Adobe Systems: Shares Remain Pricey Despite Strong Cloud Subscriber Numbers

Jun.18.14 | About: Adobe Systems (ADBE)


Investors send shares to fresh all-time highs on the back of strong subscriber numbers for creative cloud.

Second quarter results are strong, accompanied by a soft third quarter financial outlook.

Strong earnings growth is anticipated in 2015 and 2016. Still shares are rather pricey.

Shares of Adobe Systems set fresh all time highs in the wake of its second quarter results as the transition into a SAAS business model is progressing well.

Despite the very strong guided earnings growth in the coming years, I remain cautious as shares trade at premium multiples even based on 2016's expected earnings.

Second Quarter Highlights

On Tuesday, Adobe Systems (NASDAQ:ADBE) reported a strong set of second quarter results. Reported revenues were up by 5.7% to $1.07 billion. Note that analysts were looking for revenues of $1.03 billion.

Reported net earnings were up by 15.6% to $88.5 million. Earnings per diluted share were up two pennies to $0.17 per share. On a non-GAAP basis, earnings came in at $0.37 per share, seven cents ahead of consensus estimates.

Looking Into The Results

Topline revenue growth was very strong, given that the company is transitioning its business model, moving toward a subscriber based business billing model. Revenues came in comfortably ahead of the company's own guidance for revenues of $1.00 to $1.05 billion.

The company ended the quarter with 2.31 million paid Creative Cloud subscriptions, 464,000 more than the first quarter. Growth is spectacular and drives the momentum in the stock.

Little over half of total revenues, some 53% of revenues are derived from recurring revenue sources like Creative Cloud and Adobe Marketing Cloud at the moment. This marks huge progress in the transition.

Looking Into The Year

Third quarter revenues are foreseen between $975 million and $1.025 billion. On a GAAP basis earnings are seen between $0.02 and $0.08 per share, while the non-GAAP guidance is 20 cents higher. The guidance looks a bit soft compared to consensus estimates for revenues at $1.02 billion and non-GAAP earnings of $0.27 per share.

For the third and fourth quarter combined, Adobe anticipates to gain another 1 million Creative Cloud subscribers. This should result in $1.925 billion in Digital Media revenues at an annual recurring rate.

Valuing Adobe

The company ended the quarter with a comfortable war chest containing $3.33 billion in cash, equivalents and short-term investments. Total debt, including capital lease obligations, stands at $1.51 billion, resulting in a comfortable net cash position of $1.7 billion.

On a trailing basis, Adobe has posted revenues of $4.11 billion on which it net earned $383 million.

Trading at $73 per share, the company is valued at $36 billion which values operating assets just north of $34 billion. This values operating assets of the firm at 8.3 times annual revenues and nearly 90 times GAAP earnings.

Adobe does not pay a dividend at the moment.

Focused On Long-Term Growth

Back in December of last year, Adobe already provided a road map for growth, providing the market with guidance throughout the business model transition.

Total revenues were expected to grow at a 20% compounded annual growth rate between 2014 and 2016. This should result in non-GAAP earnings of about $2.00 per share in 2015, and earnings north of $3.00 in 2016.

Takeaway For Investors

Investors are cheerful, especially given the subscriber numbers for Creative Cloud which includes Photoshop and Adobe's Flash software. As such it now sees 3.3 million subscribers by the end of the year, up from a previous guidance of 3.0 million subscribers.

The move from expensive one-time license revenues to subscriptions should not only generate more recurring revenues, it should also boost revenues as piracy should be declining. Supplying software from the cloud instead off from a physical source allows Adobe to better control the usage of its software.

Investors are very much pleased about the talk and forward guidance of Adobe. CEO Narayen is excited about the product line and expects a strong second half of the year.

Assuming a constant gap between GAAP and non-GAAP earnings, GAAP earnings could improve to a billion by 2016. While this would be up substantially from current earnings, shares would still trade at 34 times earnings seen two years ahead in time. This seems rather steep to me.

As such, I remain on the sidelines after shares have seen a huge run, having shown gains of nearly 70% over the past year. This and the high valuation are my main reasons to be cautious despite the successful transition.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.