Is Adobe a Good Long-Term Investment?
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As I research the stock market, I download files in the Adobe (NASDAQ: ADBE) pdf format. I always wondered about Adobe, what they make and how they monetize it.
Adobe makes software that enables any type of multimedia experience from video making to web design and hosting and of course making electronic documents. They also make software that helps you analyze web data and market products via the web. With the internet becoming more and more of an economic necessity, Adobe may be a worthy investment, but research and due diligence are required.
Moving into the Cloud
I think that there are advantages and disadvantages to the cloud concept. The advantages can be that you can access your capabilities anywhere without the liability of a single personal laptop or device. All you need is a log-in id and a password. However, if you didn’t have internet capability then you wouldn’t have access to your files if they were only saved on the cloud. Adobe, like so many other tech companies out there, is moving into the cloud. For up to $75 a month, without a contract, a customer can have full access to the Adobe Creative Cloud, which includes the ability to download Creative Suite programs and immediately access upgrades as they come available. It also enables you to create and share content via Apple or PC apps and provides web hosting, file storage and pdf creation capability. Personally I prefer to have my software and files on my hard drive, but if the market is moving toward the cloud then I would want to own stock in a company that can change to market conditions.
Fundamentals
The fundamentals of Adobe are questionable. As shown in the first graph below, the total debt to equity ratio has declined from 57% in 2010 to 54% in the most recent quarter in 2012. As shown in the second graph below free cash flow declined from $1.2 billion in 2008 to $976 million in 2010 and then went back to $1.3 billion in 2011. For six months ending June 1, 2012 the free cash flow was $651 million, down from $652 million from June 1, 2011. Adobe does have an excellent cash to stockholders' equity position of 49% as of the most recent quarter, or close to $3 billion. Profitability is down in the most recent quarter compared to last year. Two of the biggest reasons were an increase in royalty cost and an increase in obsolete inventory. The biggest threat to any tech investment is obsolescence. The question going forward is: Can Adobe expand their cloud platforms faster than their products become obsolete? One of the advantages of the cloud is instant updating.
Competition
The competition out there for web hosting and creative media is fierce. One of the components of the Creative Cloud is web hosting. A number of web hosting services are offered for free. Google’s blogger for example hosts blog websites and they have a basic web analytic and traffic tool. Yahoo! (NASDAQ: YHOO) offers web hosting for $12 a month with unlimited storage space, unlimited site pages, and comes equipped with site design tools. Yahoo! also offers multimedia tools such as a Photo Gallery with slide show, a Paypal button and Google Gadgets. Adobe only offers 20 gigabytes of storage in their Creative Cloud for $75 per month. Adobe does offer unlimited site pages and the ability to have 5 hosted sites. Adobe offers such a wide range of graphic design tools such as photo editing that there is no comparison. Microsoft (NASDAQ: MSFT) has the SharePoint software which offers social networking capabilities, search capabilities, and website design capabilities in addition to other software tools for things such as video editing. Microsoft also has deep pockets to absorb mistakes in its product lineup.
Weighing the Risks
Adobe’s stock is trading at 20 times earnings. This makes the market price risk too high. It does have excellent cash to stockholder’s equity position of 49% as of the most recent quarter, or close to $3 billion dollars, so it can hold its own for a while fundamentally. A couple of coin tosses are: What’s going to happen to the company in the cloud world? Are there going to be more obsolete products appear in their costs?
Conclusion
The high valuation and intense competition as well as fluctuating profitability make me want to stay away from this company. If there was a steep correction in Adobe’s stock price, I might reconsider if there isn’t a corresponding decay in its business model.
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