Adobe: Plenty of Growth Prospects Ahead

Ashish is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Adobe (NASDAQ: ADBE) is positioned well in the digital media market with its strong user loyalty and ingenious product upgrades. While the investors are a little concerned about the effect on revenues from the recently changed business model, we believe that it is a step in the right direction as it makes Adobe a good investment and not just another product refresh call. Furthermore, with a considerable market opportunity in digital marketing, Adobe looks poised to grow. Hence we rate it as a buy.

Implications of Creative Cloud: Adobe released the beta version of its Creative Cloud service in 2011 and launched it officially on April 23, 2012 with CS6. With the launch of Creative Cloud, the company essentially moves from its license based business model to a subscription based model. We believe that this is a step in the right direction as it will help Adobe to gain more penetration in the total addressable market as it will result in less upfront costs for the user. We believe that the creative cloud platform is already seeing meaningful traction as 58K customers subscribed on Creative Cloud out of the total 60K new subscriptions in 2Q. Additionally, we concur with the management analysis that the subscription business model can help Adobe to increase the LTV per user from $30 per month to $40 per month (assuming 85-90% retention rates for cloud subscribers) as shown below:


<img src="/media/images/user_12976/adbe1_large.png" />

Source: Company investor Presentation

CS6 adoption may ramp up in the coming quarters:

We believe that CS6 adoption may see new growth trends with its added functionalities over CS5.5. It is the first update from adobe in the last two years and we believe that it can gain considerable traction. We believe that the developers were waiting for this new release for a long time as is shown by the fact that there have been 1 million downloads of the public beta version released in March, which surpasses any other public beta in Adobe’s history. Adobe CS6 trumps 5.5 as it speeds up the imaging and editing tasks and processes large images faster with a new Mercury Graphics Engine. An added advantage apart from speed is the brand new application, Adobe Muse which enables the designers to create and publish HTML5 web sites without writing code. Additionally, the several HTML5 tools like Adobe edge and Flash Pro CS6 will compel the designers to upgrade to the new versions.

Considerable digital marketing TAM for Adobe: Adobe’s Digital Marketing segment represented about 22% of revenues and 16% of total gross profit in FY11. The digital marketing segment currently revolves around the three recent acquisitions (Omniture, DaySoftware and Efficent Frontier) that span around data analytics, content management, and online advertising technology. Digital marketing aims to help companies optimize their marketing spend by using data from social networking sites like Facebook. While Adobe faces threat in this domain from IBM (NYSE: IBM) and Google (NASDAQ: GOOG), we believe that Adobe trumps the competitors with its advanced functionality. The management noted that Adobe enjoys a targetable market opportunity worth $6 billion in this segment in 2012 alone and the TAM is poised to grow significantly in the future. We believe that Adobe will benefit as online usage continues to increase worldwide with the penetration of smartphones and companies look to leverage data analytics to personalize their content and e-commerce websites.

<img src="/media/images/user_12976/adbe2_large.png" />

Source: Company investor Presentation

Adobe had been a product license based company before the release of Creative Cloud with its major events coming with product cycle refreshes. We believe that the trend has changed now with Adobe working towards a more sustainable and continuous business model through its subscription model. We see it as a step in the right direction and believe that it will help Adobe increase penetration and average ASP’s in the long term. As Adobe looks to increase its penetration of TAM’s in the digital marketing segment with online usage growth, we are bullish on this stock.

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The article was co authored by Rahul Agarwal and Ashish Sharma. Both have no positions in the stocks mentioned above. The Motley Fool owns shares of Google and International Business Machines. 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.

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