Adobe And The Undervalued Techs

Adobe (Nasdaq:ADBE) recently released quarterly results revealing evidence of a notable sales slowdown. However, the company's tough cost-cutting measures, including laying off 8% of its workforce, managed to keep the software giant's profitability in-line with analyst's expectations. (To learn more on analyst expectations, read Analyst Recommendations: Do Sell Ratings Exist?)

The maker of the popular Photoshop and Acrobat software managed to post earnings per share (EPS), excluding extraordinary items, of 45 cents a share compared with analyst expectations of 44 cents. Adobe accomplished this EPS despite a 12% tumble in revenues from the same period a year earlier.

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Slump Results in Upgrade
While a slump in sales of this magnitude would normally be cause for a downgrade, independent stock rater Standard & Poor's seized upon recent data which indicated that channel sales were stabilizing, and quickly moved its rating on the stock from "hold" to "buy". In addition, S&P's boosted its 12-month target price by a hefty $7 per share to $25. Rival independent research outfit Argus took a more cautious stance, and kept its "hold" rating pending more tangible evidence of a sales turnaround.

Revenue Recovery Hinges on Sales Turnaround
Adobe's Creative Solutions line of software products account for 59% of consolidated revenues. A sales turnaround in these products is essential to Adobe's revenue recovery. Existing users were reluctant to upgrade, however, and this resulted in a 20% sales plunge during the launch phase of Adobe's latest Creative Suite product. If this was just a case of temporary recession-induced caution, then sales should pick up going forward. In an effort to ensure that this takes place, Adobe has been aggressively discounting the product.

Quality Commands a Premium
The timing and magnitude of the company's sales recovery is still under debate, but most analysts covering Adobe believe that it's among the best positioned and managed companies in the tech space. Despite repeated attempts by Microsoft (Nasdaq:MSFT) to invade its market space, Adobe has managed to gain market share in the high-growth market of dynamic digital content creation and management. Adobe's recent acquisition of Macromedia is viewed as a sound strategic move which should further its market position.

Quality in the tech space can sometimes command a hefty premium. News that IBM (NYSE:IBM) may soon be closing a deal to acquire Sun Microsystems (Nasdaq:JAVA) recently sent the shares of the latter up almost 80%. While there's nothing tangible out there to suggest that Adobe could be the beneficiary of similar interest, BusinessWeek did publish an opinion piece in December 2008 that mused about the mutual benefits that would emerge from a Yahoo! (Nasdaq:YHOO) Adobe combo. The piece concluded that Adobe's recent move to develop an online suite of office software would be appealing to Yahoo! should it ever go after Microsoft's desktop franchise. (Read Mergers And Acquisitions - Another Tool For Traders to learn more about tracking these deals for profit.)

The Bottom Line
The value premium involved in IBM's potential move on Sun suggests that quality tech companies are seriously undervalued at this juncture. Given Adobe's strong management, market positioning and current S&P's rating, it stands as an undervalued tech company that still shows promise.