Wide-moat Adobe continues to execute as well as any legacy software company in terms of migrating its business to the cloud.
By Rodney Nelson | 12-15-16 | 11:50 AM | Email Article

 Adobe  delivered yet another quarter of strong results, eclipsing our lofty expectations to put an exclamation point on a thoroughly successful fiscal year. The company continues to execute as well as any legacy software company in terms of migrating its business to the cloud, as the company ended the year with 78% of its revenue coming by way of recurring subscriptions. We continue to view Adobe as one of the best business models in software today, and we are maintaining our wide moat rating. We may moderately lift our $115 fair value estimate after rolling our model forward and incorporating management’s fiscal 2017 guidance, but investors should keep an eye on shares should they experience any weakness.

Rodney Nelson is a senior equity analyst for Morningstar.

Fourth-quarter revenue rose 23% versus the prior-year period, ahead of our forecast and above the top end of management’s prior guidance range. The company grew subscription revenue more than 40% in fiscal 2016, a testament to the firm’s ability to execute on its long-term vision of migrating millions of Creative Suite users to the cloud. The firm’s migration opportunity remains in the realm of 7 million users, allowing for ample growth opportunities in fiscal 2017. Perhaps more impressive is the firm’s ability to increase operating leverage despite torrid subscription growth, a trick we have not seen executed at such a high level among transitioning legacy names. Fourth-quarter GAAP operating margin expanded more than 700 basis points to 29%, the firm’s best quarterly rate in over five years.

Management’s initial fiscal 2017 top-line guidance was slightly below our expectations, but we were heartened to see adjusted earnings per share guidance of $3.75, well ahead of our internal model. We believe Adobe’s evolution speaks to the power of the SaaS model, and we think investors should be on the lookout for discounted, moat-bearing SaaS names, as we believe these firms (including Salesforce.com) can ultimately deliver this level of elevated profitability.

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