By: Steve Smith
While Adobe’s Flash Player may be going the way of the Dodo the company is successfully migrating to the cloud and evolving into a faster growing and more profitable software design firm.
The fact is that Web technologies like Flash are no longer what Adobe is about. Adobe is now about its Creative Cloud, which puts all its popular graphics tools under a single license, and delivers them as a service. For Adobe, this means regular subscription income rather than a reliance on product sales and expensive updates. Adobe has aggressively embraced – and profited from – from the two gig trends in technology; mobile as software as a service (SAAS).
While the transition was not easy Adobe has succeeded in morphing into a company that lets customers receive products through the cloud and pay a subscription fee. In 2013, Adobe switched from selling Photoshop, Illustrator and other popular software programs to renting them to users as a subscription service.
Basically, just as Facebook’s aggressive shift to mobile platforms beginning in 2012 has boosted its earnings and its stock, Adobe’s shift to a new cloud-based business model has sparked a solid turnaround in its fundamentals.
The heavy lifting to get the Creative Cloud running is now done, and so is much of the heavy marketing expense. Now, when Adobe wants to update its software, it does so once, and that update is instantly available to all its customers. “Cloudonomics” like this are a powerful profit driver, once a company gets on the right side of it, and Adobe is now clearly on the right side of it.
Creative Cloud has been a huge hit, not only allowing Adobe to grow its top line 30% year over year, but dramatically increase margins at the same time. While its three-year annual earnings growth rate still stands at a tepid 5%, the company’s average EPS growth over the last three quarters is 67% and it sports a 27.8% annual pre-tax profit margin. Revenue growth has come in between 21% and 25% in the last three reports.
For fiscal 2016, which ends November 30, analysts expect earnings to rise 37%, followed by a 33% gain in fiscal 2017. That would extend the slowdown in EPS gains of 93%, 59% and 50% in the prior four quarters. It’s still vigorous profit growth.
With a flowing from the Cloud services Adobe can address its problems with Flash at its leisure, knowing that it is mainly taking a public relations hit from it, not a financial one. Today, with download speeds measured in megabits, the speed improvements are not as important. Flash is slowly becoming irrelevant. Many of the largest sites and browsers including Google, Microsoft Facebook and Apple have been phasing out its use. The bottom line is Adobe does not need Flash to remain relevant or profitable.
Challenges in Design
That’s not to say Adobe doesn’t face some challenges. It’s decision not to upgrade Flash, and plug security holes until last year, has allowed new comers, such as Sketch, to make inroads in the important mobile design space. It has no choice but to adapt its strategy to cater to all kinds of paying customers especially the well-paid population of UI/UX design professionals. Going forward, designing mobile content is the new growth driver of the creative industry.
Without a specialty product for UI/UX design and prototyping, that Adobe is missing out on seven-figure monthly revenue. Many UI/UX artist have abandoned the cumbersome products like Adobe Illustrator and Photoshop, which can cost over $2,800, for lightweight programs like Sketch or JustInMind which can be had for under $200.
Adobe has been on something of an acquisition spree to round out its offerings. It recently announced it will acquire audience engagement firm Livefyre to enhance the Adobe Marketing Cloud. Livefyre will be incorporated into the Adobe Experience Manager, allowing marketers to better engage customers by bringing together content from Twitter (TWTR) Facebook (FB) Instagram and other social media platforms. Other acquisitions include Omniture and Fotolia to expand the functionality of its Creative Cloud, Marketing Cloud and Document Cloud suite of services.
The chart has also taken on a constructive tone. After the gap higher following the March 17 earnings shares have consolidated above support. The volume has been relative low meaning there is not much distribution or liquidation at these higher prices.
I think the stock is building for a new leg higher. The next earnings report, due June 21, could be the catalyst. I’m want to buy call options.
-Buy July $97.50 Call @ $3.50 per contract
My expectation is for shares to hit $105 prior to the July 16 expiration date. That would make the calls worth at least $7.50 for over a 100% gain.