Adobe Systems Incorporated (NASDAQ:ADBE) CEO Shantanu Narayen stated on the company’s latest conference call – “never a better time to innovate than now.” And this is exactly what the company has been doing recently, by focusing on its two key growth objectives – Creative Cloud and Digital Marketing.
Creative cloud
In the last one year, Adobe Systems Incorporated (NASDAQ:ADBE) has been on the path of transition from the traditional boxed software business to a subscription-based model. At its recent earnings call, the company mentioned that it has completed its transition and will now sell its software through a web-based subscription service, Creative Cloud. This will enable its customers to access the company’s popular design software like Photoshop, Illustrator, InDesign, Flash, and Dreamweaver, for a subscription fee of $30 to $50 per month as against. an upfront fee of $700 to $2,500.
The company announced that, from the beginning of May, it would stop selling its traditional CD-based version of Creative Suite software. In its recent quarter, the company has been able to post strong numbers in its subscriptions, but there have been some concerns too.
The company provided an aggressive guidance of reaching 1.25 million paid subscribers by FYE13 and 4 million by FYE15. In 1Q13, it posted strong growth in its subscription numbers as it added 153,000 paid subscribers (+57%). Taking into consideration the current count of 479,000 subscribers and with a little bit of math, it will have to add approximately 250,000 subscribers per quarter to reach its target. This seems a little high, considering that it has been able to add 153,000 in the first quarter.
Another concern with the subscription-based model is the decline in revenue in the initial years, as the company begins to earn monthly fees vs. the upfront one-time chunky payment. This was visible in Adobe Systems Incorporated (NASDAQ:ADBE)’s 1Q13 $1 billion revenue, which was lower than last years $1.04 billion. In order to sustain the model, Adobe will have to maintain its retention ratio and ensure a continuous increase in its subscribers.
Adobe Systems Incorporated (NASDAQ:ADBE) faces competition from Apple Inc. (NASDAQ:AAPL) and Microsoft Corporation (NASDAQ:MSFT), which have conducted a similar changeover. Further, Google Inc (NASDAQ:GOOG) also provides a cloud-based service, Google Drive, which offers free office software through Google Inc (NASDAQ:GOOG) Docs. There are chances that Google Inc (NASDAQ:GOOG) may provide alternatives to Adobe’s cloud services, which may not satisfy professional users, but maybe good enough for the average consumer who does not want to pay a high price.
Digital marketing
Adobe Systems Incorporated (NASDAQ:ADBE)’s other cloud service is its Marketing Cloud, which provides digital marketing services. It aims to target advertising agencies and publishing executives, providing tools to measure and manage data from social sites, online purchases, and page views. This will help these companies in planning and streamlining its e-commerce strategies. In 1Q13, it posted a strong growth of 20% and plans to achieve over 25% booking growth in FY13. Management is confident that the segment will grow to generate $1 billion in revenue per year.
Again in this space, it faces tough competition from the bellwethers – Google Inc (NASDAQ:GOOG), Oracle Corporation (NASDAQ:ORCL) and International Business Machines Corp. (NYSE:IBM). All three provide strong digital advertising, databases, and business services.
Adobe in numbers
Though the company posted weak results vs. the prior year, it was well within analyst expectations. Due to its business model transition, revenue declined 4%, but in line with analyst expectations of $985 million. EPS dropped to $0.35 versus $0.57 last year. However, recurring revenue, which now accounts for 31% of total sales (versus 26% last year), increased 54% due to its new subscription model.
On the cost side, research and development expenses increased 18% and marketing expenditure increased 11%, which reflect increased spending on development of new products and creating more awareness about its Creative Cloud service.
Based on its growth in Creative Cloud and Digital Marketing, it expects 2Q13 EPS of $0.29 to $0.35 based on $975 million to $1.02 billion revenue. For FY13, it expects EPS of $1.45 with revenue of $4.1 billion. Its guidance was, by and large, in line with analyst expectations.
Silver lining?
Adobe has posted strong initial subscription numbers, and also has a good opportunity in its 1 million free subscribers. But, investors need to keep a close eye on the company’s current subscribers, and with the company’s willingness to disclose subscription on a per-week basis; it will be easier to do so.
Further, Adobe has faced a downgrade in its ratings from few research analysts. Goldman Sachs downgraded it to a sell rating and Stifel Nicolaus downgraded it to a hold rating, citing lower earnings guidance and high valuation. It’s high PE of 31 (vs. Microsoft’s 16, Oracle’s 15 and Google’s 24), seems a very high price to pay for it’s less than 5% growth along with the conspicuous absence of a dividend policy.
Versus competitors
Now I know, looking at the numbers, it isn’t fair to compare Adobe Systems Incorporated (NASDAQ:ADBE) to the two mammoths which have revenue and market caps 10 times that of Adobe, but then nothing is fair in love and war.
Microsoft reported a slight decline in its 2Q13 EPS, but revenue increased 2% due to strong sales from its Windows operating system and the latest release of Windows 8. Its online services segment, which includes in its digital marketing platform, contributes only 4% of total sales, but grew 11% in 2Q13. The company did not provide any guidance, but analysts expect EPS of $0.78 and total revenue of $20.7 billion for the current quarter.
On the other hand, Google Inc (NASDAQ:GOOG) announced an uptick in its 4Q12 results, beating analyst expectations. 4Q12 EPS increased 12% to $10.6 from last year. Google’s core business revenue, which include Google Sites and Google Network, came in at $12.9 billion, beating analyst expectations. Google Sites revenue increased 18% y-o-y and Google Inc (NASDAQ:GOOG) Network revenue increased 19% y-o-y.
Conclusion
I would still consider Adobe Systems Incorporated (NASDAQ:ADBE) a great name in the tech space. It has great growth opportunities as it transitions from a desktop software to a cloud-based service provider and constantly develops more products. However, if the company were not to meet its guidance or increase its subscriptions, it would be nothing but serious disappointment.
Shas Dey has no position in any stocks mentioned. The Motley Fool recommends Adobe Systems and Google. The Motley Fool owns shares of Google and Microsoft.
