10 year price history of Adobe’s stock

I had trouble coming up with an appropriate title for this entry, “am I delusional” or just spitting into the wind when I don’t like Adobe’s subscription and hope that some day it may change. Actually, I had adjusted to the concept of renting Photoshop until this last round of updates to Creative Cloud 2015 in which Adobe felt empowered to remove my old copies of CC2014; Unacceptable. Then there was Thom Hogan’s summary about some of the issues that Adobe customers had with their systems when updating to CC2015 and finally there is my favorite critic, Lloyd Chambers on the bugs and problems he has found with Adobe’s CC2015 (here)

However, I am reminded of a comment made by Scott Kelby at the time of Adobe’s April/May 2013 announcement that they were going to the subscription based model for virtually all of their software offerings. After he had talked to Adobe’s management, he flatly stated “get over it, Adobe is not going back” to selling software licenses. In looking at the above graph of Adobe’ stock price over the last 10 years, one has to give Mr. Shantanu Narayen, CEO and President, and the rest of Adobe’s management praise for igniting market excitement in Adobe as its stock has risen around 180% since their May, 2013 announcement. (The red line is Adobe’s 200 day average.) The investment community became excited at Adobe’s entry into the Sales-as-a-Service (SaaS) concept and rewarded Adobe’s stock appropriately. Equally important when looking at its stock valuation is the remarkably high institutional holdings it currently maintains, virtually at 87%. Given, this price action and its institutional holdings,  it is so easy to channel Scott Kelby, but I believe there are some storm clouds on the horizon.

The first thing to consider is the nature of Adobe’s stock increase over the last two years. This rise has been on the strength of its subscription story and not on its fundamental earnings as their revenues and earnings have actually declined as they moved from one model to the other. (see below, the bars in blue are actual earnings per share (EPS) numbers and the orange are what the market is expecting Adobe to achieve)
From above, there are two important numbers to focus on; first Adobe will not achieve earnings equal or greater than its license format until 2016. The second is the significant anticipated increase in earnings expected to be achieved in 2016, a virtual 150% increase from 2015 or about a 235% increase from 2014 . As mentioned, the market has loved Adobe’s SaaS story and they have rewarded it with share prices at approximately 112 times current earnings while its industry segment trades around 40 times earnings. If Adobe’s stock  were to trade at the market average, Adobe’s stock would be priced around  $30 per share.  As mentioned, Adobe has been able to sustain this stock action by demonstrating significant and continued growth in its subscription membership. Consequently, what has become really important is to maintain its subscription growth momentum and the market expects this. We see this in Adobe’s move to make it difficult to purchase Lightroom 6 as a stand alone product and encourages people to join the Photography Subscription plan instead. What I find rather ironic is Adobe’s reliance on feature enhancements and version releases to enhance subscription growth versus one of their original justification for making this change was to take the pressure off of version releases.

I believe there are significant market place factors that will make it very difficult for Adobe to achieve its projected 2016 revenue growth. These are as follows:

  • Subscription Growth in the Photography Area:
    • Declining DSLR sales: There is an increasing shift going on between investing in higher-end digital cameras in favor of smart phones. Witness the sales declines reported by both Nikon and Canon. These declines mean there are less people needing high end image processing software and will rely more on the smart phone apps like Afterlight, Layout for Instagram or Camera+, to name a few. I have personally seen evidence in this shift in our travels. On a trip to Tuscany 2013, virtually all of the tourists had a high end DSLR that they carried around and took images of the places they visited. This is in contrast with our visit to Spain this year where I saw most of the people with smart phones and using Snapchat to share the moment. Another factor in the elimination of sophisticated software is the rumored Sony sensor in their yet to be released A7000 which is reported to have High Dynamic Range (HDR) capability built into the sensor itself. Why have complicated software when the camera can handle it?.
      • iPhone 6s (or 7): It is also rumored that the new iPhone for 2015  will have a 12mp camera and produce DSLR quality images along with 4k video. This information along with Apples current marketing campaign showing images captures with the iPhone 6 and their newly designed Photo’s will make it possible for people to avoid more sophisticated image management software.
    • Increased reality that images are a commodity: Over the last couple of years not only have we witnessed whole photography departments closed at newspapers and magazines as they manage their costs, but the revenue that a person can earn from the sale of an image is becoming meaningless. In fact, an issue that drives me crazy are these photo contests held by National Geographic, Outdoor Photographer, airlines, hotels and others offering an incidental reward so that they can get a bunch of people to give them their image with full rights waved. I asked one women why she did this only to find out she was a retired person from the medical profession and didn’t need the money. Its ok to kill it for those who do.
    • Increased transition to video production: With the increased commoditization of images, many photographers are turning to video. While Adobe does offer a couple of sophisticated video products, I don’t believe they have the some dominance in this segment that Adobe has with Photoshop and Lightroom with which to take advantage of this changing dynamics. Apple has  low and middle level products which compete effectively and for the serious videoagrapher, their are more recognized higher end products like Mari 2.6, Avid Media Composure and DaVinci Resolve. The final point here, there is a rich supply of competing software products.
    • Increased competition: At the time Adobe made the switch to their subscription based model, there were no real competition for their products, particularly in the photographic enhancement arena. This is slowly, but effectively changing. When doing research for this blog entry I found this article by Digital Arts listing 22 alternatives to Creative Cloud. Not all of these products are great, but the list is growing. Witness the release  just this month of Affinity Photo, the first decent product to really compete against Photoshop and for only $40.00. It is a darn good piece of software given how new it is. Ok, it only works on the Mac for now, but this is a huge event and Adobe’s products will continue to be cannibalized from these types of new entrants and from improvements in others.  For example, DXO and Capture One are worthy competitors to Lightroom and in some cases produce better RAW development results but in other ways not quite to Lightroom’s level. Given another year or so and they will be real alternatives (not that they aren’t already).
    • Resistance to the Subscription Model: What really surprised me when Adobe announced they were going to the subscription model was the almost arrogant method of handling the small artist that had been the backbone to everything Adobe has become. From the early photographers and artists who used Photoshop to the early programmers and web developers for whom Dreamweaver and PageMaker were a necessity. It surprised me that Adobe could not find a middle ground for both the large developer as well as the small artist. As a result, Adobe was able to engender a significant amount of ill will in a very large segment of their user base. As an executive who used to be in the retail industry, I know for a fact how hard it is to win back a customer who have been disenfranchised. To illuminate this point, in December, 2014 CNET ran a small and not necessarily scientific survey and found that of the former Creative Suite customers, a full 95% were unwilling to make the change to Creative Cloud. The leading reason, “it is too expensive.” Now as a former accountant, I get why a large business would love the subscription formula, not capital justification and the straight-line ability of expensing its cost. However, for the small artist and web developer, we are talking about a significant monthly expense. With purchases, one may skip a product upgrade if the features improvements are not material.
    • Adobe needs to raise the price of their subscriptions: Here are Credit Suisse’s comments from their June 16, 2015 summation from Adobe’s last quarterly earnings release: Although Creative Cloud has effectively increased annual revenue per user versus the prior perpetual licensing model, we believe much of this enthusiasm is captured in Adobe’s current valuation. Therefore, we will monitor Adobe’s ability to (1) attract new users, (2) increase Creative Cloud pricing, (3) expand operating margins ahead of expectations, and (4) continue to expand into the digital marketing market before turning positive on Adobe’s stock. To achieve the revenue objectives above, Adobe must increase the cost of its subscriptions.
      • Strong US Dollar: A significant issue for all US based, international companies has been the strengthening of the US Dollar which means that foreign earnings decline when converted from, say the Euro to the US Dollar, all other things being equal.
    • Price sensitivity of Subscription based formula: The topic here is “when Adobe starts to raise the price of a subscription” will there be a fall-off of subscribers? I believe the subscriber base plans, particularly of the Photography plan, is very sensitive to its price point and that once Adobe starts to raise the price of these subscriptions it will see cancellations. Why, for most of the reasons I have just listed above;
      • demographic and economic changes for those who buy cameras, their use, their competition and the ability to obtain picture enhancements via smartphone apps,
      • less need for sophisticated software for smartphone users combined with increased competition at lower price points for others,
      • resistance to subscription model will be exacerbated by increases in price of these plans.

Adobe is a wonderful company and I love their products. However, I think they have positioned themselves into a tight position. In the tech industry, Wall Street doesn’t like hiccups. While Adobe is being rewarded for executing a transition to a new matrix, should some of the glitter come off the story, their stock price will be adjusted appropriately. It may be that the company saw the changes coming in the photography industry, with its falling reliance on sophisticated products and decided to concentrate its energies on business with large web presence. However, their subscription volume is still reliant on the Photography Plan to maintain their overall financial objectives for this year and the next. 2016 should prove to be a very interesting year for Adobe. Personally, I would not want to be long Adobe stock at this price point.

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