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Morningstar | ADBE Updated Star Rating from 21 Sep 2018

Wide-moat Adobe is acquiring Marketo, a software-as-a-service application vendor for marketing engagement, for $4.75 billion in what amounts to Adobe’s largest deal ever. We are maintaining our $245 fair value estimate. As we iterated in our third-quarter note on Adobe on Sept. 14, in which the rumor of a potential acquisition first surfaced, we believe Adobe’s acquisition of Marketo will further bolster the firm’s Experience Cloud as it attempts to widen its competitive positioning against Salesforce, Oracle, and SAP. This is the second major acquisition for Adobe this fiscal year, as the firm bought e-commerce firm Magento for $1.68 billion in May. As of Adobe’s last fiscal quarter-end, it held $4.9 billion in cash and short-term investments, and it intends to fund the Marketo acquisition through cash on hand and new borrowings. As a reminder, Adobe approved an $8 billion buyback earlier this year, proving the firm’s robust cash flow allows it to return cash to shareholders and be acquisitive simultaneously. While we still model solid growth for Adobe, we would wait for a wider margin of safety before investing in the firm.

In terms of Marketo, the marketing software player went public in 2013, before being acquired by Vista Equity Partners for $1.79 billion in 2016. Vista’s playbook is to acquire high-growth, mission-critical enterprise software firm and improve their operations. Visibility into Marketo’s financials is limited, but its most recent 10-K indicated that it did $209 million on the top line in 2015. Adobe’s $4.5 billion acquisition represents a significant premium to Vista’s original buyout in only a couple years.

On a stand-alone basis, we view Adobe’s Experience Cloud, which includes advertising, campaign management, and analytics, as one of the broadest digital marketing offering. Experience Cloud grew 21% year over year in Adobe’s third quarter. Magento and now Marketo help to fill potential holes in Adobe’s offerings, in our opinion.

For background, the marketing software space is still defining itself, as marketing software is an overarching term that encompasses multichannel campaign management, analytics for marketing, marketing resource management, account-based management, and CRM lead management. E-commerce solutions can sometimes be included in this bucket, as digital storefronts such as Demandware (acquired by Salesforce in 2016), Magento (acquired by Adobe for $1.68 billion earlier in 2016), and publicly traded Shopify allow customers to build multichannel digital storefronts. Increased competition, coupled with a significant market opportunity, has meant that Adobe and its competitors have been incentivised to be acquisitive in order to capture share and offer a comprehensive digital marketing platform. Together, estimates suggest marketing and commerce could possess a total addressable market, or TAM, of $45 billion. We believe the acquisitions of both Magento and Marketo allow Adobe to close gaps that potentially existed between its digital experience portfolio and the portfolios of competitors. Magento allows Adobe to compete on the commerce side, leveling the playing field with Salesforce after the latter's acquisition of Demandware. Marketo allows Adobe to build its lead management capabilities, which we have previously identified as one of the firm’s shortcomings.

Our take on the marketing software space is that enterprises and midmarket businesses have realized that digital advertising channels such as display, search, mobile, social, email, and e-commerce provide much more tangible engagement insights than legacy marketing channels such as print, radio, and billboard advertisement. Thus, Adobe, Salesforce, Oracle, and SAP have chased this opportunity through internal R&D and acquisitions, looking to cross-sell their respective solutions with other products.

We iterate that Adobe’s Experience Cloud and marketing software have largely been built out through acquisitions, in a similar matter to the firm’s digital media and Creative Cloud offerings, which we view as more mature. For reference, in Adobe’s fiscal 2017 10-K, the firm reported that digital marketing encompassed 39% of revenue, while digital media encompassed 69% of revenue. Adobe continues to invest in the high-growth Experience Cloud and marketing software business. Adobe largely entered this space through its acquisition of Omniture in 2009 for $1.8 billion, in which the firm looked to couple its content creation tools (what is now Creative Cloud) with Omniture’s web analytics offerings. The firm has added Neolane and TubMogul, among others, over the years. Today, Adobe’s solutions include Analytics, Audience Manager, Campaign, Experience Manager, Media Optimizer, Primetime, and Target.

Gartner buckets Marketo into two spaces: CRM lead management and Multichannel Marketing Hub. In terms of CRM lead management, Marketo primarily competed with Oracle, Salesforce, and IBM, with Adobe absent from this space. Lead management is essentially the ability to attract potential buyers and deliver those prospects to an enterprise’s sales team. Marketo’s email marketing software allows enterprises to tailor their marketing message to specific customers through built profiles. In our 2018 Observer on digital marketing, we detailed that while Adobe Campaign management once offered customers the ability to offer stand-alone lead management, it was discontinued in 2017, and that Adobe could be in the market for a better lead management offering. With Marketo, Adobe can once again include lead management in its portfolio.

On the multichannel marketing side, Marketo has durable business-to-business capabilities and has been building its business-to-consumer capabilities. We believe Marketo’s engagement platform would be additive to Adobe’s, helping the firm service the amalgamation of marketing needs for its customer base. While we have no plans to change our fair value estimates for Salesforce, Oracle, and SAP, we will be closely monitoring the changed dynamics in this space.

For more information on Adobe, please see our February Technology Observer, “You Call Yourself a Salesman? Not Without a Wide-Moat Marketing Cloud: Adobe and Salesforce Poised for Marketing Dominance.”