Expecting Adobe-Like Growth From Business Transition At Autodesk Is Misplaced

Includes: ADBE, ADSK
by: Nigam Arora

It is true that both Adobe Systems (NASDAQ:ADBE) and Autodesk (NASDAQ:ADSK) are in the software business and support similar PEG Ratios. The PEG Ratio of Adobe is 2.72 and Autodesk is 2.25. The PEG Ratio is defined as P/E divided by five year EPS growth rate. But Autodesk is no Adobe. Autodesk reported earnings on August 22, 2013 after the market close. On the conference call, the company mentioned business model transition and comparison to Adobe. I was struck by the positive tone and enthusiasm about the transition.

Adobe stock has more than doubled from its low of $22.89 in October 2011. Yesterday the stock closed at $46.06. The big catalyst for Adobe stock has been providing software as a service.

Adobe has benefited strongly by a business model transition to software as a service. Adobe has been able to charge more under this pricing model than the previous pricing model. Every time any other company mentions such transition the stock jumps and investors draw comparison to Adobe. Autodesk was no exception. However, a little digging beneath the surface shows that Autodesk is no Adobe. Fundamentals are simply not there at Autodesk for the stock to perform similar to Adobe.

Back in 2011, one of the most popular products of Adobe was Flash. When Steve Jobs decided that Apple (NASDAQ:AAPL) would no longer support Flash, Adobe was hit hard. Jobs was right about Flash as proven by later surrender by Adobe. Autodesk stock has never been impacted by the bravado of the likes of Steve Jobs. The point is that there has been less room for Autodesk to move up from its low comparable to Adobe's low.

Certainly a lot of credit goes to Adobe's decision to mostly abandon boxed versions of its software in favor of software as a service model. But the success Adobe has achieved with its software as a service model could not have been achieved if it was not for the rapid growth of the market for the design, publishing and development tasks related to the internet.

In contrast to Adobe, Autodesk does not play in a rapidly growing market. The premier product of Autodesk is AutoCAD for computer aided design. The product is primarily used for drafting and design in construction, engineering, and architecture. Autodesk is not likely to take significant market share from competitors.

Autodesk is essentially a global growth story. In my analysis, in the absence of any new major products, growth of Autodesk is capped at global GDP growth rate plus 3 - 5%. Further, Autodesk does not have the same long runway that Adobe had when it started business model transition. Autodesk has already rationalized most of its pricing. Carl Bass said on the conference call, "Our business, while in many ways similar to Adobe, I think when it comes to channel mix, has always been somewhat different; particularly if you look a little bit under the covers."

Autodesk stock movements and comments on social media as well as a number of emails I received show that many market participants do not appear to fully appreciate the differences. Bass clearly understands the difference from Adobe; in response to a question he said, "The next part I would say because you brought up Adobe, and really with respect to the complexity of the product portfolio, the other thing that we saw is Adobe introduced a business model transition without much of a technology transition, but really just changed the way that people pay for it, and do it rather successfully. And it became more clear to us that the customers were willing to accept and some even wanted this new opportunity. Because we're starting in a different place than Adobe, we don't feel the need to force people to degree they did to go to these new license models in perpetual licenses. And so we saw just a really good opportunity to a way that was economically beneficial for us and a benefit for the customers."

In the after-market after the earnings release, Adobe stock fell and traded as low as $33.50 after closing at $36.13. It was logical since Autodesk projected $0.36 to $0.40 EPS for Q3 compared to consensus estimate by analysts of $0.50; Autodesk also projected Q3 revenue of $540 to $555 million compared to consensus of $580.92 million.

In my opinion, investors became over exuberant over the business model transition and comparison to Adobe in the conference call by running the stock up to $41.72 the next day on August 23rd, up $8.22 from the after-market low. Yesterday, some sanity seemed to be setting in as the stock backtracked.

Adobe is a buy on a pullback; Autodesk is a short on a bounce. Those long Autodesk may consider lightening up on the present strength as the stock may get hit hard if the market pulls back.

Disclosure: I am long AAPL. 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. Subscribers to The Arora Report are long Apple.