Adobe on Track to Reach All-Time Highs

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

The software world is quickly moving to a subscription model. Adobe (NASDAQ: ADBE) is one of the companies that has recently taken its software offers into the cloud. The move was successful, and the company’s second-quarter earnings back this statement.

Adobe has reported earnings of $0.36 per share, beating analysts’ estimates. The revenue was $1.011 billion, in line with what was expected. The market liked what it saw, and the stock started the next trading day more than 5% higher after the report.

Move to the cloud

The cloud is a hot topic nowadays. Everyone is talking about it, but not everyone is using it profitably. Adobe has moved its Creative Suite products to a subscription-based model. A similar move was made by Microsoft (NASDAQ: MSFT), when it introduced its Office 365.

What are the benefits of this model for the companies?

  • They get a stable stream of cash during the product cycle. They were used to getting a cash boost after the initial launch of a product, which was followed by lower sales as the product matured.
  • They gather more money from a customer during the life of the product.
  • It is a way to fight piracy.

In turn, customers get a product that is always up to date. Also, they do not have to pay a large sum of money up front. Instead, they pay small amounts during the product's use, which is great for small businesses and individual workers, who are often tight on budgets.

Are these benefits supported by real-life results? Yes. Paid Creative Cloud subscriptions increased by 221,000 quarter over quarter.

Microsoft is also reaping benefits from going into the cloud with its Office 365. The company states that it has 140,000 Office 365 channel partners and is adding more than 5,000 per week. Microsoft estimates that 0.7%-1.2% of its Office customer base has been converted to 365 since it has launched the product in January. 

Marketing solutions

Adobe is also expanding its Marketing Cloud solutions. Marketing Cloud bookings rose 25% quarter over quarter. Marketing from the cloud is gaining steam, with new companies like Marketo (NASDAQ: MKTO) entering the tempting market. Adobe sees synergy between its Creative Cloud and Marketing Cloud solutions. It sees the customer who creates and spreads the content in Adobe's ecosystem. The fact that customers get used to products plays on the Adobe’s side, so the company benefits from cross-selling.

Marketo, which has not had a single profitable quarter in its entire existence, has to grow very fast or it will encounter serious problems. The company might want to be an acquisition target. Given the recent deal between Salesforce.com and Exact Target, this can be a desirable opportunity.

Valuation

Adobe is trading at 25.4 forward P/E and 5 times sales. The company is well positioned to grab profit from going into the cloud. Microsoft, which has had a great year, rising 28%, trades at 11 forward P/E and 4 times sales. Microsoft still offers non-cloud Office products, but you can expect the company to make moves to shift its customer base to subscription model. Microsoft, which pays a 2.73% dividend, is attractively valued despite the recent rise in price. Given the huge Microsoft customer base, the software giant is extremely well positioned to profit from the move into the cloud. 

Marketo is projected to lose money in the next two years. It currently trades at 11 times sales. This does not seem too inflated, as nowadays cloud-related companies often get stratospheric valuations. However, the fact that Marketo has never made a penny of profit presents significant risks for investors. The competition is fierce, and the company might find itself in trouble after the initial growth phase. The analysts are modestly optimistic on the stock with a mean price target of $24.83. This is an upside of less than 20% from the current price. The stock is volatile now, and the possible risks are roughly the same. 

Bottom line

Adobe is trading near its all-time high, and you can expect it to break it. The company has excellent products, and it has found a new way to capitalize on that. In the coming years, I expect earnings to rise because of the defeat of piracy. It would be harder to use outdated illegal products all over the world. There would be pressure to keep up to date with the technology, so small businesses and individuals in developing countries would be forced to purchase subscriptions. I expect positive synergy between Creative Cloud and Marketing Cloud as well. 

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool recommends Adobe Systems. The Motley Fool owns shares of 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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