Adobe (NASDAQ:ADBE) stock has rallied from $31 in August 2012 to its current market price of over $71. This translates into a return of over 135% in the last two years. Furthermore, this rally coincides with the launch of Adobe's Creative Cloud (CC), which contributes 57% to our estimated price of Adobe, and its rapid adoption amongst creative professionals. However, we believe that the current market valuation of Adobe is stretched, even as the company has entered the digital marketing market to diversify its product portfolio. In this note, we will discuss the factors that we believe will limit Adobe's valuation in the short term.
Limited Total Addressable Market for Creative Cloud
The Creative Cloud (CC) division together with Adobe's packaged division makes up 60% of Adobe's estimated value. The key drivers for this division are total creative software market and the average revenue per subscriber. While Creative products (Creative Suite and Creative Cloud) contributed nearly 50% to Adobe's revenue in 2013, the total number of licensees for Adobe's creative products stood at 12.8 million. Currently we estimate that the company is well underway to add over 3.4 million subscribers in 2014, and on track to add 10.8 million subscribers by the end of 2020. This figure represents 80% of the current 12.8 million point in suite licensees. However, to justify Adobe's current market price the number of subscribers will have to grow to over 13.8 million, which in turn will require a higher growth rate in the total addressable market (TAM).
Average revenue per subscriber (ARPS) for the company consists of a blend of subscribers that have enrolled to different levels of cloud services. While access to the complete Creative Cloud suite costs $74.99 per month, access to standalone Photoshop is priced at $9.99 per month. We estimate that the blended ARPS for the company was $27.5 in 2013. The recent trend in subscriptions indicates that users are subscribing to the annual full version of Creative Cloud. The company has also reported good growth in its enterprise term licensing agreements (ETLA), which have a tenure of three years. This leads us to believe that the ARPS will increase in the coming years as it converges to the sticker price of $74.99. We estimate that the ARPS will grow to $51 by the end of our forecast period. However, the market expects ARPS to grow at a much faster pace, which might be difficult to achieve if more products with lower price points are introduced within the cloud portfolio.
Market Share in Online Marketing Cloud
Adobe's cloud marketing division is the second-biggest division and makes up 20% of its value. Over the past few years, Adobe has built a comprehensive digital marketing platform that addresses most of the needs in digital marketing. This build up started in 2009 with the acquisition of Ominiture. Since then, the company has scaled up the functionality and product offering of its marketing platform through organic and inorganic growth. Currently, Adobe offers six products under its marketing cloud solution. The Adobe marketing cloud includes a complete set of analytics, social media optimization, consumer targeting, web experience management and cross-channel campaign management solutions. It generated around $1 billion in annual revenues in 2013. Having been built from the acquisition, the business has had a compounded annual growth rate (CAGR) of 106% over last four years. Well positioned in a growing market, this division is expected to witness robust growth in the coming years. Adobe is aiming to increase its revenues from cloud based marketing solutions by expanding in new geographies and verticals. According to the CEO of Adobe, Shantanu Narayen, the marketing cloud is easily a $10 billion opportunity.  Currently, we project revenues from its digital marketing division to reach $3.4 billion by the end of our forecast period. However, to justify the current market price of Adobe, the company will have to rake in over $4.8 billion in revenue for marketing division. We believe that this would be a difficult feat considering the intense competition in this space from companies such as IBM (NYSE:IBM), Accenture (NYSE:ACN), Salesforce.com (NYSE:CRM) and Oracle (NASDAQ:ORCL).
Acrobat Family Revenue To Grow
Acrobat family is the third-largest division and makes up 10% of Adobe's estimated value. In the past few quarters, revenue from this division has been on a decline, primarily due to the launch of document cloud services that have subscription fee spread over the period of usage. The company has amassed over 1.9 million subscribers for the document cloud service. We expect this trend to continue and forecast the subscriber base to grow to 8 million by the end of our forecast period. Furthermore, as this service gains momentum, we expect the ARPS to increase from $5.91 to $10 by the end of our forecast period. Despite this growth rate, we expect revenue to grow from $768 million to $1 billion by 2020.
Transition to Cloud Services to Negatively Impact Smaller Divisions
Smaller divisions of Adobe, which include Adobe packaged software, LiveCycle software and Print & Publishing, make up 6% of its estimated value. The adoption of Creative Cloud will negatively impact Adobe's packaged software, while up-selling to Adobe marketing cloud will impact LiveCyle and Connect pro revenues. We expect revenues from these divisions to decline in the future. We also expect the number of licenses sold for both the divisions to decline. Even if these metrics were to improve for both the divisions, it will have little impact on our stock price valuation, since contribution from these divisions is small.
We currently have a $58.14 price estimate for Adobe, which is 20% below the current market price.
Disclosure: No positions.