Summary:
- Adobe held its analyst day and talked about several important topics for long-term investors.
- AI will bring a new growth era, but not free of risks. It’s pretty clear by now that the company’s moat is shifting.
- Has the AI era rendered the Figma acquisition useless? We give our view.
We Are
Introduction
Adobe (NASDAQ:ADBE) held an Analyst Day some weeks ago, and we thought it would be interesting to write an article with the most interesting takeaways.
Note that Adobe is currently immersed in a fast transition to generative AI, meaning there’s almost constantly new information. We are not very comfortable with companies that change so fast, but we do believe Adobe is ahead in generative AI and that it could be a very profitable venture. We’ll give our thoughts on the moat in this article because it’s pretty clear now that it is shifting.
It was a special analyst day for Adobe because management focused on innovation rather than the usual financial metrics and commentary. There was, of course, some discussion around financial figures.
Without further ado, let’s jump directly into Adobe’s analyst day highlights.
The growth drivers of AI and monetization
Adobe’s management team talked extensively about generative AI, especially about its growth opportunities and how they plan to monetize it. It’s clear by now that Adobe will have two main revenue growth drivers from AI.
The first one is a significantly wider top of the funnel. Generative AI is lowering the entry barriers to digital content creation (more on this later), thereby greatly expanding the number of users with access to digital content creation. We are already seeing AI play out somewhat as a customer acquisition tool:
9 out of 10 Firefly users are not Adobe subscribers.
Everyone believes AI will have a significant impact on many industries, and we agree with this statement. This said, when the different industries will feel this impact will vary greatly. The creative industry will probably lead the way, and Scott Belsky gave a pretty good explanation here:
Of course, AI is driving trends in many industries and for many other companies that you cover, talk about it. But in many categories and scenarios, the uses of AI are really still just experiments. They’re intriguing, but maybe not quite ready for prime time. And one reason is hallucination. That continues to plague many of the use cases of LLMs.
But when it comes to creativity, hallucination happens to be a feature, not a bug.
It’s highly likely that we are already seeing AI impacting Adobe’s numbers, something that is not so clear in other industries where the shifts will probably take much more time to play out. The bottom line is that creativity is all about imagination, a use case that AI already covers.
The other growth driver is increasing the revenue per user. Management believes that AI will increase the value of their offerings, thereby giving the company increased pricing power. AI will also be a revenue generator in and of itself thanks to generative credits, although management believes it’s currently priced to drive adoption, not revenue. This strategy makes quite a bit of sense, considering that adoption leads to increased generations, which are later fed to the model as an input to improve it. What matters right now is scale; revenue can come later. Adobe has to take advantage of its distribution to stay ahead.
Express is also increasingly looking as a growth driver for Adobe, not just due to its current growth numbers…
Express grew 20% quarter over quarter MAUs (Monthly Active Users).
But also due to the role it can play in education. Adobe knows that the new generative AI capabilities give it access to non-professionals, so it’s making efforts to standardize Express in the education sector:
We have distribution partners, as you mentioned, with Chromebooks.
They’re obviously very, very well established in education, and they’re now introducing new devices that are targeted at small and medium businesses from their perspective. They didn’t believe they could be successful in SMB without Photoshop running on these devices or without something like Express on these devices, because that’s how people are communicating and likewise, our ability to access education by being on these devices is a major opportunity.
All in all, we think AI will be a significant growth driver for Adobe in the coming years, which does not mean that it’s all positive. It’s also evident that the company’s moat is shifting, meaning that the thesis is shifting too, to some extent. Let’s explain why.
Adobe’s moat is shifting
Based on management’s comments during analyst day, it’s pretty clear that Adobe’s moat is shifting. They basically told investors:
This is going to lower the learning curve and help far more types of customers really succeed in our products. The learning curve for all of Adobe’s apps will gradually dissipate.
Adobe had a moat of switching costs because its products were so difficult to use that professionals were unwilling to switch once they reached a certain expertise level. AI is breaking these barriers, so switching costs will likely decrease over the coming years. The moat will now be one of developing the best AI, thereby reducing the incentives to switch for customers. This is what will happen on the non-professional side. In the professional sector, Adobe still has a lot of opportunities to win across enterprise customers (more on this later).
The good news is that this moat shift will come with a more significant growth opportunity as the company will target users that it historically didn’t. As discussed above:
These new technologies, these new capabilities, they position us to capture billions of potential users in the years ahead.
This should technically lead to more paying members, according to Shantanu Narayen, Adobe’s CEO:
Over a multiyear period, you’re absolutely right. We should have an order of magnitude of more paying subscribers.
It’s pretty obvious that the opportunity ahead is significant, but this does not mean that the moat shift will be good for Adobe. What is the propensity to pay for these new customers? What will retention be? At what rate will Adobe convert these to paying members? These are more critical questions to assess Adobe’s returns going forward. We honestly don’t have the answer to any of them, but we do believe that Adobe can win in AI despite many believing it’s a much weaker moat than the company had historically had.
Why can Adobe win in gen-AI?
There are several reasons why we believe Adobe can win in AI. The first and most important one is probably distribution. Adobe is the dominant player in the creative industry, making customers unwilling to switch so long as Adobe can match AI features available elsewhere:
What’s even more exciting for us is actually the amount of Firefly generations that are happening within our interfaces. And I think it just reflects for companies like us if we can enable our interfaces that people are accustomed to, there is an advantage to when people use our products and incumbency in this, assuming we innovate at the right place, I think it helps us more than any other company in this space.
And the fact is, while we’ve said that there’s over 3 billion of these generations, the vast, vast, vast majority of those generations are happening in our products because that’s where people see the value.
We see this distribution advantage play out for other big tech companies like Alphabet. When ChatGPT (Open AI with Microsoft) came out, everyone thought Google was “done” and that many people would start to use Microsoft’s search engine, Bing. We are obviously not seeing this play out. Bard has managed to get up to speed fast and is now widely used thanks to Google’s distribution advantage. It is important to note here that Bard uses Firefly for generative AI images.
The other advantage Adobe has against other companies is an end-to-end value chain. While in environments such as ChatGPT or Bard, the value chain is simply “question -> answer” and it stops there, things are very different for images. Generative AI is just one step of the process, and the most likely outcome is that users will want to tweak their designs further. Adobe offers a comprehensive suite of tools to do this, but other peers don’t:
And lots of people use Generative Fill in Firefly. Usage is newly 9x higher in Photoshop.
The other advantage the company has relates to enterprises. For starters, the company is one of the few (if not the only one) in the world that has a connection between creation (creative cloud) and distribution and measurement (experience cloud) of digital content. This might be of little use for an individual user, but it’s essential for large corporations. These large customers can also have the assurance that they are creating commercially safe content, something that (most?) other generative AI tool can’t ensure.
And yes, we know that many people just use generative AI to have fun and don’t really care about an E2E value chain or commercially safe content, but those are not potential paying users after all, so they are pretty irrelevant for Adobe. What matters is that Adobe can win where the dollars are.
The content supply chain resonates with advertising agencies
We mentioned above that the content supply chain is geared more toward large corporations. While we believe that claim is true, Adobe seems to have found a way to capture some of the content creation outsourced to advertising agencies with its content supply chain. This has come in the form of partnerships with advertising agencies like Havas, Publicis, or WPP. Based on the quote below, these will probably act as both a user and a vendor of this offering:
And all of this comes together between the 3 clouds through this comprehensive content supply chain that we’ve been talking to you about. And so that helps content creation and delivery across all of the different constituencies that we serve.
And that’s been exciting to see because whether you’re Publicis or WPP or Havas, all of these companies are now recognizing that they need to have something like GenStudio of this content supply chain implemented both for them as well as all of the content that they as agencies are producing, but also create custom versions of that for every single enterprise that they’re serving.
It’s common knowledge that a good chunk of the digital content that will be created in the future will go toward digital ads, and some of this will go through these agencies. Adobe is significantly ahead of any company in being able to provide something like this:
And the result is what you see here. This is the studio — GenStudio solution that we just announced. And I’m convinced that we’re years ahead of where anybody else is in terms of bringing all of this together in a unified solution.
AI applications in the Experience Cloud
The value proposition of the Experience Cloud is clear, but what impact will generative AI have on it? According to management, there are three direct benefits:
So 3 things you can expect in the Digital Experience — I mean, Digital Experience when it comes to generative AI. First category, an AI Assistant, which really enhances the productivity and makes it available for a lot more users across the Experience Cloud apps.
Second category is, most of our Experience Cloud apps, we are reimagining those apps. And I’ll talk about that Adobe Experience Manager, which we relaunched today, the launch of the new release, completely rebuilt using new technologies, like Edge delivery and generative AI.
And the third category is entirely new solutions built for the age of generative AI, like Adobe GenStudio.
Of all these, the most important, or maybe better said, the one with the most tangible benefits, is the AI assistant. The experience cloud is quite complex (I used it in my previous job), and business people (not technicians) typically find a lot of value in it but need help to learn to use it. That changes with the AI assistant:
With the AI Assistant, anybody can use it.
This should help more people across the enterprise find more value in Adobe’s Experience Cloud.
Interesting applications for gen AI on Document Cloud
When Adobe started talking about generative AI, we immediately understood its implications for Creative Cloud (they were evident), but we struggled to see how it could be applied to the other clouds. We have just explained its implications for the Experience Cloud, and how management will apply it to the Document Cloud is also very interesting.
Generative AI will be applied to the document cloud in two main ways:
-
Allowing users to have a “conversation” with documents: this will allow users to extract important information from PDFs much faster. We believe this might actually be a game changer for investors, who will be able to go through more PDFs in less time. We had never contemplated paying for an Acrobat subscription, but this might do the trick. We think our personal example also shows how AI can widen the funnel.
-
Increasing user productivity in gathering feedback: a document typically receives a lot of feedback, and AI will help users condense this feedback and organize it.
You can see how those of these come to life in the following video shared by Adobe:
Is the acquisition of Figma necessary at this point?
Something that we have been increasingly thinking about is whether the Figma acquisition is necessary at this point. The context under which Adobe decided to acquire Figma significantly differs from today’s.
For starters, generative AI was not the buzzword back then. This is important because, with its arrival, it seems that Adobe is now in a better competitive position than peers:
We just continue to think this will drive top line growth and it will be profitable. And I think it’ll actually further separate Adobe from the other companies.
In short, in a gen-AI-world, Figma does not seem such a threat as it was in a non-gen-AI world.
The second reason is that Adobe has been working hard on its collaborative products, most of them on the web:
And the shift from siloed creativity to a far more collaborative process continues with our multiyear efforts to take products like Photoshop and Illustrator to the web and develop capabilities like Share for Review and Frame.io, we are breaking down barriers and making it much easier for creatives to work with all of the stakeholders of creativity around them.
Recall that this was one of the reasons why Adobe supposedly acquired Figma. However, it seems like the company can figure it out by itself. We still think, though, that Figma’s non-designer user base is still very appealing for Adobe, but it’s unclear to us if that’s worth $20 billion.
Looking ahead
Management also gave us a bit of forward-looking commentary. First, next quarter is expected to be the company’s first quarter above $5 billion in revenue. This is a significant milestone, but it seems the company will be able to achieve higher. Dan Durn, Adobe’s CFO, did not give a timeline but claimed that $30 billion in revenue is on the horizon:
Adobe Investor Presentation
The management team expects the AI era to be the most revolutionary tech era of all, and they’ve been through quite a few of these eras:
So we really look at this and say that every single one of these eras has added to our opportunity. But I take a step back and I think all of these is probably dwarfed relative to what the opportunity is now in the AI era.
One of the worries in the investor community is that AI will cannibalize the seats available to Adobe due to its significantly higher productivity. Scott Belsky thinks that this will not happen and that it’s a net benefit:
Now this is consistent with job growth in previous platform shifts, whether it be engineers becoming increasingly more efficient over the last few decades, the advent of no-code web builders in the early 2000s, the rise of social and user-generated videos over the last 2 decades. Through all of these changes, the need for more engineers, more web developers and video pros, these needs only grow. And the results actually from our own customer surveys are also encouraging. We’re starting to really connect with our customers. We’re trying to ask them what all this means for them, what they’re perceiving.
And right now, about 8 and 10 creative pros believe gen AI will have a positive impact on their careers by helping them create more and better content. It goes back to finding that better solution through some of the power of these tools.
65% of communicator and consumer audience that we’ve surveyed believe gen AI will increase the quantity of content they create and a growing number are already starting to tinker and experiment with these tools.
Adobe Investor Presentation
The good news is that Adobe is not only focused on growth but on profitable growth:
As these inflections take hold, we expect to deliver stable, consistent operating margins through this investment cycle. We’re oriented towards growth and we’re going to invest in growth. We’re going to do it in a profitable way.
It’s pretty impressive to see Adobe deliver the margins it’s delivering now that it has invested significantly into AI but has yet to reap its benefits.
Conclusion
We hope this article helped you understand the main highlights of the company’s analyst day. Management touched on many more topics, but these stand out as the most important ones. AI will bring a significant opportunity for Adobe but it will also shift its moat.
In the meantime, keep growing!
Analyst’s Disclosure: I/we have a beneficial long position in the shares of ADBE either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Best Anchor Stocks helps you find the best quality stocks to outperform the market with the lowest volatility/growth ratio. We look for top-notch quality compounders, with solid growth and lower volatility than you would expect.
Best Anchor Stocks picks have a track record of revenue growth combined with below-average volatility. Since the inception in January 2022, our portfolio has outperformed the S&P 500 by almost 12% (on 05-16-2023).
At Best Anchor Stocks, we follow up our quality compounders meticulously, so you don’t have to worry about your portfolio.
There’s a 2-week free trial, so don’t hesitate to join Best Anchor Stocks now!