$Adobe(ADBE)$ is down 8% after reporting earnings.
As often, it was not the earnings themselves that caused this, as Adobe beat estimates, but rather 1) CEO leaving and 2) guidance.
Shantanu Narayen, who has led Adobe for 18 years, announced yesterday that he is stepping down. He led ADBE through the difficult business model transition from licensing to SaaS subscriptions.
He couldn't be leaving at the worst time for the company, as ADBE is going through a generational disruption threat to its business.
While Adobe is integrating AI in its offerings, there is a growing fear that AI could lower the barrier to entry for competitors, in many use cases, eliminating the need for Adobe, thus reducing the number of paid seats.
My personal opinion is that in the future, where AI does 95% of the grunt creative work, significantly fewer Adobe licenses will be required.
Thus, Adobe must transition to a new business model, not based on per-seat licenses, but based on charging for the volume and value of the AI output.
I am not entirely convinced that in this future $ADBE makes as much money as they do now.
Today, the company makes billions from overpriced subscriptions to corporations. The cost to Adobe of each additional subscription is basically $0. This guarantees high margins as each incremental subscription dollar goes straight to the bottom line.
However, if ADBE charges customers depending on AI output, then AI computing costs could grow in tandem with revenue, or at least much faster than costs grow in the subscription business.
This could mean lower margins than under the current business model.
Narayen leaving now is not a sign of confidence, as he could be leaving before things go sour. Whatever he says in public, privately, he could be seeing writing on the wall.
Couple that with guidance that implies only 9-10% revenue growth, ADJ operating margin decreasing Q/Q from 47.5% to 44.5%, and the company doesn't look that cheap at 16x earnings.
The street wants to see acceleration in revenue growth and improving or steady margins to dispute the AI disruption narrative, but $ADBE is guiding for the opposite.
Most concerningly, we could be starting to see the first signs of the highly profitable legacy business eroding, and the new AI revenues having lower margins due to higher costs.
"In Q1, we experienced a greater-than-anticipated decline in our traditional standalone stock book of business." ADBE CFO
Management is effectively guiding for a transition period where high-margin legacy revenue (such as Stock) is replaced by new, lower-margin AI revenue (such as Firefly), which requires significant computing power (GPU costs).
As I said, I am not convinced the future brings faster growth and better margins.
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