The world has changed a lot in 30 years. Landlines to iPhones, Sega consoles to the metaverse, cable to streaming; you get the idea. Technologically, the world around us is vastly different from the 1990s.

We still don’t have flying cars, a cure for cancer, or colonies on Mars, but we’ve come a long way. Despite all that change, a few constants remain: PDFs are the go-to document format, and Adobe’s suite of creative products, including Illustrator, Photoshop, and After Effects, among others, are the industry standard for creative professionals.

Whether you’re editing a photo, designing an app, driving past a billboard, signing a document, or watching a YouTube ad, odds are high that Adobe was involved somewhere along the way, or maybe even from start to finish.

It’s a company so embedded into the creative world that you might not even realize how often you interact with it. And yet, for a business with over 40 years of history, Adobe is still growing — still evolving — and now facing perhaps the most consequential shift in its history with the rise of AI tools and mass-market competitors like Canva.

Even with its wide moats, impressive profitability, and robust growth, the market has soured on this powerful compounder. Does this represent a buying opportunity?

The answer to that, and more, below.

— Shawn

Adobe: From Photoshop to Acrobat

A Quiet Giant

Adobe’s story begins in a garage, as all proper Silicon Valley tales do. Founded in 1982 by John Warnock and Charles Geschke, Adobe’s earliest goal was surprisingly simple: fix the formatting inconsistencies that plagued digital printing. Their invention of PostScript was groundbreaking, a solution that enabled digital documents to be reliably printed as intended.

Steve Jobs saw the potential immediately, investing $1 million and securing the right for Apple to license Adobe software. From that deal was born not only the desktop publishing industry but also a decades-long partnership between Apple and Adobe that helped establish both companies as creative juggernauts. The combination has been paradigm-defining, so much so that the Macbook-wielding, Adobe-using creative professional is nothing short of stereotypical.

Over time, Adobe added more arrows to its quiver: Illustrator in 1987, Photoshop in 1990, and later, the PDF, a universal file format that became the global standard for document sharing. The PDF wasn’t just a product, though; it was a massive network effect.

And Adobe Acrobat? It’s still the best-in-class tool for editing them.

Acrobat & The Document Cloud

Adobe introduced Acrobat in the early ’90s to handle and edit PDF files, and the product quickly became an indispensable tool for enterprises and governments alike.

Fast forward to today, and Acrobat (alongside Adobe Sign and the broader Document Cloud suite) brings in nearly $4 billion in revenue annually — about 15% of total sales.

If Creative Cloud (think Photoshop and Illustrator) is Adobe’s engine for the creative economy, then Document Cloud is Adobe’s answer to the knowledge economy. You don’t need to be a designer to use Acrobat; you just need to handle contracts, pitch decks, onboarding forms, or any type of document you want to preserve in a universal format.

And here’s the kicker: Acrobat is slowly morphing into a creative tool, too. Increasingly, Adobe is bundling visual editing features directly into Acrobat, meaning you can design infographics, add charts, build visual documents, and collaborate across teams, all within a single PDF workflow.

This blurs the line between Adobe’s business units, but it also expands the value of Acrobat in a world that’s only becoming more digital and remote.

The Experience Cloud

While the Creative Cloud and Document Cloud are Adobe’s bread and butter, its third major pillar is the Experience Cloud, which powers digital marketing, customer analytics, and content personalization for enterprises.

Think of the Experience Cloud as the behind-the-scenes engine that helps brands deliver the right ad, to the right user, at the right time. You might say that creative professionals build their assets in Adobe’s Creative Cloud, and they distribute them and track their performance through the Experience Cloud. Across these two business units, Adobe facilitates the creative lifecycle from the first sketch of an advertisement to A/B testing different versions of it and tracking performance.

Although Adobe is better known for Photoshop than for its marketing stack, this division now generates billions in revenue each year (about 25% of total sales).

It’s also where Adobe competes directly with the likes of Salesforce, Oracle, and even Google. Fierce competition!

Unlike the Creative Cloud, which has a wide moat and near-monopoly status, the Experience Cloud is still finding its footing. Adobe has spent billions on acquisitions, as with Marketo and Magento, to beef up this division, and while those bets haven’t all paid off yet, Adobe’s strategy is clear and bears repeating: Own the full content lifecycle from creation (Creative Cloud), to format and distribution (Document Cloud), to performance tracking and personalization (Experience Cloud).

For large brands, the pitch is compelling: use Adobe for everything — from your billboard graphics to your presentation design, sales PDFs, document signing, ad targeting systems, and more.

The SaaS Renaissance

We should mention that, clearly, Adobe didn’t just become a high-quality compounder by selling CDs with Photoshop on them. The real transformation in business quality came in 2013 when Adobe pivoted from one-time software purchases to a subscription model, launching what we now know as the Adobe Creative Cloud.

Instead of selling boxed software every 12-18 months, Adobe moved to a recurring revenue stream. This meant updates became seamless, piracy rates dropped, and customer adoption exploded, all while revenue smoothed out, predictability increased, and margins expanded.

Best of all, it allowed Adobe to cross-sell lesser-known tools by bundling them with flagships like Photoshop and Illustrator, growing their adoption and Adobe’s dominance into new areas.

Today, over 95% of Adobe’s revenue is subscription-based. That’s a beautiful, recurring flywheel serving a mix of design professionals, enterprises, teachers, students, and side-hustling creatives.

Democratizing Design Tools

To distill Adobe’s moat down to two words, it would be "Creative Cloud." No other company offers such a robust suite of interoperable creative software deeply integrated into the workflows of major corporations, advertising agencies, Hollywood film studios, freelance marketers, and everyone in between, with the Creative Cloud business unit driving 60% of the company’s sales.

That dependence can also be a vulnerability, though, if disrupted further by Canva, Figma, or other emerging competitors.

Still, whether you’re animating, editing, designing, or publishing, Adobe’s tools are engineered to work seamlessly together. You can go from a pencil sketch to a 3D animation, all within Adobe’s platform. (And you thought Apple’s ecosystem of connected products was impressive!)

Plus, Adobe isn’t only for professionals anymore. With Adobe Express, the company is targeting casual users like teachers, small business owners, and influencers, offering templates and drag-and-drop tools that compete directly with Canva, a company that filled a void in the design industry by making affordable, simplified tools for non-professional designers.

Canva’s growth is exploding, leaping past 200 million users worldwide, raising concerns that a whole generation of individuals and small businesses may never enter the Adobe ecosystem, instead finding Canva “good enough” for their needs. 

While Canva is eating the low end of the market, Adobe’s dominance among enterprise and high-end creatives has hardly wavered. Your favorite HBO show’s production almost certainly still runs through Adobe, and that’s not likely to change.

To keep up with the times, however, Adobe is now doubling down on generative AI, embedding AI tools into all of its design platforms and creating a specific app devoted to AI called Firefly. With these tools, you can, for example, convert a sunny sky to a sunset with the click of a button, matching the same style as the rest of your image.

As you can imagine, that’s a powerful offering, especially when integrated into your existing workflow.

Is Adobe Losing?

The elephant in the room, then, is the question of whether Adobe is getting disrupted. The short answer is probably not, at least not in the way people think.

There’s a certain crowd rooting for Adobe to fall. Maybe they resent how essential Adobe products have become, how hard they are to avoid, and how expensive they can be. Or maybe they’ve seen viral demos of AI tools creating images and videos and assume Photoshop is toast.

But, as mentioned, Adobe has its own generative AI product called Firefly. And it’s not just a novelty like many AI tools today. It’s built specifically for commercial use.

Adobe paid to license the content it trained Firefly on and guarantees its outputs are commercially safe. In a world of copyright lawsuits and intellectual property landmines, being able to use AI worry-free matters a lot to corporate marketers and design professionals more broadly.

Additionally, Adobe doesn’t train Firefly on customer content. That’s another major selling point for creatives who don’t want their work cannibalized by the AI they’re feeding.

In other words, Adobe is, arguably, not playing defense. It’s playing offense, at least with AI. It’s certainly been caught backfooted by Canva and Figma in some ways — something I’ll (Shawn) touch on in a moment.

But, to do my own ‘scuttlebutt’ research of sorts, it was only natural for me to reach out to my colleagues here at The Investors Podcast Network, who do our audio & video editing behind the scenes, asking about Adobe. The anecdotal feedback I received was unequivocal:

• Adobe’s products remain the gold standard for sophisticated professionals
  

• It would be nearly unimaginable for our company, like many others, to move away from Adobe anytime soon
  

• The next generation of students continues to be trained on Adobe’s products
  

• So far, AI tools have only strengthened Adobe’s relative advantages

One of our colleagues raved to us about Photoshop’s Generative Expand feature, which can extend a headshot into a full portrait or remove and replace objects with simple prompts. One example, of many, powerful ways Adobe has turned AI into an opportunity to enhance creative professionals’ productivity.

In my view, AI won’t eliminate Adobe; it will amplify the need for Adobe’s tools.

More people than ever are creating designs. Yet, while ChatGPT is good at creating images on request that might be sufficient for social media use, it lacks the precision necessary for serious designers working at the pixel level to align a piece of content with a company’s branding.

The Figma Flop

Of course, not everything’s gone perfectly for Adobe, and we shouldn’t pretend it has. Back in 2022, Adobe announced its intention to buy Figma — a sleek, collaborative design tool that’s particularly useful for imagining websites, apps, and other digital interfaces — for $20 billion.

I actually used to use Figma frequently to plan updates to our TIP Finance site, and, well, it was great. I don’t know about $20 billion great, but I see why it’s popular.

Yet, the deal was contested by regulators, pushing Adobe to swallow a $1 billion breakup fee.

That one hurt, but beyond the financial cost, Adobe’s desperation to acquire Figma at a steep price showed just how far behind Adobe was in UI/UX design and how it had succumbed to the innovator’s dilemma, failing to meet the next generation of designers with products that actually met their evolving needs.

After abandoning the merger, Adobe also abandoned its Adobe XD product, which was meant to compete with Figma but held an embarrassing, and shrinking, market share.

Adobe realized too late that cloud-based collaborative interface design was a big business. Then, it truly missed the boat as the Figma acquisition fell through, leaving Adobe defeated in this design niche.

It’s hard to say what comes next. However, it seems clear the company is no longer trying to directly compete with Figma and has even hinted at partnering with them (perhaps directly integrating Figma into Adobe products?).

The lost Figma battle, both in court and in the hearts of UI/UX designers, is no nail in the coffin for Adobe in Daniel and my opinion. A sign of vulnerability? Yes, but ultimately, it was a defeat in just one corner of Adobe’s very large addressable market.

Adobe’s suite of products is immensely valuable, especially to enterprise clients who see Adobe as an all-in-one solution for many of their needs. That wide product portfolio, and the ability to bundle these tools together, offer an advantage over Canva and Figma, but also show why they’re popular, too . Canva is just, Canva.

There aren’t six other services baked into it, and that simplicity stands out to non-professional designers who just need to make a one-off design every now and then.

You might describe that as Canva’s core audience, and the question for them is whether they can move up the ladder and offer services for more sophisticated clientele, which would really begin to step on Adobe’s toes.

Valuation & Intrinsic Value Portfolio Decision

So…what’s Adobe worth?

Despite a 30% net income margin, consistent double-digit free cash flow growth, and a bulletproof balance sheet, Adobe trades like a company on the decline. Shares are down more than 20% in the last 12 months (nearly flat over the last 5 years), and its price-to-free-cash-flow multiple sits near the highest level in a decade.

In my model, I went through three different scenarios: My base case, bull case, and bear case.

I made basic estimates for how quickly I think Adobe can grow its three core businesses (Documents, Creative, and Experience) based largely on how they’ve historically grown. My base case is mostly in line with analyst estimates, while the bull case anticipates a bit more growth, and the bear case reflects a dramatic slowdown in growth, presumably due to market share losses to Canva, Figma, and other AI-based competitors.

And then, I looked at things like how much of operating profit typically converts to free cash flow, average net reductions in share counts each year from stock repurchases, trends in operating margins, and so on, and that all goes into my model to get a rough estimate of what Adobe’s free cash flow per share will look like by 2029 in different scenarios.

From there, like I usually do, I tried to use a range of exit multiples with weighted values and then used a discount rate to convert those 2029 values into today’s dollars, giving me a ballpark number of the company’s fair value, which is basically the price where I’d expect to earn an average return from going forward.

To get a target price where I’d be interested in adding Adobe to our Intrinsic Value Portfolio, I tacked on a 20% margin of safety to my fair value estimate to arrive at roughly $390 per share in my base case, and if the company can converge on my estimate of fair value from that level over the next 5 years, then that would imply a return of roughly 12-13% per year.

In a bull scenario, I count on slightly higher revenue growth rates, but the real difference is in operating margins, where I expect profitability to be about two percentage points higher due to economies of scale and reductions in R&D spending once the hype around AI tools starts to wear off.

And, naturally, with higher growth and profitability would come higher valuation multiples in five years, suggesting that the stock could compound at more than 19% a year from current prices. That’s optimistic but not crazy.

And then, in the bear scenario, I imagine lower revenue growth and Adobe’s operating margins compressing considerably as they’re forced to spend more and more on R&D to compete with Figma and Canva, as well as a cheaper valuation multiple.

The result — see below — is painful but not devastating, suggesting the stock is overvalued presently. But I think the company’s wide moats should protect it from truly worst-case scenarios, leaving us with a somewhat capped downside (3-4% returns per year, as I model in a bear case from current prices, would be tough but not devastating.)

Portfolio Decision

All in all, Daniel and I like Adobe at current prices, and we think the market has become too pessimistic about the company, which is one of the highest-quality tech businesses in the world, sporting an average ROIC north of 20%, average revenue growth of 18% a year over the last decade, 30-40% free cash flow margins (depending on whether you net out stock-based comp as I did above), and a very reasonable valuation, with wide moats, particularly around its Creative Cloud, which is its core business.

We hardly even talked about the Document Cloud and Acrobat, but this is also an incredible business unit that helps diversify Adobe’s revenue streams since it appeals to more traditional corporate clients over creative types.

As such, we want to take advantage of the current market fears about Adobe to build a position in the company, which we see as one of the few software companies that has compounded returns at impressive rates for four decades while still benefiting from substantial network effects and switching costs for its core products.

Updates in the section below on how we’ll size the position.

For more, you can check out our full podcast here on Adobe, and you can download our model for Adobe here to add in your own assumptions (hit “file” and “download”) — keep scrolling for the latest updates on our Intrinsic Value Portfolio.

Weekly Update: The Intrinsic Value Portfolio

Notes

• This has been a busy week! After our analysis of Adobe, Daniel and I decided to initiate a position in the company at an average price of approximately $380 per share, with a 5% weighting (at cost) in our portfolio. We’re really excited about getting to own one of the best software businesses in the world at less than 18x free cash flow. In my personal portfolio, I was able to get an even better price during the April tariff turmoil in the mid-$350s.
  

• Speaking of deep moat, world-class software businesses, we continue to be bullish on Alphabet, believing that the market is overreacting to fears of search disruption. Our understanding is that the most commercially valuable searches (not asking ChatGPT to do your homework) still run through Google. We don’t expect that to change for a long time, either, while Alphabet continues to rapidly grow its Cloud business, YouTube, and boasts some very promising developments out of Waymo, too.
  

  • And with AI overviews, Google is finding new ways to improve its search product and monetization. Yet, this past week, markets flipped out over a report from a senior figure at Apple implying that, in April, search queries declined for the first time ever. Not ones to overreact to one month of data, Daniel and I were reassured when Alphabet released a statement addressing the reports and properly contextualizing them, which spurred a rally in the stock.
    

  • Still, there’s a good bit of fear and uncertainty surrounding Alphabet at the moment, and we used that this past week to add to our position with new buys at approximately $150 per share, making Alphabet our largest portfolio holding at 8% (at cost).

Quote of the Day

"People think focus means saying yes to the thing you've got to focus on. It means saying no to the hundred other good ideas that there are. You have to pick carefully."

— Steve Jobs

What Else We’re Into

📺 WATCH: Bill Ackman on why he wouldn’t bet against Berkshire post-Buffett

🎧 LISTEN: Investing and life lessons with Mohnish Pabrai

📖 READ: Generative AI, inference, and thinking about returns on AI spending

You can also read our archive of past Intrinsic Value breakdowns, in case you’ve missed any, here — we’ve covered companies ranging from Alphabet to Airbnb, AutoZone, Nintendo, John Deere, Ulta, Uber, Coupang, and more!

Your Thoughts

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