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Adobe (NASDAQ:ADBE) recently announced its third quarter 2010 earnings results, in which the management gave weak outlook for the fourth quarter of 2010 [1]. Adobe’s stock declined by 20% from $33 on Tuesday to $26 the following day.

Management cited the slow education market, which is the company’s largest business vertical, and the weak Japanese market, which is the company’s second largest market after the U.S., as the reasons for the weak outlook. We are not as bearish as the market on Adobe shares and have updated the Trefis price estimate for Adobe stock down slightly from $38 to $36. Despite Adobe’s weak outlook, we believe that the company will continue to dominate the creative software market over the long term.

Importance of Creative Software for Adobe

We estimate that Creative Software business constitutes around 54% of the $36 Trefis price estimate for Adobe’s stock. Some of the popular create software products for Adobe are:

  1. Photoshop, used for images and animation,
  2. Dreamweaver, used for web designing,
  3. Flash Professional, used for interactive rich content, and
  4. InDesign, used for print layouts and digital publishing.

Long-Term Demand for Adobe’s Creative Suite

Adobe released the newest version of its flagship product Creative Suite version 5 in June 2010, but sales have trended below Trefis expectations. Management’s weak outlook suggests that Adobe’s creative software market share for 2010 will be around 44% rather than the prior Trefis market share estimate of 46% [2].

Demand for Adobe’s creative software is based on new releases which leads to cyclical market share. We expect that Adobe will continue to maintain share and have around 42% share by the end of Trefis forecast period.

However, there remains risk to our estimates. In the future, Adobe may not be able to deliver incremental software features that are compelling enough for buyers to upgrade and such failures could further hurt its market share. There could be a downside of 5% to the $36 Trefis price estimate for Adobe’s stock if its market share were to decline to around 38% by 2016, instead of around 42% that we forecast.

You can see the complete $36 Trefis Price estimate for Adobe’s stock here.

Notes:
1. Q3 2010 Earnings Transcript
2. Adobe’s market share in Creative Software market is an implied number based on units and the total creative software market as provided by Adobe management . The calculation is:

Adobe Creative Software Market Share = Number of Licenses Sold/Total Creative Software market.

SEC filings provide information on annual growth in the the number of licenses sold. We have used these growth figures over time along with estimates of the number of licenses to calculate the licenses sold in each historical year.

Source: Potential Upside to Adobe Based on New Market Levels