Core views

Adobe (ADBE.US)'s main financial data for the Q3 fiscal year 2020 all exceeded market expectations. The health incident accelerated the penetration process of digital media products, and the creative cloud and document cloud businesses all performed strongly; however, due to the continued drag on the advertising cloud business, the performance of the digital marketing business was still poor. The overall impact of short-term health events was limited. It is expected that the continuous improvement of the original customer ARPU, the continuous expansion of the user base of creative cloud products, the digital penetration of document cloud products, the improvement of the profitability of digital marketing products, and the accumulation of marketing data are still the main growth paths of the company in the medium to long term.

Matters:Adobe, the global leader in creative+marketing SaaS, recently released its financial report for the 2020Q3 quarter. The quarter's revenue and net profit all exceeded market expectations. Our comments on this are as follows:

Performance: The performance of the main financial data exceeded expectations, and there is still no guidance on full-year results.In Q3 of fiscal year 2020, the company achieved revenue of US$3.23 billion (+13.8%), exceeding market expectations by 2.2%, of which subscription revenue was US$3 billion (+17.8%), accounting for 93.0%. The gross profit margin of the Q3 company was 86.8% (+1.4pcts). The improvement in gross margin was mainly due to the company ceasing to operate the transaction-driven advertising cloud business in Q2, and the gross margin of this business was low. The non-GAAP operating margin was 43.5% (+2.8pcts), and the reduction in travel costs led to a significant decrease in the operating expenses ratio over the same period; the increase in operating profit margin also made net profit show elasticity that exceeded revenue. The company's non-GAAP net profit for the quarter was US$1.25 billion (+23.9%), exceeding market expectations by 6.9%. The company expects revenue in Q4 of fiscal year 2020 to be about US$3.35 billion (+12.0%), of which the digital media business contributed about US$2.45 billion (+18.0%), and the digital marketing business contributed about US$859 million, the same as the previous year.

Digital media: Strong revenue growth continues.Q3's digital media business achieved revenue of US$2.34 billion (+19%), of which: 1) the creative cloud business achieved revenue of US$1.96 billion (+19%), ARR (Annualized Revenue) reached US$8.29 billion, professional video products continued to grow rapidly, mobile paid subscriptions penetrated rapidly, and the expansion of the education sector was also outstanding; 2) the document cloud business had revenue of US$380 million (+22%), and ARR also reached US$1.34 billion. Demand for digital documents is still high, of which The number of AcrobatMobile installations increased 33% year over year, and the usage of Adobe Design increased 200% year over year, reaching major customers such as PWC, Pepsi, and HSBC. The release of the Education Resource Center application also accelerated the penetration of the document cloud in vertical fields.

Digital marketing: The impact of advertising cloud business remains the same, and other businesses continue to grow.Q3's digital marketing business achieved revenue of US$840 million (+2.0%), of which subscription revenue was US$730 million (+7.0%). Excluding the advertising cloud business, the subscription revenue of the digital marketing business increased 14% year over year. With the exception of some vertical industries facing difficulties and weak demand from small and medium-sized enterprises, the sharp decline in advertising cloud revenue is the main reason for the poor performance of this business. The weakness in the advertising cloud business is due, on the one hand, to the sharp decline in global advertising spending in the macroeconomic environment. On the other hand, due to low gross margin and deviation from the main subscription business, the company stopped operating the transaction-driven advertising cloud business in the middle of Q2. In addition to the advertising cloud business, AI, data analysis, and visualization-related functions quickly penetrated the Adobe Experience platform this quarter, winning large customers such as Elilly, Truist, Nike, Lowe's, Shell, and the US Department of Commerce. It also collaborated with Red Hat and IBM to form a hybrid cloud deployment solution.

Mid-term outlook: There is still plenty of room for business expansion.In terms of Creative Cloud, it is expected that the size of the company's core user base will continue to grow by 7% to 8% per year, while the promotion of mobile products will continue to increase the reach rate of disseminators and fans; in terms of document cloud, health events accelerate the process of document digitization. Relying on the company's dominant position in products such as PDF document reading, scanning, signing, and sharing, the business is expected to continue to grow; in terms of digital marketing, due to macroeconomic uncertainty and the subsequent impact of strategic adjustments in the advertising cloud business in the last quarter, short-term pain is inevitable, but strong mergers and acquisitions integration capabilities, ARPU Continued improvement, and the increase in the level of intelligence brought about by the accumulation of superimposed data will still drive the continuous growth of the company's digital marketing business in the medium to long term.

Risk Factors:Risks of business integration and profit margin fluctuations due to continued mergers and acquisitions of companies; risks of new user development and product price increases falling short of expectations; risks of mobile product conversion rates falling short of expectations; risks of continued intensification of market competition in the marketing software sector; downside risks of corporate IT spending exceeding expectations due to macroeconomic downturn, etc.

Investment advice:Currently, the company's stock price corresponding to the 2020 P/S valuation is 18X, which is significantly higher than the average of about 12x in the US stock SaaS industry, reflecting the market's recognition of the company's outstanding competitive position, profitability, and certain growth in the market. Looking at the medium term, performance growth, operating profit margin, and merger and acquisition integration effects are the main factors affecting the company's valuation level. They are also core indicators that require continuous follow-up and observation in the future.