Adobe Systems: A Huge Upside in Creative Cloud

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Adobe Systems (NASDAQ: ADBE), a diversified applications package company based in San José California is one of the companies that need to adapt the shifting culture to cloud based services. Founded in 1982, Adobe Systems offers a line of software and services used by creative professionals, marketers, knowledge workers, application developers, enterprises, and consumers. Adobe is the largest maker of graphic design software globally.

Cloud computing allows service providers and software developers to provide online support efficiently, thereby enhancing user experience. It is not only cheap for the company, but also helps companies deliver the best service and support to their customers. Other application software companies engaged in cloud computing include Salesforce.com (NYSE: CRM) and Oracle (NYSE: ORCL).

The transition is on

Adobe’s Creative Cloud subscriber numbers beat analyst estimates, sending the stock up 5.58% to close at $45.78 per share last Wednesday. Analysts had projected the company to report 600,000 subscribers to its creative cloud software, but the numbers announced were higher by 16.67%, after the company reached 700,000 subscribers.

Based on these numbers, the company remains on course to reach its target of 1.25 million subscribers by the end of its current fiscal year, which ends in November 2013. In other words, Adobe expects to add another 525,000 subscribers to its creative cloud package in six months. This is compared to the 700,000 subscribers the software has notched a year after its launch, which depicts a growing rate in user subscriptions.

Optimistically, Adobe expects to reach 4 million subscribers for its creative cloud software by 2015, although it maintains that there is a potential of getting 8 million. And why not? If the company intends to convert its 12 million plus desktop subscribers from the creative design software to the cloud based system, that is very realistic.

The company’s average fees received per subscriber per month stand at about $37, compared to $50 for the full suite. Based on the current numbers, this translates roughly to about $77.7 million worth of revenues from the creative cloud software for the company’s fiscal third quarter 2013. Considering that these numbers are still growing, the company should be able to report at least $100 million from the unit in FQ3.

While this is just a fraction compared to its online marketing software, whose sales for the most recent quarter increased by 11% to $285.4 million, it is only a matter of time before creative cloud becomes one of the major revenue generators for Adobe. Consider the possibility of having 8 million subscribers; this could translate to nearly $900 million in revenue per quarter, and with improved subscription fees per month, $1 billion could be within touching distance.

The company also intends to shift a majority of its desktop packages to the online subscription-based system. Eventually, this will result in recurring revenues, with growth levels pegged to the number of new subscribers and the average subscription fees per user per month.

Competition

Adobe Systems faces competition from Salesforce.com and Oracle. Oracle competes directly with Adobe for its application software business, while Salesforce.com is a dominant force in the provision of cloud-based sales and marketing software.

Adobe’s revenues matched the analyst estimate of $1.01 billion and expects to report a figure within that range for the next fiscal third quarter. Earnings per share came in at $0.36, slightly above the analyst estimate of $0.34. The company’s earnings fell by 66% from amount reported the same quarter last year, while revenues were down 8.8%.

Salesforce.com, a dominant figure in cloud computing, is facing increasing competition from technology industry giants, such as Microsoft and Apple, which have ventured into the cloud business. The company reported a loss of $67.7 million in its most recent quarter results compared to a loss of $19.5 million reported in FQ1 last year. The company also acquired Buddy Media for $745 million, last year, a Social Media Marketing software company, in a bid to boost revenues for its sales and marketing software.

Oracle, the king of database systems and very competitive in application servers business, reported a 0.9% decline in revenues year-over-year, while earnings increased by a marginal 0.2%. The company’s revenue of $9 billion for the quarter came short of the analyst estimate of $9.37 billion. Oracle reportedly blamed the new sales team for missing targets. However, Oracle remains very competitive in the application software business, thereby posing a notable threat to Adobe.

Valuation

Adobe’s gross margins are the best, standing at 88% compared to Oracle’s 80% and Salesforce.com’s 77%. However, its operating and profit margins are easily trumped by Oracle, which has 39% and 28% margins, compared to the graphic design software giant’s 23% and 16% margins respectively. Salesforce.com posted an operating loss of 4%, while the net loss margin stands at 10%. (All figures are for the annualized last four fiscal quarters).

Oracle trades at about 15.87 earnings, while Adobe is pegged at a P/E of 32.28. Oracle’s PEG of 1.19 is the most impressive, compared to Adobe’s 3.03 and Salesforce.com’s 3.55.

The bottom line

Adobe Systems’ fundamentals may not be the most impressive, but in terms of outlook, there is so much to look forward to. Its focus on cloud-based products will certainly help the company cut on sales and support related costs. Additionally, the incremental revenue from its creative cloud software presents a huge upside for the company. With the possibility of generating as much as $1 billion in sales from this software by 2015, the company could begin growing revenue by double digits from 2014, thereby boosting earnings.

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Nicholas Kitonyi has no position in any stocks mentioned. The Motley Fool recommends Adobe Systems and Salesforce.com. The Motley Fool owns shares of Oracle.. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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