A new species of whales was discovered in Mexico. I kinda had mixed feelings after reading this. On one hand, I was glad we made this discovery. On the other, there may be some ignorant and greedy people trying to hunt them down for food or just an ego booster.
On its 2020 Investor Day, Disney showed everybody that it was going to be a force to be seriously reckoned with in the streaming business in the years to come. The four hour presentation was packed with announcements on upcoming titles, business updates and impressive revised projections. Netflix fans always point to the fact that the streamer won the streaming war by having a much bigger subscriber base than any other competitors. The big subscriber base allows Netflix to operate at a much lower cost advantage. For the same investment of $1 billion in content, a base of 100 million subscribers will lead to a cost of $10 per subscriber while a base of 10 million will result in a cost of $100/user. As each user brings in monthly revenue, a lower cost structure enables a higher profitability which, in turn, enables more money in content creation which, in turn, leads to more appeal to consumers.
Netflix, with 195 million subscribers, enjoys a cost advantage to other competitors. It already got over the peak operating losses and has seen positive free cash flow for the past three quarters, despite spending a massive amount of money on content. I believe none of the other streamers achieved that feat yet. In short, Netflix has an invaluable head start.
Enter Disney Plus. Last year, Disney forecast to have around 60 to 90 million subscribers by the end of FY 2024. They just announced that the number of Disney+ subscribers was 86.8 million as of December 2, 2020. Critics say that Disney reached this number due to a huge subsidy in the Indian market which constitutes 30% of the base now. Well, that’s true, but it’s hard to reach the mass market in a short period of time and keep the price high. You have to take a multi-step approach. Expand the base first, add more value and increase the price.
That’s what Disney is doing now. With more than 86 million subscribers in the pocket, the company is planning 100+ titles per year for the next few years, coming from established brands such as Marvel, Disney, Pixar, Star Wars and National Geographic. At the same time, Disney is addressing the Average Revenue Per User (ARPU) issue with a price hike of $1/subscriber/month in the US and €2/subscriber/month in EU starting March 2021 and with a Premier Access model. The Premier Access model lets subscribers gain first access to select titles before everyone else for an additional fee. A few months ago, Mulan cost Disney+ subscribers an additional fee of $30 in exchange for first exclusive access.
As a result, Disney expects to have around 230-260 million Disney+ subscribers by the end of FY2024. Within one year, they revised the forecast from 60-90 to 230-260 million subscribers for the same time frame. There must have been some sandbagging, but I believe that even the folks at Disney didn’t expect to have such a big leap. The new figure should put Disney+ in the same conversation as Netflix by the end of FY2024 and well ahead of the other streamers. The profitability expectation remains at the end of FY2024, unchanged from the Investor Day last year, even though the legendary company expects to at least double its content cost by FY2024. The same upgrade in expectation is similar for ESPN+ and Hulu
Those are impressive revisions, particularly given Disney’s distinct advantages. First, streaming services aren’t the only way they generate revenue and profits. Their Media and Parks segments generate considerable revenue and profit as well, especially Parks. Parks has been hit particularly hard by the pandemic, but once we go back to normal and vaccine is delivered to the public, Disney should have no problem attracting guests back to their hotels, parks and resorts. Even though the other segments don’t directly subsidize the streaming services, having them around definitely helps the company as a whole in terms of profits, revenue and cash flow. Netflix, rightfully worth every accolade for their laser focus, has only one line of business. As long as that line of business thrives, they will enjoy the full benefits of not having to spread resources like Disney. However, on the other hand, a crisis would hit them harder than Disney without any cushion.
Moreover, Disney has so many ways to appeal to consumers. First, they have an extraordinary library of content and brands, ranging from series, films, documentaries and sports. Second, they can always create value out of a bundle such as what they are doing now with a bundle of Disney+, Hulu (ads and no ads) and ESPN+. Another model that can be deployed is Premier Access as I describe above or a theatrical release in which a movie will be available first in theaters and then on Disney+. An example is Black Widow. This takes me to another strength that Disney has. A portfolio of household brands that need no introduction. When somebody mentions Avengers characters or Star Wars, there is little introduction needed. That kind of brand power helps draw viewers regardless of the medium. When Disney releases Black Widow in theaters first, they likely won’t need to persuade Marvel fans to pay to watch. What they may need to persuade them on is whether it’s worth getting into theaters when the pandemic may still be around. This brand power isn’t just limited to consumers with kids. On the 2020 Investor Day, Disney CFO revealed that more families without kids are subscribers than families with kids; which is a very interesting revelation since it was assumed that Disney would appeal parents through content for kids.
In short, I believe the future is bright for Disney’s streamers and the company as a whole. That doesn’t mean that I think Netflix is doomed. The sizeof the market and the consumer behavior should allow these two behemoths to co-exist. As long as other streamers have the financial ammunition to compete, they should have a seat at the table, but this should be a two-race non-zero-sum market. The winners should be consumers who will get more choices and talents, including actors, directors, creators, storytellers and so on, who will be sought after as streamers strive to create quality content.
Adobe’s extraordinary story continues
Adobe may not be as popular as some of its products. It’s the creator of Photoshop, Illustrator, InDesign and PDF. It also owns Behance, the LinkedIn of creative folks. Its less known products include Marketing Solutions, such as Email Marketing, eCommerce and Customer Analytics, and Document Solutions such as eSignatures or Document Intelligence Services. Besides its famous products, Adobe is also known for being the trailblazer in transitioning to a Software-as-a-Service model. The transformation started in about 2011 or 2012, and it has been the case study as well as the envy of established software makers all over. Adobe’s revenue grew at a CAGR of 18% from 2013 to 2020, reaching almost $13 billion in 2020. More impressively, its FY 2020 Operating Income was even higher than its revenue in FY 2014. Additionally, its Operating Margin in FY 2020 was 32%, the highest in the last 6 years.
The transformation was best reflected in Adobe’s subscription. In 2013, only 28% of the company’s top line came from subscriptions which have higher margin and stickiness. In FY 2020, the figure stood at 90%. In terms of CAGR of subscriptions’ absolute dollars, it is an extraordinary 39%.
Among the main business segments, Digital Media is the biggest and certainly the driver of growth at Adobe. Since 2013, Digital Media’s revenue grew by almost 300%. Within Digital Media, Creative and Document Cloud Annual Recurring Revenue more or less doubled in the last 4 years.
While Digital Experience, which includes B2B solutions, faces stiff competition from the likes of Salesforce, Adobe is clearly the market leader with their Digital Media offerings. How many designers or creators in the world don’t have an Adobe product? Which document format can replace the de factor PDF when it comes to official documents? Their Digital Media products, whether it’s Creative Cloud or Document Cloud, are popular among subscribers. According to Adobe’s 2020 Investor Day
75% individual subscribers in 2020 were completely new to Creative Cloud
Individual subscribers made up more than half of the Creative Cloud’s revenue
2 billion mobile + desktop devices were installed with Acrobat Reader
75%+ individual subscribers in 2020 were new to Acrobat
Mobile IDs were more than 300 million in total as of Q4 FY 2020, with more than 175 million created
More than 60% of Creative Cloud ARR is based on All Apps subscribers. An All-App subscription costs $53/month, much more expensive than individual app subscriptions.
All these data points show how much customers love Adobe products. As more and more people use Adobe products, it helps the company establish an invaluable network effect. If you are a designer collaborating with other designers and businesses that are used to working with Illustrator and Photoshop, it’s difficult not to use those applications. That’s perhaps the strongest moat Adobe has. There may be better alternatives than their products on the market, but those products don’t have the brand names, the popularity, the established sales channel and the network effect that Adobe has. Once a company can establish this kind of relationship and network effect, its priority should be to continue add values to subscriptions to keep the churn low. In other words, as long as the existing subscriber base doesn’t shrink, Adobe’s revenue will only grow. Any new subscribers acquired will only add to their fortune.
Disclaimer: I own both Disney and Adobe in my personal portfolio.
What does Autodesk do? What were the significant events in the past 5 years?
Founded in 1982 and headquartered in California, Autodesk creates software for professionals in engineering, architecture, construction, manufacturing, media and entertainment industries. Some of you may know Autodesk by its notable product AutoCAD. Basically, what Autodesk is to architects, engineers, manufacturing professionals is what Adobe is to creative folks. See below for a few examples of what Autodesk software can do.
The company’s main business segments include AEC (Architecture, Engineering & Construction), AutoCAD & AutoCAD LT, Manufacturing (MFG) and Media & Entertainment (M&E). Below is a summary of some of the main products offered in each business segment:
In FY 2020, revenue share of these segments was 42% for AEC, 29% for AutoCAD, 22% for MFG and 6% for M&E. Compared to FY2019, share of AEC and AutoCAD increased by 200 and 100 basis points respectively, while that of MFG and M&E decreased.
Regarding distribution, Autodesk employs three different distribution options. Firstly, the company sells products through its online store to end users and through dedicated internal salesforce. Secondly, Autodesk sells directly to resellers who, in turn, sells to end users. The last option is a two-tiered distribution in which Autodesk sells to tier-1 distributors who sells to resellers before products get to end users. Combined, the two largest distributors (Tech Data and Ingram Micro) were responsible for 45% of the company’s revenue in FY2020. Given that indirect sale was 70% of total revenue, those two distributors occupied 64% of the indirect sale.
Geographically, EMEA and the US were Autodesk’s two biggest markets with 40% and 34% share of revenue in fY 2020 respectively, followed by APAC (19%) and other Americas (7%). Emerging economies such as Brazil, China, Russia and India made up 12% of the total revenue. These figures have stayed largely consistent in the last 3 years for the most part.
Just like most software companies, Autodesk traditionally sold their products through perpetual licenses and earned additional revenue through maintenance plans which allowed customers to receive future upgrades. Perpetually-licensed users could use the software forever, but without new features. Companies could buy a multi-user license or a network license.
The transition was first signaled by the current CEO Andrew Anagnost, who was then the Senior VP of Strategy & Marketing. Later, in February 2016, Autodesk announced that it would stop selling standalone licenses. The only way that customers could use its software individually is through a subscription. The announcement was made in advance to smooth out the transitions in the near future. But why did Autodesk move to subscriptions? There are several reasons:
Subscriptions allow management to make reliable forecast on the business in terms of revenue and cash flow; which is important to any executives.
By continuously delivering new updates and features frequently, Autodesk can increase customer satisfaction. Additionally, Autodesk can also receive customer feedback through data analytics and incorporate such feedback into product development faster.
Frequent updates also bring more security .
Instead of a hefty sum upfront, a smaller subscription fee makes it easier to convince potential customers to buy in.
Plus, customers can easily scale up and down investments on a monthly/yearly basis, if necessary.
The longer a customer stays subscribed, the more profitable he or she is. Hence, Autodesk is incentivized to deliver on products and services to keep customers happy & locked in.
The company probably took notice of the success of the trailblazer Adobe, which also switched to subscriptions in 2012.
In June 2017, Autodesk revealed a Maintenance-to-Subscription (M2S) which enabled customers on maintenance plans to trade in their seats and credit for subscriptions. At the same time, Autodesk increased the price of maintenance plans to make them financially unattractive to nudge customers towards subscriptions. The company later said that it would retire maintenance plans by 7th August 2021. On the 2020 Analyst Day, Autodesk declared that their transition to subscriptions was complete and the company is now onto the next targets.
Financials and fruits of the switch to subscriptions
In FY 2020, Autodesk recorded its highest revenue ever at almost $3.3 billion, up 27% from FY 2019 which in turn was up 24% from FY 2018. Recurring revenue rose from 46% in 2015 to an astonishing 96% in 2020. Remaining Performance Obligation (RPO), which refers to revenue that is contractually stated, yet realized, in FY 2020 was more than $3.5 billion. Subscription Annual Run Rate, a key performance metric in subscription model, went up to $3.1 billion in FY 2020 from $1.2 billion in FY 2018. Subscription revenue in 2020 stood at $2.7 billion, up 53% YoY, offsetting the decrease in maintenance revenue.
This is the power of subscriptions. The management team can forecast future revenue very reliably. As a result, they can plan ahead for strategic moves and allocate resources accordingly.
In FY 2020, Autodesk delivered $1.36 billion in Free Cash Flow (FCF), meaning that their Fresh Cash Flow Margin (over revenue) was 41%. To put the figures in perspective, in fiscal 2019, Autodesk’s FCF was $310 million. The outstanding growth in FCF showed that the company became much more efficient in generating cash from its operations.
For the first time since 2016, Autodesk was profitable operationally with $343 million in operating income (a tad over 10% operating margin). It was due to the economies of scale when revenue grew substantially and marginal cost was minimal. Furthermore, Autodesk’s operational leverage was higher in 2020.
Expenses as % of revenue rose from 2016 to 2018 and gradually declined in 2019 and 2020. Marketing expense as % of revenue in 2020 was actually a bit lower than that in 2016, and so were other expenses. This proves that even though expenses in absolute dollars increased, the company became more efficient and grew the top line as a faster pace than expenses’ growth.
What is next for Autodesk?
Guidelines till FY2023
On 2020 Analyst Day, Autodesk announced targets for FY2023 that include 16% – 18% Revenue CAGR, $2.4 billion in FCF and 55% – 65% of FCF Margin + Revenue Growth. In the SaaS world, there is a rule of 40 which states that if your FCF and revenue margin combined is 40%, your company’s efficiency is pretty awesome. Hence, Autodesk’s target of 55-65% is pretty incredible.
Noncompliant and legacy users
One of the main initiatives is to convert legacy users who are on perpetual plans and noncompliant users that refer to those who are using Autodesk’s software illegally. According to Autodesk, in addition to the existing 5 million paying subscriptions, there are 12 million noncompliant users and 2 million legacy users. Out of the 12 million noncompliant users, they estimate to have 7 million users that opened their software at least 11 times in the last 90 days and are using a version released in the last 5 years, a population considered to be highly convertible.
There are several initiatives aimed at converting these noncompliant and legacy users, including:
Stop offering maintenance plans in 2021
Harden student verification process
Ban offline activation
Switch from serial numbers to named users, a change that can allow corporate IT teams to avoid leaks and control usage
Apply concurrent user limits
Message target users with in-app messages and emails
Autodesk has a lot of tailwind behind them. Lisa Campbell, Chief Marketing Officer, estimated that in FY2025, the total addressable market (TAM) for Autodesk would be $69 billion. Given that the company’s FY2020 revenue was around $3.3 billion, the estimate implies a lot of room for growth for Autodesk. The confidence stems from favorable trends such as 1) collaboration between professionals from different backgrounds on increasingly complex projects in architecture, manufacturing and construction; 2) digitization in industries that use Autodesk’s products; 3) suburbanization; 4) Building Information Model (BIM) mandates in countries.
In addition, Autodesk can also grow horizontally by expanding its footprint in overseas markets. In some areas, its penetration is still low, signaling that there is a lot of opportunity at play. Take BIM penetration as an example. Building Information Modeling (BIM) is a process that essentially enables Architecture, Engineering and Construction professionals to collaborate effectively and efficiently during the entire construction project. In some countries, there are BIM mandates in construction projects while a growing number of other countries are planning to introduce their own mandates. Below is Autodesk’s map of BIM footprint. Almost all countries where Autodesk’s presence is low are developing countries whose need for building new infrastructure will undoubtedly grow in the future.
The decision to switch to subscriptions is massive for Autodesk. It enables the company to be more agile and unlock more value for both customers and shareholders. From what I have seen, the future is bright for the company. There are a lot of tailwinds behind Autodesk and the fact that its revenue has grown since the switch to subscriptions signals a positive acceptance from customers. One look at Adobe can offer a bit more perspective. Adobe started its journey to subscription-based model in 2012. Below is how much the company has grown since then
The trend looks familiar. If Adobe’s 2012 is Autodesk’s 2016, the former’s 2016, when its growth really kicked into high gear, can really be Autodesk’s 2020. Hence, Autodesk can likely follow the trajectory of Adobe and grow its top & bottom line further in the years to come.
Disclaimer: This post took me a few days to write. When I first started, I was looking into it as a potential investment. By now, I own the stock in my personal portfolio
In this post, I am looking at Adobe’s Q2 top line performance compared to Q2 2018 and Q2 2017. Disclaimer: I have Adobe in my personal portfolio. The data was retrieved from Adobe’s official quarterly reports. Before we go further, it’s important to look at what the segments entail
Digital Experience (Experience Cloud)
Overall, revenue YoY growth in 2019 increased compared to that in 2017. Revenue growth in both years stood at mid 20s. However, gross profit and particularly, operating income slipped.
In terms of segment revenue YoY growth, product and services improved in 2019, compared to 2018. While subscription revenue YoY growth slightly decreased in 2019, compared to that in 2018, the figures in both years are still higher than those of Product and Services.
Subscription and Services saw their Gross Margin slightly slip across the last 3 Q2s, both outperformed by Product. It’s obvious that Subscription and Product are significantly more profitable than Services.
With regard to segment revenue as % of Total Revenue, all three segments look pretty consistent over the past 3 Q2s.
When YoY revenue growth is looked at, Publishing and Digital Experience impressed, compared to Digital Media
However, Digital Media and Publishing are more profitable to Adobe than Digital Experience
If we simply look at YoY revenue growth from subscriptions in these segments, Digital Experience significantly improved in 2019 compared to 2018 while Publishing stagnated in 2019.
At a lower level, inside Digital Media, while Document Cloud revenue grew pretty much at the same pace in 2019 as in 2018, Creative Cloud revenue growth slowed in 2019.
In terms of ARR, Adobe looks to be in good shape. I didn’t do a YoY analysis since they showed numbers in different currency rates
Adobe has been a darling of Wall Streets for the past few years and a trailblazer of the SaaS movement. Below is Adobe’s stock performance for the past 5 years.
Today, I decided to take a look at Adobe’s past performance since the strategic switch from selling software as a perpetual license to a subscription-based model in April 2012. Even though I do own a few stocks of Adobe, this post stemmed from my curiosity about how the company has performed and if/how the strategic switch impacted the bottom line. Before we go into details, there are a few notes worth mentioning:
Adobe’s three main product lines include Digital Media, Digital Experience and Publishing
Adobe reports financial data by Product lines as just mentioned above and segments (subscription, product and services).
Why Adobe switched to cloud?
In 2011, Creative Suite brought to Adobe more than $4 billion in revenue and a filthy gross margin of 97%. The company sold the software and other products in perpetual licenses. In April 2012, the company announced the transition to the cloud and subscription model. Why?
I’ll let Adobe CFO Mark Garrett and VP of Business Ops & Strategy Dan Cohen at the time answer this question. Per Mark Garrett in an interview with McKinsey:
There were a number of reasons, both financial and strategic. For one, even though customers had higher creative demands, our creative business wasn’t really growing. The number of units we shipped under the old perpetual-licensing model was about three million units a year, and it remained flat for a long time. We were driving revenue growth by raising our average selling price—either through straight price increases or through moving people up the product ladder. That wasn’t a sustainable approach.
The perpetual-licensing model was also limiting us from delivering new innovations and capabilities to our customers. Historically, we had delivered product updates only every 18 or 24 months, but our customers’ content-creation requirements were changing much faster than that, with advances in devices, browsers, mobile apps, and screen sizes.
Inside the company, we had this fundamental belief that there were broader market opportunities for us. Where content was being created and managed, when it was being consumed, and where it was going to be monetized—all of that was changing. We also believed that data were going to become more important. We already had a strong presence in content creation, and we saw an opportunity to broaden our presence in these areas.
The recession was also a factor. During the downturn in 2008 and 2009, our revenue and stock price suffered more than that of most software companies, because other companies had high recurring revenue. Our recurring revenue for the prior fiscal year was about 5 percent annually. We had virtually no financial buffer.
And from Dan Cohen in the same interview:
When we looked at how other software companies were faring during the recession, we saw that companies with high recurring revenue had smaller declines in their growth rates and valuations. We had a very big drop in both—our revenue dropped about 20 percent, and our valuation fell even more. We had extremely high customer-satisfaction rates for our products, but when we drilled down into the numbers, we saw that people were saying things like, “I’m happy with what I have, I don’t see the need to ever buy another one again.” Clearly, we needed to figure out how we could get people to want to buy from us more regularly, and, related to that, how we could innovate better and faster for our customers. We saw that the new software companies that were reaching scale were those operating under a cloud model.
Except the two years after the launch (2012 and 2013) and 2018, revenue growth has been climbing. The past three years have seen a revenue growth of more than 20% on average.
Even though the trend looked negative from 2008 to 2013, the past 5 years has seen an amazing streak of increase in net income as % of total revenue.
Subscription revenue as % of total revenue
Before 2012, subscription revenue never accounted for more than 16% of Adobe’s revenue. However, everything changed after the launch and as of now, subscription revenue made up more than 87% of Adobe’s revenue.
Segment Revenue Growth
Since 2012, subscription revenue YoY growth has remarkably outperformed that of Products and Services.
Segment Gross Margin
On the other hand, Product reigned superior in terms of Gross Margin while that of subscriptions has crept up over the years. My guess is that Product refers to the sale of perpetual licenses while subscriptions refer to the regular charge of fees for usage of Adobe’s software. Meanwhile, the margin of Service continues to drop.
Subscription-based revenue by Products
Below is the subscription-based revenue by Products: Digital Media, Digital Experience and Publishing. Missing data is due to the lack of reporting by Adobe
For Digital Media and Digital Experience, revenue from subscriptions makes up the majority of each revenue stream.
Around 2011 when the subscription model wasn’t as popular as it is now, Adobe took a considerable risk by being a vanguard going into an uncharted territory. Nonetheless, it seemed that the company had no choice. Based on the interview with the two C-Suite executives at the time, as mentioned above, the business was entering into a threatening and tricky period. Raising prices was not a sustainable solution. Plus, the company faced a risk of being left behind as the explosion of content outpaced the development & release rate at the time. By turning to the cloud & a different delivery model, Adobe avoided the risk of being obsolete.
Retrospect is a beautiful thing. Looking at the wild popularity of SaaS model nowadays and the data above, it’s clear that Adobe made a correct strategic call to switch the cloud and subscription model.