Adobe Systems Inc. (NYSE:ADBE), which offers a broad range of software and services (including the renowned Photoshop) used by professionals, released its Q3 earnings after markets closed Tuesday. Its total revenue earnings of $995.1 million missed the consensus estimate of $1.10 billion, and its EPS of $0.32 was below the industry estimate of $0.34. Adobe had expected its EPS to come in between $0.28 and $0.34, below the consensus estimate of $0.41. The company expects Q4 revenue to be in the range of $1.00-$1.05 billion, again below the consensus estimate of $1.08 billion.
Share prices fell about 5% following the news, but then recovered - rising 13% - as the market chose to ignore the missed targets and instead focused on Adobe's cloud subscriptions.
Adobe Sailing High on the Cloud
Adobe succeeded in expanding its cloud subscriptions in Q3 by 331,000 Q/Q to 1.03 million, compared to expectations of an expansion in the range of 262,000. This is significant since the decision by Adobe in May 2013 to shift from perpetual licensing to periodical subscriptions was deemed to be highly risky by market experts. A subscription system - under which users purchase time-limited subscriptions of the latest versions of the products - along with a shift to the Cloud, meant that Adobe could now force those customers who wished to stick to its products to update regularly. At the same time, it could bundle in less popular products with the more popular ones.
This was highly beneficial for Adobe since, under perpetual licensing, many users who did not want the new features simply did not bother to upgrade. On the other hand, the system resulted in a considerable cost increase for Adobe loyalists and led to a considerable stir among Adobe's customer base. However, after seeing the markets cheer the higher-than-expected rise in Cloud subscriptions, there is a chance that the user complaints may turn out to be nothing more than white noise. Adobe CEO Shantanu Narayen appeared to have this in mind when he said, "We exceeded 1 million subscriptions during Q3, demonstrating that the transition to Creative Cloud is happening sooner than expected."
Insiders Selling Adobe Stock
Markets turned a little jittery following news that James E. Daley, an Adobe director, sold 25,000 Adobe shares at $52.70 per share for a total of $1,317,500. This pulled down share prices by 0.74% to $52.31.
With the company's stock rising to unbelievable highs, there is a growing belief that Adobe has hit the right note as far as shifting to a different business model is concerned. Many are now hoping that Adobe may become as successful as Salesforce.com (NYSE: CRM), whose stock sells at 8.6 times sales compared to Adobe's stock, which sells at 5.7 times sales. RBC Capital Markets (NYSE: RY) analyst Robert Breza raised his price target to $58 and rates the stock as "outperform." Regarding the future prospects of Adobe, he said, "We continue to like the stock as the transition occurs and look for an eventual flow-through to substantial margin expansion and cash flow generation, which we expect to occur over the next several years."
It should be remembered that competitors may try to use the reservoir of resentment regarding the transition to wean customers off Adobe, although as of now such efforts don't seem to be bearing much fruit. This, along with the high projections from major analysts, indicate that the Adobe rally is likely to continue for the time being, and as such the best options are to "hold" the stock if one already has shares, or "buy" to some extent.
Disclosure: I am long ADBE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.