This Company’s Restructured Model Should Deliver

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Adobe Systems (NASDAQ: ADBE) reported better-than-expected fourth quarter results last Thursday with its new cloud service and subscription model gaining great acceptance. Digital media and digital marketing are the two target businesses of the newly restructured subscription-based model of Adobe.

Into The Numbers

Abode's revenues have beaten analysts’ expectations of $1.10 billion and reported at $1.15 billion though flat compared to a year ago period, but sequentially up by 7%. Net income was reported at $222.3 million, or 44 cents a share, compared with a year-earlier profit of $173.7 million, or 35 cents which marks a rise of 28% on the year. Rapid adoption of subscription service is the reason of lower revenue in the short term as fees are collected on a monthly basis instead of a one-time payment upfront.

Dig Deeper

The flat revenue was because of the Creative Cloud subscriptions being collected on a monthly basis rather than upfront. The bright side is the overwhelming response it has received from the third quarter to the fourth quarter with subscriptions rising from 8,000 to 10,000 per week. The switching over to monthly subscriptions was to promote the growth potential of products like ‘Creative Suite’ and ‘Abode Creative Suite’ as large upfront fees on them were hindering the organic growth prospects of the company over the years.

The adoption to subscription system should no doubt generate good cash flows, but it does not make other companies like Facebook (NASDAQ: FB) and Apple (NASDAQ: AAPL) friendlier to Adobe. Digital Media can prove a very lucrative business for Adobe. Facebook and other companies like Groupon and Pandora are trying to reduce the revenue-per-user gap between desktop and mobile users which has tremendous opportunities for Adobe’s Digital Marketing business segment.

How to See the Transition Phase?

The new subscription model should reap benefits in the years to come. The customers currently pay $780 upfront in the perpetual model, but in the subscription model they will pay $480 annually. This explains lower current revenues and lower guidance for the coming year, but with a retention ratio of 80% of annual subscribers, the revenues, earnings and cash flows should improve by 2014 or 2015. A compound growth of 15% annually from its creative cloud business would amount to 30% of its revenue about a couple of years from now and thereby adding great value to the firm.

A Look at Others Around

Apple’s iPhone 5’s sales have been lower than expected and a cannibalization can be noticed as strong iPad Mini sales are affecting larger and more expensive iPads. Apple seems to be stuck in its own business issues at the moment. The company’s patent disputes with most of its rivals in its smart phone business have given the Android platform users an edge and the bulk of the market share. Apple is a strong company with diverse product offerings which gives it an edge over competitors and with prices close to $530 this stock is a good buy.

Microsoft (NASDAQ: MSFT) is another company like Apple that has a diverse portfolio of products to offer. The company’s high cash reserves of about $66.1 billion with a high dividend payout policy make it an attractive stock for investors. The shares are definitely not trading cheap at current prices relative to their historical earnings growth rate. The company’s hold in the PC market and partnership with Nokia to deliver Windows Phone 8 should help it to claim better positioning in the market. Microsoft’s future earnings depend a lot on the success of Windows Phone 8 and though the company is not trading cheap, an investor can surely be lured by its payouts and future prospects which seems bright to me.

Final Words

Abode’s recent quarterly earnings have shown an uptrend on a sequential basis which means that the new subscription model is gaining acceptance. The negative correlation between stock price movements and guidance for the future shows that the investors have faith in the company and are optimistic that lower earnings in the short-term will make way for better numbers in the long run. Adobe is a very good tech stock to be held by long term investors.

tarunbachhawat has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Facebook, and Microsoft and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Apple, Adobe Systems, Facebook, and Microsoft. 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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