Thank you for your article on Adobe. I was particularly intrigued by your conclusion of Adobe's capital allocation policy. While I do appreciate that you have reached your own conclusion I would like to share some thoughts regarding this:
1) The conclusion on the capital allocation policy is based on past actions and the current share price performance. Playing the devil's advocate, if the share price instead increased by 30% since their last purchase, would your conclusion on capital allocation policy change? Mine would have, which made me rationalize and decide that it would be due to hindsight bias that looking at the current share price in determining a successful capital allocation policy is deemed unsatisfactory.
2) Carrying on from your comments regarding the capital allocation policy, I dug into the quarterly statements for Adobe over the past 5 years. An interesting conclusion can be drawn from doing this. The main feature of their share buyback policy is that they are in the market every month via a financial institution. My conclusion would thus be that their capital allocation policy is at best neutral and at worst unthoughtful.
3) As something that is c. 3x more capital intensive than acquisitions, I believe that management should deploy more management energy and thoughtfulness into their share buy backs. Some mechanical start and stop thresholds based on valuation (as you alluded to when you said they did not consider valuation) would be a prudent way to start and still be aloof.
4) Building on a wider framework to analyze their capital allocation policy, I thought of ways that management uses capital. The three chief ways capital can be utilized is via debt, shares, and operating cash in my opinion. On the front of debt capital usage, it appears they are not inclined to turbo charge debt to buy back shares. On the shares front, that capital has been used to reward management via SBC and to make acquisitions. On the operating cash front, the main use has been to buy back shares and make acquisitions. Thus, I personally concluded that a look at their capital allocation via their acquisitions would make better sense. On this front, over the past 10 years, they have spent north of 10bn in cash on acquisitions and probably issued many shares along the way to the founders/CEO of the acquired firms. However, over the same 10 years, their total write-down, impairments, and restructuring charges amounted to 50m dollars (From Capital IQ, correct me if I am wrong on this). From this angle, when management deploys capital to acquire companies, it does so in either an extremely shrewd way or there's some nefarious thing like non-reporting of impairments.
So when I look at Adobe and their capital allocation policy, what I see is that they appear to be soggy fried chickens with regard to when and how to buy back shares, something maybe they should work on but is not the end of the world if they continue with their current policy. However, that should not detract from the value they have created and their extreme success at acquisitions.
Great comprehensive coverage of a great business, great for a Sunday read! Thank you!
Complementary, just 2 charts I shared on twitter with the Free Cash Flow & Share Buybacks overviews: https://twitter.com/Maverick_Equity/status/1579068575398387712
Hi Victor and JPA,
Thank you for your article on Adobe. I was particularly intrigued by your conclusion of Adobe's capital allocation policy. While I do appreciate that you have reached your own conclusion I would like to share some thoughts regarding this:
1) The conclusion on the capital allocation policy is based on past actions and the current share price performance. Playing the devil's advocate, if the share price instead increased by 30% since their last purchase, would your conclusion on capital allocation policy change? Mine would have, which made me rationalize and decide that it would be due to hindsight bias that looking at the current share price in determining a successful capital allocation policy is deemed unsatisfactory.
2) Carrying on from your comments regarding the capital allocation policy, I dug into the quarterly statements for Adobe over the past 5 years. An interesting conclusion can be drawn from doing this. The main feature of their share buyback policy is that they are in the market every month via a financial institution. My conclusion would thus be that their capital allocation policy is at best neutral and at worst unthoughtful.
3) As something that is c. 3x more capital intensive than acquisitions, I believe that management should deploy more management energy and thoughtfulness into their share buy backs. Some mechanical start and stop thresholds based on valuation (as you alluded to when you said they did not consider valuation) would be a prudent way to start and still be aloof.
4) Building on a wider framework to analyze their capital allocation policy, I thought of ways that management uses capital. The three chief ways capital can be utilized is via debt, shares, and operating cash in my opinion. On the front of debt capital usage, it appears they are not inclined to turbo charge debt to buy back shares. On the shares front, that capital has been used to reward management via SBC and to make acquisitions. On the operating cash front, the main use has been to buy back shares and make acquisitions. Thus, I personally concluded that a look at their capital allocation via their acquisitions would make better sense. On this front, over the past 10 years, they have spent north of 10bn in cash on acquisitions and probably issued many shares along the way to the founders/CEO of the acquired firms. However, over the same 10 years, their total write-down, impairments, and restructuring charges amounted to 50m dollars (From Capital IQ, correct me if I am wrong on this). From this angle, when management deploys capital to acquire companies, it does so in either an extremely shrewd way or there's some nefarious thing like non-reporting of impairments.
So when I look at Adobe and their capital allocation policy, what I see is that they appear to be soggy fried chickens with regard to when and how to buy back shares, something maybe they should work on but is not the end of the world if they continue with their current policy. However, that should not detract from the value they have created and their extreme success at acquisitions.
Do I understand correctly from that table that you're discounting FCF with a 15% WACC? If so, how do you get that?