Profit From Adobe As It Makes The Right Moves

| About: Adobe Systems (ADBE)

When a company goes up against Apple (NASDAQ:AAPL), it usually ends up on the losing side. However, there are times when a company is needlessly billed as "losing to Apple," when in fact the whole issue is largely irrelevant.

Adobe (NASDAQ:ADBE) is one of the world's largest software firms, and its product line is an industry standard. Its Creative Suite line shows up in almost every facet of entertainment. Flash is an internet standard, and Adobe is ready to capitalize on HTML5, the most likely successor to Flash. Shares of Adobe have fallen by about 6% over the last year, and we think now is a good time to get into the stock, as Adobe is forecast to post record profits and revenues this quarter, and has a number of initiatives going for it.

Adobe shares have been battered by concerns over the demise of Flash, around which its feud with Apple has centered. Investors have worried that a lack of a presence on iDevices would hurt Adobe, but we are not concerned with the past. We are looking towards the future, and think we Adobe will outperform going forward for the following reasons.

  1. Digital Publishing: Adobe's Digital Publishing Suite supports iOS 5 and has been embraced by leading publishers as a way to create and enhance their digital presence. CEO Shantanu Narayen, on the conference call, noted that "digital publishing represents a large opportunity as they [publishers] all want to get their content out to new devices."
  2. HTML5: Adobe's management knows that the tides are shifting against Flash, due to HTML5's superior technological characteristics. And Adobe is embracing it fully, becoming a leader in the emerging new internet standard. Flash Media Server now fully supports HTML5, and Adobe stands ready to monetize HTML5.
  3. Subscriptions: The Creative suite division, which accounts for the majority of Adobe's revenue, is subject to seasonality, and release cycles of Creative Suite. The business model is inherently unstable, but Adobe is working to stabilize it. One of the things we love about Oracle (NASDAQ:ORCL) and IBM (NYSE:IBM) is their stable subscription revenue streams. By moving the Creative Suite into the cloud, Adobe will be able to smooth out the volatility in sales, and customers will always have the latest version of the product. While we do not think that this transition will happen overnight, the initiative is off to a great start. Mark Garrett, Adobe's CFO, stated on the call that "our subscription offering with CS5.5 is attracting new users. More than 1/3 of the subscribers have never bought an Adobe product before, and 2/3 of the subscribers today tell us they would not have purchased without this offering."
  4. The release of the Creative Cloud at Adobe's MAX Conference in early October will further integrate Adobe's leading applications into the cloud, allowing customers to access their creative data anywhere they choose too, and share it how they want to.
  5. Valuation: Adobe shares currently trade at under 15 times earnings, and about 10.5 times forward earnings. Given the strong growth profile of Adobe, we think this multiple is too low.
  6. Balance sheet: Adobe has $1.4 billion in net cash on the balance sheet, and its cash flows allow for continued investment in both R&D and share buybacks.

Macroeconomic concerns have weighed on Adobe shares, but we think it is important not to let them muddy the bigger picture. On the call, multiple analysts asked about issues in Adobe's European division, and CFO Mark Garrett reminded them that:

Again, the weakness that we saw in Europe was primarily driven by weakness in the enterprise. If you look at our guidance though for the full year, we still expect that enterprise can grow 20%. And I know you're all very focused on quarterization, which I completely understand. But we expect the year, the full year, to play out exactly as we had talked to you about the end of last year. So the year is playing out exactly right.

Too often, we lose sight of the bigger picture by obsessing over each quarter. Though Europe may have impacted the quarter, or the full year, Adobe does not see Europe as having a meaningful impact on its performance. It is important that investors do not lose sight of Adobe's long-term success in the midst of some short-term cloudiness.

We think Adobe represents a great investment due to its leadership in HTML5 and its cloud initiatives. Analysts agree, with Credit Suisse seeing the stock at $33, S&P sees it at $35, and the Reuters average price target is $31.95, representing upside of over 20%. And we think that as analysts see Adobe's future the way we do, they will adjust their targets upward. Adobe is leading the next wave of innovation in the Internet, and we think Adobe is an innovative way to increase your portfolio's profits.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.