Adobe Subscribes to the Cloud

By Peter Pham - October 18, 2012 | Tickers: ADBE, MSFT, NOK, ORCL | 0 Comments

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Adobe Systems (NASDAQ: ADBE)posted a 3.2% increase in Q3 net income from Q2 due to strong performance from the Creative Suite and Digital Marketing divisions. The company is embracing subscription services based on the cloud and shifting away from selling traditional packaged software. Under the leadership of CEO Shantanu Narayen, Adobe, like Microsoft (NASDAQ: MSFT) and Oracle (NASDAQ: ORCL), is transitioning towards providing its trademark services over internet on tablets and smartphones.

Its users can either purchase the Creative Suite 6 Master Collection for $2,600 or subscribe to use its equivalent Creative Cloud Membership, which includes additional features as well, for $49.99 per month, ~$600 per year. This change in strategy means that Adobe will be entering the $109 billion cloud services market by providing Software-as-a-Service (SaaS).   

The downside of this strategy is that as the customers switch to subscription services instead of packaged software, the revenues may fall.   But SaaS streamlines development costs as well as marketing new versions; this means that subscribers get treated to a constant stream of smaller updates.  The gaming industry has this model down cold--think World of Warcraft, but for web designers. 

This brings stability to revenue streams, as well as inertia to cutting off payments. Adobe’s income was $201.4 million off of revenues of $1.08 billion. Revenues from product sales dropped slightly by 0.2%, but subscription and service support revenues increased by 51% and 12%, respectively. Adobe’s goal was 5,000 subscriptions per week for its Creative Suite. It ended up with 200,000 customers for the quarter, 8,000 additions per week. Moreover, 40% of these additional customers are new to Adobe.

The value proposition for buying $2600 or more worth of software for $50 up front is too good to pass up for many people, even if it requires a minimum 12 month contract.  It makes it easier to budget, fitting better into a business’s revenue streams.  Microsoft backed away from a pure per-month subscription plan for Office 365 instead going for the annual subscription; this may be a mistake, but one they can rectify if consumers don’t embrace it.  Yes, price point is good: $99/year and it covers 5 devices. But a $7.99 per month subscription plan makes a lot of sense for those with just one device in their home. 

Unlike Adobe, Oracle is pushing hard towards cloud computing through a string of acquisitions, including the $1.9 billion buyout of the cloud-based talent management business Taleo in early 2012, which was followed by half-a-dozen further acquisitions in the current fiscal year. Microsoft is slightly less aggressive with its acquisitions, but not its overall cloud strategy. After introducing Office365, the company bought Yammer, a developer of a cloud-based enterprise social network, for $1.3 billion.

However, Microsoft’s move to the cloud is taking shape in the 4^th quarter, and its future is closely tied to Windows 8 and the roll out of the live-tile interface across all devices.  Smart phones and the Xbox have already received their makeover, and for the first time Windows Phone will have flagship devices on par with the best from Apple and Android.  Windows 8 on the PC and tablet is the next phase of Microsoft's move to integrate their home users directly with their cloud services via SkyDrive and at the enterprise level with Azure.  Office 365’s SaaS model is the carrot on a stick, like Adobe’s offering everything for $49.99 per month.

Unfortunately for Microsoft and others, its software sales have suffered in the emerging markets due to piracy.  The SaaS model is being embraced by many developers simply as a means to defend against these pirates.  By bundling Windows and Office on the tablet, for example, this ensures that a license fee is paid for the software.  In the case of Windows tablets it’ll be close to $85.  The latest rumor to be confirmed is that Microsoft is in final testing on its own smart phone.

Oracle is clearly ahead of its rivals due to its aggressive expansion strategy, which is translating into higher returns for shareholders.  They announced earlier in the week the adoption of Nokia’s (NYSE: NOK) location services, which are currently used in 85% of all cars sold in the world and will be on every Windows Phone and (probably) tablet as well.  In that sense even Nokia is embracing SaaS by building big data sets and the apps to use them and licensing that data to others who need it.  Adobe has been more cautious. Its growth in the cloud sector has largely been organic and the initial returns look very promising.   The release of Edge Tools & Services last month improves the value of their subscription service. 

The question is how long it will take for Adobe’s SaaS model for its content creation tools to overcome discrete software sales.  Changing one’s business model is always scary, but software has become so complex and development costs so high that sticker shock is definitely a real issue, especially for smaller content producers.  $50 per month for a freelance graphic artist is nothing, and cuts his initial costs to get working down significantly.  Discrete software sales were $810 million, or 75%, of Adobe's total revenue in the most recent quarter.  Sales in Europe are slowing as well, but the same economics apply.  Lots of reorganization is happening in the European periphery. and cheaper initial costs make it easier for people to rebuild their income streams.

Adobe is trading at a multiple of 20.7. and the stock has vacillated around the $30-35 region for most of the past three years, excluding a dip into the mid-$20's.  SaaS is the future for the larger software development houses, and judging by the preview download numbers for their Edge Tools & Services Adobe looks like it found a way to tap into a broader, but shallower pool of potential clients. 

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