Adobe’s Long-Term Outlook
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As Adobe Systems (NASDAQ: ADBE) begins its transition to a subscription-based product roster, the company’s recent earnings results have been viewed with some skepticism. In the midst of a long-term shift in any company’s business model, it is easy to see any signs of weakness as the beginning of the end. Also impacting investor perception is the increased number of free offerings provided by competitors that have the potential to disrupt Adobe’s business. Despite these factors, however, when the company is understood across the breadth of its products, it looks solid and worth owning at current levels.
The Adobe Product Line
One of the central misconceptions about Adobe by most investors is in the heart of the company’s business. The form of interaction with which most of us are familiar is with the Document Services segment of the Digital Media Solutions division, specifically the Adobe Acrobat line of products. While the division was responsible for 71.2% of the company’s total revenue last quarter, only 24.1% of the division’s revenue came from Document Services. This means that just over 17% of the company’s revenue comes from Document Services. It is worth noting that the segment had a record quarter with the mentioned results for the third quarter.
If we stay within the realm of perception briefly, it is easy to see why a cursory glance at the landscape would cause concern. Where Adobe was once the only pdf option available, both for reading and writing to the format, both Google (NASDAQ: GOOG) and Microsoft (NASDAQ: MSFT) have introduced free options that are competitive. The Microsoft version is embedded in the company’s enterprise software solutions, while Google’s is housed in Google Apps. Particularly as an increasing number of governments and businesses begin to adopt Google Apps as their central platform, a degree of business is expected to be lost by Adobe. Other free pdf options are also available through other providers.
Given that the bulk of Adobe’s business does not come from Document Services, a more objective look at the company’s position reveals that while recent results have been lukewarm, the prospects can still be considered strong. The company is in the midst of a shift from a classic software model to a cloud-based subscription model. Through products like the Creative Cloud subscription service, the company gives customers monthly access to critical development products that are responsible for the bulk of the company’s revenue. These include products like Photoshop, Dreamweaver and Edge that let users build and maintain websites, while collaborating in the cloud environment. In the third quarter, the company added over 100,000 subscribers, bringing the total to around 200,000.
Strictly by the numbers, revenue came in at $1.08 billion; the figure represents a 6.7% year-over-year increase, although it qualifies as a 3.8% sequential drop. GAAP income came in at $0.40 per share, also a year-over-year increase and sequential fall. One reason cited for the decrease is the business model shift. Where the company used to book a larger lump-sum amount on an upfront basis, it now targets sustainable, yet lower, income streams from subscription business. As such, there will be a lag period while the transition normalizes over time. The long-term picture is more favorable, despite the short-term disruption that the shift will cause.
While Adobe’s trailing P/E seems a bit high at 20.4, its forward multiple of 13.5 is very respectable. Truly understanding this stock requires both delving into the real nature of the company’s products and allowing for the business plan transition. While I do not expect the company to have a significant upside surprise in the near-term, the medium and long-term prospects are very strong at current levels making the stock a buy for your core portfolio.
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Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Google and Microsoft. Motley Fool newsletter services recommend Adobe Systems and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.