A few thoughts on Adobe

Adobe (ADBE) is clearly a magnificent franchise by almost any definition. Adobe Acrobat certainly plays an important role in office productivity. Creative professionals use Illustrator, Photoshop, InDesign and Dreamweaver. The product cycle seems to demonstrate that the integration of Macromedia with parent Adobe is well underway. Pretty impressive, given the fact that the deal only closed at the beginning of December.

PDF and Flash are ubiquitous platforms on which customers can build very feature rich Internet applications that drive even better customer interaction against a backdrop where broadband also is becoming more ubiquitous.

But a few things bother me:

• How much of a cross-selling opportunity is there really?


• Will the growth rates of Illustrator and Photoshop not slow dramatically, below a consensus 15% top-line growth rate?


• Will the push into “intelligent documents” not require more S,G&A costs than the current business?

Finally, a few thoughts on current valuation: Enterprise Value/EBIT is currently at over 30 times. Operating margins at 37% are near peak levels. Free cash flow yield is only at 2.9% versus FCF margins that run at an amazing 33%.CFFO, always exceeds net income showing high quality earnings and has totaled about $2.3 billion over the last five years. In contrast, capex over that period has been merely $200 million.

How much free cash flow found its way back to shareholders? Only about $270 million in share buybacks net of stock issuance over the last five years and roughly another $60 million or so in dividends. The company has been very wise to continue to reinvest in itself at these fabulous ROIC, running at almost 35% last year, and still above 30% despite the Macromedia integration.

There is some economic sensitivity…revenue growth in the last five years was about 9.2% but clearly below the 15% estimates that I see.

Overall, there seems to be a rather cheery consensus for what I agree has been a real gorilla of a business.

Insiders too seem to be decided sellers in the last six months.

One final note, a tongue in cheek but I think a relevant comment. There were more than twice as many attendees at the recent analyst meeting versus the last similar meeting, at least according to one of my analyst friends/ observers.

This is a great company, but it seems well exploited and fully valued, at least in my view.