Decoding Adobe - What the Market is Missing in AI Transition

Decoding Adobe - What the Market is Missing in AI Transition Hello fellow investors, This will be a short piece on what the Market and some investors may be missing in Adobe’s story. I took some time to digest the results, read last 3 quarters call transcripts, read buy- and sell-side analysts, and read some hedge fund commentary. What I realized is that some of the AI revenue is already hidden in the headline revenue numbers, which management isn't breaking down or explicitly differentiating. This is making it harder for investors to understand/clearly model growth. Don't get me wrong; management has more to prove, especially with an AI-first strategy & Freemium conversion. But I think the market may be underestimating growth based on reduced ARR & RPO. # Q3’26 results snapshot: Below are Q3 and Q2’ 2026 results showing Key Metrics and their YoY growth rates. At first glance, the results are amazing. Revenue Growth >10% **✅** Maintaining Margins **✅** EPS Growth **✅** FCF Growth **✅** Share repurchases are going according to plan **✅** **What gives me pause:** Total ending ARR growth ❌ RPO exiting the quarter growth ❌ Now let’s compare that to Salesforce ($CRM). There is no particular reason I picked [CRM 0.00%↑](https://substack.com/search/%24CRM) except that it was part of the SaaSocaplype and it rose from ashes after its recent earnings. See the screenshot below (screenshots from quarterly financial slides in appendix); ARR and RPO are slowing for $CRM, along with revenue. But the stock gained 15% post-results [](https://substackcdn.com/image/fetch/$s_!GYBW!,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa45b6714-5867-44c3-b09b-d6c57c2391fc_2179x1235.png) # Why is Market pricing one Company different from Other? Some SaaS companies like [CRM 0.00%↑](https://substack.com/search/%24CRM) & [NOW 0.00%↑](https://substack.com/search/%24NOW) can clearly differentiate their AI revenue vs [ADBE 0.00%↑](https://substack.com/search/%24ADBE) cannot (for now). Salesforce’s Agent force IRR exceeded $1.5 billion in the 2nd quarter, which is 240% YoY growth. The AI piece of revenue, though small compared to the core business, is growing rapidly for Salesforce and the Market is noticing and awarding appropriately. What Salesforce is telling the investors is that they figured out how to be relevant to companies and monetize AI. Which is amazing! # ADOBE & AI Integration [ADBE 0.00%↑](https://substack.com/search/%24ADBE) AI revenue is twofold: one is AI-first revenue from Freemium users converting to paid and using additional tokens, and the other is token usage from existing customers, where they hybridized “per-seat” pricing to “per-seat/Token spend”. Before we jump into the details, I want to mention that during the last year, Adobe did not increase prices. So, the additional revenue came from AI & new user growth. **AI-first Revenue**: AI-first ending ARR now exceeds **$650 million** and is growing more than **150% YoY.** Q3’25 to Q3’26, **revenue grew \~$772 M**, so a good portion of that revenue came from AI-first. Which is great news. AI is still very young, and there is a lot of runway. I say this with confidence because a lot of companies are just trying to figure out how to get productive with AI. Companies are still in the testing and learning phase. Figuring out how the roles are evolving and what (human vs. AI tokens) is cheaper to finish the task. So in the near term, two things will happen: first is AI tokens will get cheaper as companies use models that are specific to the task, so less computing power is needed; and second, token usage will go up as companies can get a lot more done cheaper. This change in industry dynamics will help most of the software companies, including [ADBE 0.00%↑](https://substack.com/search/%24ADBE), [CRM 0.00%↑](https://substack.com/search/%24CRM) , [NOW 0.00%↑](https://substack.com/search/%24NOW) , etc. How’s Adobe thinking long-term: * **User Acquisition:** Shantanu (Ex-CEO) & Anil (CEO) both made clear that their “Singular Focus” for the company is to leverage its freemium strategy to attract millions of new users, and it is turning out really well. Creative freemium Monthly Active Users (MAU) are surpassing 100 million. * **Value Realization:** Management continues to monitor engagement signals, such as the intensity of AI usage, to determine the optimal timing for future pricing and conversion strategies. * **Long-term Growth:** This is really important in my opinion. Leadership maintains that the current strategy of prioritizing user adoption and product innovation will ultimately drive durable, long-term growth across its creative, productivity, and customer experience segments. Adobe had to find a way to grow with AI or else they will be left in the dust. So they decided to focus on the long term, which is: * Get users into the funnel * Let them use the product and show how much “Value add” Adobe products provide them * Utilize AI for free to get sucked into the Adobe universe and product integration * Convert them into AI users and long-term ARR Does this strategy sound familiar? Google, Claude, ChatGPT, etc. are all using the same strategy to grow. Freemium helps new people to try the product; once they see the value they receive, they are willing to spend additional $ because they know it will offset something else with more cost (whether it is time or resources) **Hybrid Pricing**: Management has specifically addressed this during the conference call. They deliberately made a decision to defer pricing initiatives in favor of prioritizing user acquisition and market expansion. **Management is clearly focusing on long-term rather than short-term financial relief.** # Why is ARR and RPO growth reducing? But investors are concerned for [ADBE 0.00%↑](https://substack.com/search/%24ADBE) and not for [CRM 0.00%↑](https://substack.com/search/%24CRM) ? **The vast majority of AI revenue from existing users is completely buried inside the $20.75 billion Creative Cloud ARR block.** Under GAAP ASC 606 revenue rules, if a professional subscriber uses natively embedded AI tools such as **Generative Fill** in Photoshop, **Generative Remove** in Lightroom, or text-based editing in Premiere Pro, their subscription fee only remains classified as standard **Creative Cloud ARR**. AI revenue, which is variable, should not be considered under ARR. Currently, Adobe only has **“Pay as you go”** pricing, so most of the expected AI token revenue is not in ARR It does not touch the isolated $650 million **AI-First ARR** metric, which only tracks net-new users buying standalone AI plans (like the standalone Firefly web app premium tier or Acrobat AI Assistant add-on). A similar thing happened at [CRM 0.00%↑](https://substack.com/search/%24CRM) but they are clearly showing AI growth and separating the revenue, whereas [ADBE 0.00%↑](https://substack.com/search/%24ADBE) is still burying some AI usage and making it hard for investors to get a better understanding # What’s Market is missing/cautious about? The stark divergence in how Wall Street reacted to **Salesforce (+11% revenue growth, stock soared)** vs. **Adobe (beat and raised, but stock dropped)** boils down to **contract transparency, monetization visibility, and structural risk**. While Salesforce and ServiceNow can definitively **show “hard money” AI contracts**, Adobe is asking analysts to trust an opaque “freemium-to-conversion” mathematical bridge that won’t bear fruit until 2027. So Market wants to see if this freemium strategy works in the long run and if AI will take off. I think the answer is not **“If”** but **“When”** it will take off. Replacing Adobe is not that easy. They just do not offer editing; they also take care of all the background licensing, copyrights, etc. **International Revenue**: Asia & the Middle East are just starting their journey on targeted advertising, and companies are just utilizing products like $ADBE. There is a huge runway there which the market is not even bothering to price in # Valuation: Mr. Market is currently pricing [ADBE 0.00%↑](https://substack.com/search/%24ADBE) FCF to decline by \~1%-2% annually in the short-term and then grow at a modest rate of 2-3% terminally. Even if Adobe grows at a **modest 6% annually** on average for the next 10 years and 3% thereafter, I think the **stock is worth \~$475** (85%+ discount to current price). Share buyback on top of that; they are purchasing shares rapidly. Just in the last quarter, they purchased 9.5 million shares, and **they have $25 B remaining under their April 2026 share repurchase program!** **That is 25% of its current Market Cap.** Including that in the calculation, **the stock is worth \~$600, which is 140 % upside** [](https://substackcdn.com/image/fetch/$s_!cFn8!,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F59f0c6c1-280b-4bfd-b9c0-7657c14b2e51_2560x1440.jpeg) I think there is a lot to prove by the management, but all the actions the management is doing is directing it in the right direction. I love the long-term vision and slowly executing it, even at the risk of short-term pressure on price is what I like to see as a long-term investor. As we know, Mr. Market's mood changes very quickly, and I think it will happen in the next 12-18 months!