adobe simply is a cash machine - adobe systems incorporated (nasdaq_adbe) _ seeking alpha

8/10/2019 Adobe Simply is a Cash Machine - Adobe Systems Incorporated (NASDAQ_ADBE) _ Seeking Alpha

1/11


2/11

Adobe Systems has an excellent combination of strong free cash flow generation and low financial leverage. Weexpect the firm's free cash flow margin to average about 28.5% in coming years. Total debt-to-EBITDA was 2 lastyear, while debt-to-book capitalization stood at 18.4%.

Adobe continues to gain significant traction with respect to Creative Cloud subscriptions. Growing from just 195k inthe third quarter of 2012, Adobe anticipates exponential growth in coming quarters and will round out fiscal 2014 with2.8 million-plus paying subscribers. We love this recurring, subscription-based model.

Adobe Marketing Cloud is quickly becoming a favorite of Chief Marketing Officers as digital marketing bookingscontinue to expand at a nice clip.

Adobe registers a Valuentum Buying Index rating of a 6.

Business Quality

Economic Profit Analysis


3/11

The best measure of a firm's ability to create value for shareholders is expressed by comparing its return on investedcapital with its weighted average cost of capital. The gap or difference between ROIC and WACC is called the firm'seconomic profit spread. Adobe Systems' 3-year historical return on invested capital (without goodwill) is 201.6%, whichis significantlyabove the estimate of its cost of capital of 10.6%. As such, we assign the firm a ValueCreation rating ofEXCELLENT. In the chart below, we show the probable path of ROIC in the years ahead based on the estimatedvolatility of key drivers behind the measure. The solid gray line reflects the most likely outcome, in our opinion, andrepresents the scenario that results in our fair value estimate.


4/11

Cash Flow Analysis


5/11

Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually consideredcash cows. Adobe Systems' free cash flow margin has averaged about 34.3% during the past 3 years. As such, wethink the firm's cash flow generation is relatively STRONG. The free cash flow measure shown above is derived bytaking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which weuse in deriving our fair value estimate for the company. At Adobe Systems, cash flow from operations decreased abou52% from levels registered two years ago, while capital expenditures fell about 10% over the same time period.

Valuation Analysis

Our discounted cash flow model indicates that Adobe Systems' shares are worth between $52-$78 each. Shares aretrading at roughly $63 each at the time of this writing.

All value is based on the future free cash flow stream. The future will always be unpredictable to a degree. The largerthe unpredictability of a company's future free cash flow stream, the bigger the margin of safety around a company'sfair value. The margin of safety around our fair value estimate is driven by the firm's LOW ValueRisk rating, which isderived from the historical volatility of key valuation drivers.

The estimated fair value of $65 per share represents a price-to-earnings (P/E) ratio of about 115.1 times last year's

earnings and an implied EV/EBITDA multiple of about 41.4 times last year's EBITDA. Our model reflects a compoundannual revenue growth rate of 13.3% during the next five years, a pace that is higher than the firm's 3-year historicalcompound annual growth rate of 2.2%. Our model reflects a 5-year projected average operating margin of 28.3%,which is above Adobe Systems' trailing 3-year average.

Beyond year 5, we assume free cash flow will grow at an annual rate of 5.2% for the next 15 years and 3% inperpetuity. For Adobe Systems, we use a 10.6% weighted average cost of capital to discount future free cash flows.


6/11

We understand the critical importance of assessing firms on a relative value basis, versus both their industry and peersMany institut ional money managers - those who drive stock prices - pay attention to a company's price-to-earnings ratio


7/11

and price-earnings-to-growth ratio in making buy/sell decisions. With this in mind, we have included a forward-lookingrelative value assessment in our process to further augment our rigorous discounted cash flow process. If a company isundervalued on both a price-to-earnings ratio and a price-earnings-to-growth ratio versus industry peers, we wouldconsider the firm to be attractive from a relative value standpoint. For relative valuation purposes, we compare Adobeto peers Microsoft (NASDAQ:MSFT) and Oracle (NYSE:ORCL).

(click to enlarge)

Margin of Safety Analysis

Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows.Although we estimate the firm's fair value at about $65 per share, every company has a range of probable fair valuesthat's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if thefuture was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at theirknown fair values. Our ValueRisk rating sets the margin of safety or the fair value range we assign to each stock. Inthe graph below, we show this probable range of fair values for Adobe Systems. We think the firm is attractive below$52 per share (the green line), but quite expensive above $78 per share (the red line). The prices that fall along theyellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.

Future Path of Fair Value

We estimate Adobe Systems' fair value at this point in time to be about $65 per share. As time passes, however,companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below comparesthe firm's current share price with the path of Adobe Systems' expected equity value per share over the next threeyears, assuming our long-term projections prove accurate. The range between the resulting downside fair value andupside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range
http://static.cdn-seekingalpha.com/uploads/2014/10/11/933684-1413052127359341-Valuentum_origin.pnghttp://seekingalpha.com/symbol/orclhttp://seekingalpha.com/symbol/msft


8/11

of potential outcomes also is subject to change over time should our views on the firm's future cash flow potentialchange. The expected fair value of $88 per share in Year 3 represents our existing fair value per share of $65increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges arederived in the same way, but from the upper and lower bounds of our fair value estimate range.

Pro Forma Financial Statements

(click to enlarge)


9/11

(click to enlarge)
http://static.cdn-seekingalpha.com/uploads/2014/10/11/933684-14130521610078456-Valuentum_origin.png


10/11

(click to enlarge)
http://static.cdn-seekingalpha.com/uploads/2014/10/11/933684-14130521714008234-Valuentum_origin.png


11/11

In the spirit of transparency, we show the latest study of the Valuentum Buying Index here. Past results are not aguarantee of future performance. Thank you for reading!
http://www.valuentum.com/articles/20141003_1http://static.cdn-seekingalpha.com/uploads/2014/10/11/933684-1413052182542437-Valuentum_origin.png

adobe simply is a cash machine - adobe systems incorporated (nasdaq_adbe) _ seeking alpha

Documents