 13,356,841 14,468,304 ROIC=NOPLAT/Begin IC 7.00% 11.72% 18.87% 20.15% 22.26% 22.61% 22.97% 23.99% 25.02%
NOPLAT 454,971 799,112 1,410,510 1,803,256 2,226,507 2,565,055 2,853,438 3,204,161 3,620,031 Begin IC 6,498,804 6,815,455 7,474,450 8,947,871 10,003,411 11,346,831 12,421,516 13,356,841 14,468,304 End IC 6,815,455 7,474,450 8,947,871 10,003,411 11,346,831 12,421,516 13,356,841 14,468,304 15,765,705 FCF=NOPLAT-Change in IC 138,320 140,116 (62,911) 747,717 883,088 1,490,369 1,918,113 2,092,698 2,322,629
Begin IC 6,498,804 6,815,455 7,474,450 8,947,871 10,003,411 11,346,831 12,421,516 13,356,841 14,468,304 EP= Begin IC*(ROIC-WACC) (36,988) 283,182 844,694 1,125,903 1,469,249 1,706,099 1,913,129 2,193,048 2,524,780
25 Adobe Systems Inc Weighted Average Cost of Capital (WACC) Estimation
Rd 4.285% Tax Rate 24.1% ST debt - LT debt 1,902,068 Current portion of LT debt - Operating Lease 303,598 Value of debt $ 2,205,666 Wd 3.3%
Rf 2.920% MRP 4.51% βe 1.026 Re 7.55% Market Price $ 129.99 Shares outstanding 494,697.996 Market Cap 64,305,792.50 We 96.7%
WACC 7.40%
26 Adobe Systems Inc Discounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models
Key Inputs: CV Growth 2.90% CV ROIC 25.02% WACC 7.40% Cost of Equity 7.55%
Fiscal Years Ending Dec. 31 2017E 2018E 2019E 2020E 2021E CV 2022E
DCF Model NOPLAT 1,803,256 2,226,507 2,565,055 2,853,438 3,204,161 3,620,031 Change in IC 1,055,539 1,343,420 1,074,685 935,325 1,111,463 1,297,401 FCF 747,717 883,088 1,490,369 1,918,113 2,092,698 2,322,629 CV Value 71,044,854 Dicounting Periods 1 2 3 4 5 5 PV of FCF 696,167 765,519 1,202,880 1,441,381 1,464,157 49,706,543
Value of Operating Assets 55,276,649 Excess Cash 1,011,315 Short-term Investments 3,749,985 Long-term debt 1,902,068 PV of Operating Leases 303,598 PV of Employee Stock Options (ESOP) 61,834 Value of Equity 57,770,449 Shares Outstanding 494,698 Intrinsic Stock Price 116.78 Adjusted Stock Price 119.61
EP Model NOPLAT 1,803,256 2,226,507 2,565,055 2,853,438 3,204,161 3,620,031 Beginning Invested Capital 8,947,871 10,003,411 11,346,831 12,421,516 13,356,841 14,468,304 ROIC 20.15% 22.26% 22.61% 22.97% 23.99% 25.02% WACC 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% EP 1,140,682 1,485,772 1,724,841 1,933,646 2,215,110 2,548,678 CV Value 56,576,551 Discounting Periods 1 2 3 4 5 5 PV of EP $ 1,062,040 $ 1,287,966 $ 1,392,123 $ 1,453,054 $ 1,549,802 $ 39,583,793
Value of Operating Assets $ 55,276,649 Excess Cash 1,011,315 Short-term Investments 3,749,985 Long-term debt 1,902,068 PV of Operating Leases 303,598 PV of Employee Stock Options (ESOP) 61,834 Value of Equity $ 57,770,449 Shares Outstanding $ 494,698 Intrinsic Stock Price 116.78 Adjusted Stock Price 119.61
27 Adobe Systems Inc Dividend Discount Model (DDM) or Fundamental P/E Valuation Model
Fiscal Years Ending Dec. 31 2017E 2018E 2019E 2020E 2021E CV 2022E
EPS $ 3.21 $ 4.12 $ 4.88 $ 5.55 $ 6.37 $ 7.35
Key Assumptions CV growth of EPS 2.90% CV ROE 22.13% Cost of Equity 7.55% Retention Ratio 13.11%
Future Cash Flows P/E Multiple (CV Year) 19.24 EPS (CV Year) $ 7.35 Future Stock Price $ 141.34 Dividends Per Share 0.00 0.00 0.00 0.00 0.00 0.00 Future Cash Flows 0.00 0.00 0.00 0.00 0.00 141.34 Discount Period 1 2 3 4 5 6
Discounted Cash Flows $ - $ - $ - $ - $ - $ 91.34
Intrinsic Value $ 91.34 Adjusted Stock Price $ 93.55
28 Adobe Systems Inc Relative Valuation Models EPS EPS Est. 5yr Ticker Company Price 2017E 2018E P/E 17 P/E 18 EPS gr. PEG 17 PEG 18 ORCL Oracle Corporation $44.61 $2.64 $2.84 16.9 15.7 8.75 1.93 1.79 SAP SAP SE $98.17 $4.32 $4.76 22.7 20.6 8.31 2.74 2.48 MSFT Microsoft Corporation $65.86 $2.96 $3.26 22.3 20.2 9.30 2.39 2.17 IBM Intl. Business Machines Corporation $174.14 $13.78 $14.13 12.6 12.3 2.56 4.94 4.82 CRM Salesforce.com $ 82.49 $ 1.01 $ 1.26 81.7 65.3 27.94 2.92 2.34 Average 31.2 26.8 3.0 2.1
ADBE Adobe Systems Inc $129.99 $ 3.21 $ 4.12 40.4 31.6 17.97 2.2 1.8
Implied Value: Relative P/E (EPS17) $ 100.42 Relative P/E (EPS18) 110.48$ PEG Ratio (EPS17) 172.43$ PEG Ratio (EPS18) 158.99$
29 Adobe Systems Inc Key Management Ratios
Fiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021E CV 2022E
Liquidity Ratios Current Ratio CA/CL 1.85 2.18 2.08 2.05 2.23 2.49 2.78 3.09 3.39 Quick Ratio (Cash & Equivalents + ST investments+A/R)/CL 1.74 2.11 1.99 1.98 2.16 2.41 2.71 3.01 3.32 Cash Ratio (Cash & Equivalents+Invested Funds)/CL 1.50 1.80 1.69 1.68 1.86 2.11 2.41 2.71 3.02
Activity or Asset-Management Ratios Receivable Turnover Rev/AR 7.01 7.14 7.03 7.25 7.25 7.25 7.25 7.25 7.25 Total Assets Turnover Rev/Avg. TA 0.39 0.43 0.48 0.53 0.56 0.56 0.54 0.52 0.50
Financial Leverage Ratios Debt to Equity Ratio TL/SE 0.59 0.67 0.71 0.67 0.66 0.61 0.56 0.52 0.48 Debt Ratio TL/TA 0.37 0.40 0.42 0.40 0.40 0.38 0.36 0.34 0.32 Interest Coverage Ratio EBIT/Interest Expense 6.91 14.07 21.20 21.59 34.02 39.81 44.77 50.81 57.98
Profitability Ratios Return on Assets NI/Avg. TA 2.54% 5.59% 9.57% 12.17% 14.10% 14.66% 14.69% 14.76% 14.81% Return on Equity NI/Avg. SE 3.98% 9.14% 16.20% 20.55% 23.41% 23.94% 23.29% 22.70% 22.13% Operating Profit Margin Operating Profit/Revenue 9.95% 18.83% 25.51% 25.17% 27.18% 28.35% 29.10% 29.92% 30.76%
Payout Policy Ratios Divdend Payout Ratio Dividends PS/EPS 0 0 0 0 0 0 0 0 0 Dividend Yield Div/Price 0 0 0 0 0 0 0 0 0
30 Present Value of Operating Lease Obligations (2016) Present Value of Operating Lease Obligations (2015) Present Value of Operating Lease Obligations (2014) Present Value of Operating Lease Obligations (2013)
Operating Operating Operating Operating Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases 2017 $ 45,201 2016 $ 41,192 2015 $ 44,769 2014 $ 48,360 2018 $ 40,777 2017 $ 32,138 2016 $ 40,676 2015 $ 36,270 2019 $ 41,342 2018 $ 27,795 2017 $ 30,943 2016 $ 29,377 2020 $ 39,756 2019 $ 24,437 2018 $ 26,547 2017 $ 23,991 2021 $ 32,829 2020 $ 21,416 2019 $ 23,774 2018 $ 22,172 Thereafter $ 177,509 Thereafter $ 46,569 Thereafter $ 48,644 Thereafter $ 63,058 Total Minimum Payments $ 377,414 Total Minimum Payments $ 193,547 Total Minimum Payments $ 215,353 Total Minimum Payments $ 223,228 Less: Interest 73816 Less: Interest 26631 Less: Interest 29012 Less: Interest 32153 PV of Minimum Payments 303598 PV of Minimum Payments 166916 PV of Minimum Payments 186341 PV of Minimum Payments 191075
Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases
Pre-Tax Cost of Debt 4.29% Pre-Tax Cost of Debt 4.29% Pre-Tax Cost of Debt 4.29% Pre-Tax Cost of Debt 4.29% Number Years Implied by Year 6 Payment 5.4 Number Years Implied by Year 6 Payment 2.2 Number Years Implied by Year 6 Payment 2.0 Number Years Implied by Year 6 Payment 2.8
Lease PV Lease Lease PV Lease Lease PV Lease Lease PV Lease Year Commitment Payment Year Commitment Payment Year Commitment Payment Year Commitment Payment $ 1 $ 45,201 43343.7 $ 1 $ 41,192 39499.4 $ 1 $ 44,769 42929.5 $ 1 $ 48,360 46372.9 $ 2 $ 40,777 37494.8 $ 2 $ 32,138 29551.2 $ 2 $ 40,676 37402.0 $ 2 $ 36,270 33350.6 $ 3 $ 41,342 36452.4 $ 3 $ 27,795 24507.6 $ 3 $ 30,943 27283.3 $ 3 $ 29,377 25902.5 $ 4 $ 39,756 33613.6 $ 4 $ 24,437 20661.4 $ 4 $ 26,547 22445.4 $ 4 $ 23,991 20284.3 $ 5 $ 32,829 26616.3 $ 5 $ 21,416 17363.2 $ 5 $ 23,774 19274.9 $ 5 $ 22,172 17976.1 6 & beyond $ 32,829 126077.0 6 & beyond $ 21,416 35333.3 6 & beyond $ 23,774 37005.7 6 & beyond $ 22,172 47188.3 PV of Minimum Payments 303597.9 PV of Minimum Payments 166916.2 PV of Minimum Payments 186340.8 PV of Minimum Payments 191074.8
31 Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding
Number of Options Outstanding (shares): 600.00 Average Time to Maturity (years): 1.67 Expected Annual Number of Options Exercised: 359.28
Current Average Strike Price: $ 28.28 Cost of Equity: 7.55% Current Stock Price: $129.99
2017E 2018E 2019E 2020E 2021E CV 2022E Increase in Shares Outstanding: 359.28 240.72 Average Strike Price: $ 28.28 $ 28.28 $ 28.28 $ 28.28 $ 28.28 $ 28.28 Increase in Common Stock Account: 10,160 6,808 - - - -
Change in Treasury Stock 864,757 864,757 864,757 864,757 864,757 864,757 Expected Price of Repurchased Shares: $ 129.99 $ 139.80 $ 150.35 $ 161.70 $ 173.90 $ 187.03 Number of Shares Repurchased: 6,652 6,186 5,752 5,348 4,973 4,624
Shares Outstanding (beginning of the year) 498,345 492,052 486,107 480,355 475,007 470,035 Plus: Shares Issued Through ESOP 359 241 0 0 0 0 Less: Shares Repurchased in Treasury 6,652 6,186 5,752 5,348 4,973 4,624 Shares Outstanding (end of the year) 492,052 486,107 480,355 475,007 470,035 465,411
32 VALUATION OF OPTIONS GRANTED IN ESOP
Ticker Symbol ADBE Current Stock Price $129.99 Risk Free Rate 2.92% Current Dividend Yield 0.00% Annualized St. Dev. of Stock Returns 31.83%
Average Average B-S Value Range of Number Exercise Remaining Option of Options Outstanding Options of Shares Price Life (yrs) Price Granted Range 1 600.00 28.28 1.67 $ 103.06 $ 61,834 Range 2 Range 3 Range 4 Range 5 Range 6 $ - Range 7 $ - Range 8 $ - Range 9 $ - Range 10 $ - Range 11 $ - Range 12 $ - Range 13 $ - Range 14 $ - Total 600 $ 28.28 1.67 $ 103.06 $ 61,834
33 WACC $ 120 6.37% 6.47% 6.57% 7.57% 8.57% 8.67% 8.77% 2.40% $ 111.42 $ 111.42 $ 111.42 $ 111.42 $ 111.42 $ 111.42 $ 111.42 2.50% $ 112.92 $ 112.92 $ 112.92 $ 112.92 $ 112.92 $ 112.92 $ 112.92 2.60% $ 114.49 $ 114.49 $ 114.49 $ 114.49 $ 114.49 $ 114.49 $ 114.49 2.70% $ 116.12 $ 116.12 $ 116.12 $ 116.12 $ 116.12 $ 116.12 $ 116.12 2.80% $ 117.83 $ 117.83 $ 117.83 $ 117.83 $ 117.83 $ 117.83 $ 117.83 CV Growth of NOPLAT 2.90% $ 119.61 $ 119.61 $ 119.61 $ 119.61 $ 119.61 $ 119.61 $ 119.61 3.00% $ 121.47 $ 121.47 $ 121.47 $ 121.47 $ 121.47 $ 121.47 $ 121.47 3.10% $ 123.41 $ 123.41 $ 123.41 $ 123.41 $ 123.41 $ 123.41 $ 123.41 3.20% $ 125.45 $ 125.45 $ 125.45 $ 125.45 $ 125.45 $ 125.45 $ 125.45 3.30% $ 127.59 $ 127.59 $ 127.59 $ 127.59 $ 127.59 $ 127.59 $ 127.59 3.40% $ 129.84 $ 129.84 $ 129.84 $ 129.84 $ 129.84 $ 129.84 $ 129.84
Cost of Debt $ 120 3.685% 3.885% 4.085% 4.285% 4.485% 4.685% 4.885% 2.01% $ 274.60 $ 274.00 $ 273.39 $ 272.80 $ 272.20 $ 271.61 $ 271.02 2.51% $ 219.05 $ 218.68 $ 218.31 $ 217.94 $ 217.57 $ 217.21 $ 216.84 3.01% $ 181.91 $ 181.66 $ 181.41 $ 181.17 $ 180.92 $ 180.68 $ 180.44 3.51% $ 155.33 $ 155.16 $ 154.99 $ 154.82 $ 154.64 $ 154.47 $ 154.30 4.01% $ 135.39 $ 135.27 $ 135.14 $ 135.02 $ 134.89 $ 134.77 $ 134.65 Equity Risk Premium 4.51% $ 119.89 $ 119.79 $ 119.70 $ 119.61 $ 119.51 $ 119.42 $ 119.33 5.01% $ 107.49 $ 107.42 $ 107.35 $ 107.28 $ 107.21 $ 107.14 $ 107.07 5.51% $ 97.36 $ 97.30 $ 97.25 $ 97.19 $ 97.14 $ 97.09 $ 97.03 6.01% $ 88.93 $ 88.88 $ 88.84 $ 88.80 $ 88.76 $ 88.72 $ 88.68 6.51% $ 81.80 $ 81.77 $ 81.74 $ 81.71 $ 81.67 $ 81.64 $ 81.61 7.01% $ 75.71 $ 75.69 $ 75.66 $ 75.64 $ 75.61 $ 75.59 $ 75.56
Beta $ 120 0.876 0.926 0.976 1.026 1.076 1.126 1.176 0.920% $ 288.13 $ 258.08 $ 233.61 $ 213.30 $ 196.18 $ 181.55 $ 168.90 1.420% $ 228.95 $ 209.40 $ 192.86 $ 178.70 $ 166.43 $ 155.69 $ 146.23 1.920% $ 189.66 $ 175.94 $ 164.02 $ 153.58 $ 144.36 $ 136.16 $ 128.82 2.420% $ 161.69 $ 151.53 $ 142.54 $ 134.54 $ 127.36 $ 120.89 $ 115.03 Rf 2.920% $ 140.77 $ 132.95 $ 125.94 $ 119.61 $ 113.86 $ 108.63 $ 103.85 3.420% $ 124.55 $ 118.35 $ 112.72 $ 107.59 $ 102.90 $ 98.58 $ 94.61 3.920% $ 111.60 $ 106.57 $ 101.96 $ 97.72 $ 93.81 $ 90.19 $ 86.84 4.420% $ 101.04 $ 96.88 $ 93.03 $ 89.47 $ 86.17 $ 83.09 $ 80.22 4.920% $ 92.26 $ 88.76 $ 85.51 $ 82.48 $ 79.65 $ 77.00 $ 74.52 5.420% $ 84.86 $ 81.87 $ 79.08 $ 76.48 $ 74.03 $ 71.73 $ 69.56
COGS as a % of Sales (Scription) $ 120 5.10% 5.60% 6.10% 6.60% 7.10% 7.60% 8.10% 25.0% $ 88.87 $ 87.22 $ 85.58 $ 83.94 $ 82.29 $ 80.65 $ 79.01 27.0% $ 96.92 $ 95.17 $ 93.42 $ 91.67 $ 89.93 $ 88.18 $ 86.43 29.0% $ 105.73 $ 103.87 $ 102.01 $ 100.15 $ 98.28 $ 96.42 $ 94.56 31.0% $ 115.37 $ 113.38 $ 111.40 $ 109.41 $ 107.42 $ 105.43 $ 103.44 Subscription growth 33.0% $ 125.89 $ 123.77 $ 121.65 $ 119.52 $ 117.40 $ 115.27 $ 113.15 35.0% $ 137.36 $ 135.09 $ 132.82 $ 130.55 $ 128.28 $ 126.00 $ 123.73 37.0% $ 149.85 $ 147.42 $ 144.99 $ 142.55 $ 140.12 $ 137.69 $ 135.25 39.0% $ 163.43 $ 160.82 $ 158.21 $ 155.61 $ 153.00 $ 150.39 $ 147.79 41.0% $ 178.17 $ 175.37 $ 172.58 $ 169.78 $ 166.99 $ 164.19 $ 161.40 43.0% $ 194.16 $ 191.16 $ 188.16 $ 185.16 $ 182.16 $ 179.16 $ 176.16
CV ROIC $ 120 16.02% 19.02% 22.02% 25.02% 28.02% 31.02% 34.02% 25.0% $ 81 $ 83 $ 85 $ 86 $ 87 $ 88 $ 88 27.0% $ 88 $ 90 $ 92 $ 93 $ 94 $ 95 $ 96 29.0% $ 95 $ 98 $ 100 $ 101 $ 103 $ 103 $ 104 31.0% $ 103 $ 106 $ 108 $ 110 $ 111 $ 112 $ 113 Subscription growth 33.0% $ 112 $ 115 $ 118 $ 120 $ 121 $ 122 $ 123 35.0% $ 122 $ 125 $ 128 $ 130 $ 132 $ 133 $ 134 37.0% $ 132 $ 136 $ 139 $ 141 $ 143 $ 144 $ 146 39.0% $ 143 $ 148 $ 151 $ 154 $ 155 $ 157 $ 158 41.0% $ 156 $ 161 $ 164 $ 167 $ 169 $ 171 $ 172 43.0% $ 169 $ 174 $ 178 $ 181 $ 184 $ 185 $ 187
34