Investors should keep the wide-moat software-maker near the top of their watchlist in case of a pullback.
By Rodney Nelson | 09-20-16 | 08:50 PM | Email Article

 Adobe's third-quarter results and fourth-quarter guidance were both well ahead of our expectations as the company’s execution of its business model transition continues to shine through. The company managed to outperform our subscription revenue growth projection while simultaneously outpacing our profitability forecast. Given the strong momentum Adobe is seeing across its core product verticals in the Creative Cloud and Digital Marketing, we are raising our fair value estimate to $115 per share from $104 as we account for the time value of money and modestly greater operating leverage in the medium term. We maintain our wide moat rating, and recommend that investors should keep Adobe near the top of their shopping list in case of a pullback.

Rodney Nelson is an equity analyst for Morningstar.

Third-quarter revenue rose 26% year over year to $1.46 billion, driven by 51% growth in the firm’s subscription revenue base. Creative Cloud continues to serve as the company’s key revenue driver, as both greenfield customers and cloud migrators are providing a consistent lift in the annual recurring revenue base. We believe ample growth opportunities remain across both Creative Cloud and Digital Marketing, particularly as consumer users migrate and enterprise customers consolidate digital content creation and marketing spend around suites of applications versus point solutions.

The company is beginning to show the two main benefits of renewal billings in its subscriber base, which are higher prices and substantially lower customer acquisition costs. As a result, GAAP operating margin exceeded our forecast by more than 300 basis points at 25%, the firm’s best quarterly mark since the fourth quarter of fiscal 2012. While we suspect the firm will need to maintain aggressive investment in sales and marketing, particularly as competition for digital marketing wins remains intense, we think the increasing renewal mix of Creative Cloud billings will smooth this effect, yielding mid-30s operating margins in the long run.

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