Adobe and Netflix aren’t competitors in their underlying operations, but they do compete for capital and investor attention in the technology sector. Both companies know what it feels like to be at the top of their game. And both are struggling with varying degrees of disruption.
In the past week, Adobe traded 5% higher and Netflix fell 7%. Adobe’s year-to-date pain (down 29%) isn’t much worse than Netflix’s 24% decrease. But why is Adobe catching a bid? And is Netflix really deserving of this kind of punishment?
In case you’ve been under a rock for the past year, the TL;DR at Adobe is that the golden days of the software-as-a-service (SaaS) business model are gone. There are now numerous AI tools that can do many of the things that Adobe is used for. There are cheaper alternatives servicing the mid-market, such as Canva. Adobe’s remaining moat is in the most demanding professional applications, a much smaller market than the broader appeal Adobe used to have.
Adobe acknowledged this on its latest earnings call. The company is moving to a token-based model that will allow users of various AI tools to plug into Adobe for specialist solutions as required. This is the polar opposite of the traditional SaaS model, where customers pay a time-based subscription instead of usage-based fees.
I’ve seen many recent videos about Adobe that were made with a heavy dose of schadenfreude. Creatives have felt ripped off by the subscription fees for years. This market was begging to be disrupted.
The jury is out on what the financial future looks like, but the market is voting with its feet in the meantime. The price/sales multiple has dropped dramatically to 3.7, having peaked at 22 during the pandemic. The more useful comparison is the 10-year average of 12.3, reflecting the high regard that the market once had for the best days of SaaS.
The bull argument is that Adobe doesn’t need to return to former glory. If the multiple can just get halfway back to the long-term average, the share price will deliver incredible returns. This is why we are seeing some buyers emerge.
At Netflix, we find a company operating in one of the most competitive business models of all: the battle for eyeballs.
Netflix’s management team has been trying to drive home the point about total addressable market, and how early it still is in its journey. This is a typical argument put forward by growth companies. Ironically, this abundance of global content is a top-of-mind risk for Netflix bears, especially when it comes to such wildly successful competitors as YouTube.
Guided revenue growth of 12% for the next quarter suggests Netflix’s growth is slowing rather than accelerating. Another concern is that viewing hours per member are under pressure, implying heightened risk of churn. With the decision to stop reporting subscriber numbers, Netflix can’t easily allay those fears by pointing to the data.
It does give other interesting numbers, such as how the kids category gets 5% of content spend and achieves 8% of viewing hours. That’s money well spent. The recent push into the live category requires 5% of its content budget for just 1% of viewing hours, but management believes that these events are highly valued by the audience. That does seem plausible — after all, think of all the people you know with DStv subscriptions purely for the Springboks.
Netflix’s strategy gives bears another argument here, as the push into live, podcasts and gaming could show that the core business is maturing. This transition from growth to maturity is coming through in the valuation, with price/sales down at 5.9 vs the 10-year mean of eight. But bulls will quickly point out that full-year operating income growth is expected to be 20%, making Netflix attractive on a forward earnings multiple of 20.
I own both Adobe and Netflix in my portfolio. I haven’t added to either during this time of strife, but I do feel strongly that Netflix has a far superior business model to Adobe’s. The problem is that the stock I trust less has a valuation that I trust more, with Adobe trading at multiples not seen since the 2008/2009 global financial crisis.
Where Adobe bulls are enjoying a margin of safety at these levels, Netflix bulls have to bravely consider what happened in 2022, when the price/sales multiple fell as low as 2.4. And with Netflix having just dropped below the 200-week moving average, it’s hard to judge which of these stocks (if any) might be a dip worth buying.