On Tuesday, Adobe Systems Inc (ADBE) will announce their fiscal Q1 earnings. With the acquisition of Behance for $150 Million as the major news item this quarter, ADBE is betting big on building a community, something that it has basically no experience doing. While I don't like that acquisition, at less than 1% of its market cap, maybe ADBE can afford to take the risk. But I don't see the strategy, and I think the stock is a sell.
Over the last 6 quarters, ADBE has stagnant earnings growth, though they have managed expectations well. Below are historical results (all data from thestreet.com:
|Q4 2012||$ 0.57||$ 0.61||$ 0.04||$ 0.67|
|Q3 2012||$ 0.58||$ 0.58||$ 0.00||$ 0.55|
|Q2 2012||$ 0.59||$ 0.60||$ 0.01||$ 0.55|
|Q1 2012||$ 0.57||$ 0.57||$ 0.00||$ 0.58|
|Q4 2011||$ 0.60||$ 0.67||$ 0.07||$ 0.56|
|Q3 2011||$ 0.54||$ 0.55||$ 0.01||$ 0.54|
ADBE has a mature product set: forward sales are visible and they collect huge margins as products aren't under much further development. However, there hasn't been a growth story here for a long time: there isn't much upside from organic growth. The company has basically been treading water for the last few years.
This obviously sets the stage for acquisitions like Behance. Adobe actually is credited with 5 acquisitions in 2011 and I would imagine a few tiny, non-material ones have happened of late as well. To me, this bodes very poorly: a mature company like Adobe with little growth should be returning money to shareholders, not chasing down growth by buying at the top of the market.
Adobe is a tough company to find true comps for. Most sites use Apple (AAPL) and Microsoft (MSFT) as the best comps, but realistically Adobe doesn't have nearly the moat that those companies have with their entrenched software associations. Regardless, Adobe trades at a higher multiple than either one (data from Yahoo):
|Ticker||Market Cap||Revenue Growth||Gross Margins||Op Margins||Net Income||PE||PS|
At 25x earnings, Adobe seems really rich for a company with no growth.
I think Adobe is ripe for disruption and is a sell, if not a short candidate. While the company has been trying to adapt to HTML 5 and new developments on the web, it's going up against hostile companies like AAPL that are looking to kill it. The company makes decent tools, but isn't really producing any category changers, and it shows.
The one risk to a short, and my main hesitation, is a potential dividend. Other SeekingAlpha commentators have been pushing for Adobe to start paying out cash, and they are right: the company has the profile of a utility, not a hot internet startup. If ADBE does that or increases their buyback program, the stock could get a kick. But if the company continues to throw money into acquisitions outside their core competency, I don't think it will end well. Buying companies at a 50x+ multiple while (generously) valued at 25x is not.