Adobe | Investment Thesis
The creative one.
Pretty sure you guys already know Adobe, if only for its PDF reading software or its famous Photoshop. Both come from the same house, but there’s much more to say about the company.
The Business.
The company could be called a serial acquirer. Their strategy was simple: to find other companies with great products following their business line - creativity, and buy them. They did it with Photoshop in 1989. And with many other softwares through the years until becoming the leader in the sector.
It would be unfair to say they did nothing but buy others though, they kept working on the softwares they acquired, developed many more, notably the PDF format and Adobe Reader in 1993 which became the standard for electronic documents - still is, which is pretty impressive. They also focused on creating an ecosystem and pivoted their business model from licensing - one time purchase, to subscriptions in 2003 with the creation of the Creative Suite.
This decision paid off as it blew their revenues. Adobe was already the best at what they were doing then. And they still are today.
We’ll go over everything. But I need to present the company first & its three branches: the Creative Cloud, the Document Cloud & the Experience Cloud. Here’s an overview of the applications which can be found in the two first.
Not bad, right? This is Adobe, today. As you can see, they’ve been quite busy between acquisition & development. We have to add to those softwares the Experience Clouds which isn’t represented here.
As I said, a pretty big company.
The Creative Cloud.
I will start with the most interesting & important part of their business, responsible for around 60% of the company’s revenue FY24. The biggest source of revenues. You can find in the screenshot above all the softwares the company proposes. You probably already know at least Photoshop, probably Lightroom & Premiere.
I won’t go over each of them as it would make no sense, but all of them have a thing in common: they are focused on creativity. Drawing, photography, videography, visual effects & more. If you want to create, Adobe has a software for you.
And it doesn’t stop here. Everything is interconnected through a cloud, so you can use different softwares from a centralised place where all your content is stored. This is Adobe’s biggest strength as creatives usually need to use content from different sources for their art, like doing a video montage in Premiere & directly importing some FX you worked on in After Effects, or doing some photo manipulation in Photoshop from pictures retouched seconds ago in Lightroom.
This interconnection is what gives Adobe its edge & what makes it the go-to platform for most creatives. This & the quality of their softwares, which are constantly updated with new tools - AI lately, more on this later.
It doesn’t mean Adobe doesn’t have competition; on the contrary. Each software has strong competition, usually equivalent or close to being so in terms of quality & often less expensive. We could talk about Gimp, Inkscape, Blender, & many more… Adobe isn’t far superior—although their main ones, Photoshop or Premiere, are better than the competition, but most users could use alternatives & be satisfied.
Adobe’s competitive advantage isn’t with their individual software but with their cloud system & subscription bundles. No other company can propose as much as Adobe as they simply propose everything a creative could ask for, and more. They do not edit only one software for one purpose. They propose an entire creative ecosystem.
A Creative Cloud.
It is rare for a creative to use one application only, so Adobe proposes packages which include everything, a few applications for one specific range of creativity, one software only, or maybe just its smartphone or light version... You can be a professional or just an enthusiast; you will find what you want.
Adobe is very, very flexible but yes, subscriptions are expensive. Although truth is, they remain more than competitive & are priced for a software quality you will struggle to find anywhere else.
They propose a premium ecosystem, and their market likes it.
This is why their Creative Cloud revenues look like this & grew 15% over the last five years. This is Adobe’s biggest business, but it isn’t its only business.
The Document Cloud.
This part will be fast as we are talking about their PDF format & their software to read them, Adobe Reader. They offer tons of features with it like sign, comment, and many new AI tools which make everything easier.
I’ve always been surprised by how fast this portion of their business was growing - the fastest of the company at the moment, as we now have free alternatives or can always find ways around. It seems like the tool isn’t less used at all, especially in professional environments, proving that Adobe is capable of justifying its premium.
Any subscription to access those is part of Document Cloud’s revenues.
The Experience Cloud.
The last piece of Adobe’s business & their second source of revenues. The Experience Cloud is focused on business, offering them marketing & data analysis tools to grow, focusing on reaching & converting their market.
It’s hard to go over all the solutions proposed, but here’s a brief list: advertising tools to plan & optimize actions with CCMS, data analytics to have clear feedback on their results - or lack thereof, some AI services like customer support, customer behaviour analytics tools, AI marketing content generation, templates for any kind of social media advertising a brand might need, & more…
The Creative Cloud helps brands create content and the Experience Cloud helps them distribute it & analyse how their customers react, to then leverage this data and boost engagement or sales, depending on their needs. They are now leveraging AI more & more to deliver better results.
Another very competitive field, but again, Adobe advantage lies in its interconnection of softwares & network effect. Their clients have their content, advertising strategies, delivery methods & data analytics through Adobe’s cloud, a unique & interconnected platform, vertically integrated. Much easier to use than X different platforms.
Once again: everything optimized in one cloud service.
Artificial Intelligence.
This should be the biggest chunk of our discussion today. What will be the impacts of AI, especially of text-based content generation, on Adobe’s softwares?
The market believes that no one will use their softwares anymore because generation or other simple web apps will do the same or probably even better. So why would anyone bother learning how to use such complex softwares, or pay for them? No point. As you can imagine - as I am taking time writing an investment case, my opinion is different. Entirely opposed even, as I believe those are a tailwinds.
Let’s go over my reasoning & I’ll let you disagree in the comments if you feel like it.
Artists.
At the end of the day, those are the ones using Adobe’s software, be it professionally or just for fun. I’ve been doing photography for some time and have a subscription to Lightroom & Photoshop. I don’t make money from it; it’s just a hobby. Some love to create clips, add some FX to their kids’ videos, love to draw, or add some monsters to their pictures with Photoshop. Or, like me, simply make them look better through classic color grading, contrast adjustments, & more.
You don’t need to be a professional or to generate revenue from to enjoy Adobe’s softwares. What I am trying to share is that most users are doing it for fun, while only a few are using them for their jobs. I’ve always been a huge fan of Kienan Lafferty - especially for his work on League of Legends but also for everything else.
If you have ever been a bit creative, you should know that no AI will ever give you this kind of result. If you, yourself, did draw, make videos, do photography, or anything related to graphics, you know you will simply never have the perfect result from a prompt-to-image process. Not close to what you had in mind.
Here’s proof of it.
I asked Grok to describe precisely D.Va’s image and copy past the result directly into MidJourney - to which I have a subscription & which is known to be one of the best text-based generators on the market. I won’t copy and paste the prompt given by Grok - too long, but here’s the result from MidJourney.
Here’s the original.
Don’t get me wrong, the result is awesome. But you can understand the differences: the style to start with, which some might like & others dislike, but it isn’t the point; this is what art is. The details then, which are wonderful but far from what was drawn. The hallucinations then, as we have a background & some details I never asked for, but AI thought it would be nice. MidJourney took some matters into its hands & didn’t respect what was asked to the letter.
This is about images; what about videos? I have truly been amazed by what video generation can do by now. Here’s a sample, and it is magnificent.
Does that mean we will be able to make Disney movies using AI? No. Why? Because animation is more than beautiful images. It is about communicating emotions & this is done through complete control. I’ve been blown away by Moana 2, by how insane the animation was, sharing exactly what animators wanted to share. This video is great, but it is soulless. Does it mean AI won’t be used? Not at all; I sure hope it will. But it will be used in addition, something Adobe understood already.
What I am trying to share here is that art is the process of translating its imagination to a drawing, an image, a song, a video, or anything really. AI will never know what is in your head, and you will never be able to find the right words for it to understand. Art is about complete control, not approximations.
Those tools will be perfected. But they won’t be perfected enough to give users their imagination on paper, to give perfection & personalized styles. They will however create volume and give access to creation to people who couldn’t create before. Which brings me to my next points.
Retention.
The question is, will Adobe keep its users while AI alternatives arise, and to go further, will they be able to attract new ones? I’ve made the points for the actual users, be it the professionals who want & are capable of creating perfect content compared to their imagination, or the casual users, who do it because they enjoy the process.
In both cases, I do not see any reason why they would stop using Adobe. The pros do not have alternatives as we detailed above, and the casuals are doing it for fun, which means they enjoy it. Those who are only focused on the results could certainly leave, assuming another software or web app proposes a better solution, but Adobe has something called Firefly, which is why they won’t leave - bear with me a bit longer.
This leaves us with growth. How can Adobe bring in new users? Why would people who had no interest in their softwares change their minds & pay for a subscription? My opinion is that those were not users because either they have no interest, which means they aren’t the targets & this won’t change, or they didn’t have the time nor capacity to play with those tools.
Those now have access to prompts which can give them images they only dreamt of being capable of doing before. I dreamt of drawing, tried to do animation, wanted to do FX… Never had enough patience to go through with it. But I now I can do this in a few seconds.
The prompt?
“Ultra-realistic image of a woman's hand palm, a feather, and a diamond in it, seen from above.”
Let’s say… It’s not perfect. But it’s something. Something I can work with.
More Content Than We Could Have Dreamt Of.
It isn’t what I had in mind, but it is a wonderful start; it is already much better than I could have ever done by myself. What I could potentially do now is actually use Photoshop from here to make it perfect, make it look like what I had in mind.
Maybe I could generate each component one by one first to have better generations. And then compile them all in one picture. This won’t take me as much time as drawing it myself - which I can’t either way. With the same idea, maybe I could generate tons of 3-second video clips from Sora & then combine them all to create the 1-minute video I wanted to.
You see where I am going with this, right?
We are entering a time of enormous volume of high-quality content, accessible to everyone. But nothing perfected enough to satisfy the ones who generate them. Anyone who wants perfection will need more than a text prompt. But it gives the opportunity to everyone to create high-quality content, with almost no, or at least much lower, competencies.
And while naysayers call for the doom of Adobe, management understood clearly the difference between image generation & users’ needs, between an image & the image. That is why they are perfectly positioned to capitalise on this new demand.
Adobe Firefly.
Finally, here we are.
Many seem to forget that we are talking about a multi-billion-dollar company, with sound financials & competent R&D teams who have been at the top of content creation for decades. You’d really think they’d sleep on AI?
Come on. Meet Firefly.
I could go further, but do I really need to? This one-minute video shows you that not only are they not behind, they clearly are better positioned than the competition. Not only do they provide image generation, they also provide many, much more precise tools for image, video, & FX modifications.
To be fair, their tools aren’t focused on image generation from scratch, like text-based prompts. They are focused on what they do best: modifications. On using existing content & making it better, allowing their users to reach what they had in mind for videos, photos, any kind of content really.
Once more, I personally know of no other company which propose this kind of service - changing the color of the watch or changing the season during a video, from spring to winter in a few clicks. They made accessible in a few clicks what required hundreds of hours of practice and, by doing so, gave the opportunity to those who didn’t have time or didn’t want to learn to finally do what they wanted.
The requirement to create high-quality perfected content has dropped. Significantly.
And exactly like it happened decades ago when Adobe released Photoshop & other softwares afterwards, they now have tools capable of doing much more with much less. And by offering such tools, they will certainly attract users who discover that, after all, they have what it takes to become artists.
And Adobe continues to have the upper hand thanks to its entire ecosystem.
I personally believe that while most were using Adobe’s softwares instead of trying to find alternatives to each of them individually, this tendency will continue while many more will join as they start their artist careers, and Adobe isn’t home to only the best softwares anymore, but also to the best AI tools for them to tailor their content to their imagination.
It is important to say that Firefly isn’t yet really monetized by Adobe. They are focused on releasing an excellent tool which will help artists & content creators to do more with less: less knowledge, fewer clicks, less time. They are focused on onboarding their users & letting them try what those new tools can do; they will focus on monetisation only afterwards.
Other AI tools will exist; Adobe will continue to innovate, but the vertical integration, centralisation & interconnection of Adobe Cloud can win, exactly like their Creative Cloud won years ago & still has the upper hand today.
It isn’t about the softwares alone. It won’t be about AI alone. It is about the ecosystem.
Financials.
As I said earlier, Adobe is a really, really solid company.
I need to say that for a company that’s going to be disrupted by AI generation tools, growth has been pretty good even these last two years, since ChatGPT came into our world. Better, we are talking about a company with software gross margins above 80%, which gives management room for improvements, although with 35% pre-tax margins… It’s hard to do better.
Their business allowed them to grow a strong balance sheet with $873M of net debt & return tons of value to shareholders already through buybacks. They reduced their shares outstanding by 9.2% over the last five years & their actual buyback plan would allow them to buy 10% more of it at today’s price.
Adobe is a real cash machine with huge margins & correct growth, while their new AI services will allow them to, at worst, maintain those margins & generate more growth as I detailed above, once monetized. With competent management & strong returns to shareholders… The only consequence is this free cash flow per share rising.
Seems like a catch.
Conclusion.
Adobe is a wonderful company which has been a pioneer in the visual graphics sector for decades now, slowly onboarding millions of users as their softwares were the only ones allowing artists to do their best work.
The situation isn’t the same today. Creativity is a crowded space & many companies now offer comparable tools, often for less. But Adobe’s strength doesn’t lie only in its softwares; it lies in the large & interconnected ecosystem it created through the years, constantly answering users’ demands & focusing on delivering the best services they can. There is no competition to this ecosystem, especially after adding to the Creative Cloud their Experience Cloud. None.
As for AI, and the market’s worry that text-based generation tools would take over, that artists won’t need those softwares anymore, I made my case above. Art isn’t just about beautiful images; it is much more than this. Adobe knows this & perfected its tools for this. Millions of users being able to create wonderful content should, on the contrary, grow the usage of these tools as they will want to make their content better-looking, closer to their imagination, and that is what Adobe excels at. Especially with their new in-app AI tools, already much better than competition.
Add to this great financials, management, cash generation, & return to shareholders. As I said earlier, it seems like a catch. Although for long, the company’s rich valuation was honestly a concern & a reason for me not to buy in. I chose not to comment on valuations in Investment Cases anymore - you will need to follow my last write-ups or quarterly commentary to have my opinion, but it sure got more accessible with the latest dump in equities - at the time of writing.
Adobe is a wonderful company, strong financially, with focused management & an advantage over competitors thanks to its strong & interconnected ecosystem which makes it all very easy to use. The company continues to innovate & their AI tools are certainly going to prove that this new revolution won’t leave them behind, nor will it kill creativity or reduce the need for personalisation.
I believe Adobe will thrive in a world where content becomes easier & faster to create. It only means more of it, not less.
"What I am trying to share is that most users are doing it for fun, while only a few are using them for their jobs." On what are you basing this statement, my feeling that is entirely the opposite. I doubt they generate $22B from hobbyists.
Aren't there tens of thousands of licenses used by corporations that have historically been the key to their growth? These were the most sticky ones and the ones that I see most likely to be canceled because of AI.
While I agree with you about your assessment of art, I think you are forgetting that artists need to eat too. Most financial decisions that make them money are made by nonartists, who will gladly use AI. I have already seen AI-made advertising posters on buses and online. Before AI someone with Adobe license had to make them. Adobe will not disappear, but I think their growth slows down significantly.