With Adobe (Nasdaq:ADBE) is still in the midst of a significant change in its business model (towards a subscription-based model), it is likely that it is still going to take a few more quarters for investors to really dial in their expectations. Nevertheless, it does look as though this switch holds the potential of rejuvenating a model that some thought was bereft of growth. Adobe's valuation isn't as compelling as it was just a quarter ago, but this remains a quality company trading at a discount.

Guide To Oil And Gas Plays: We've got your comprehensive guide to oil and gas shales in North America.

A Good Close to the Year
Adobe reported relatively strong results for the fiscal fourth quarter relative to expectations, though investors should realize that sell-side analysts are still trying to get their models right after the company's switch to a subscription-based model.

Revenue was flat relative to the year-ago period, but up about 7% on a sequential basis. The company's digital media business saw a 2% year-on-year decline, while revenue increased 5% sequentially. Readers should recall that the switch in the business model changes the revenue recognition process, so the year-on-year comps aren't quite as useful. In digital marketing, revenue rose 5% from last year and 10% from the prior quarter, while the printing/publishing business saw revenue down 5 and 4%.

While reported GAAP gross margin fell 70 basis points (BPS) from last quarter, overall earnings were solid. GAAP operating income rose 22% from last year and 11% from the prior quarter, leading to a 100 BPS sequential improvement in operating margin.

SEE: How To Decode A Company's Earnings Report

Have Subs Recharged the Growth Story?
As a brief refresher, part of the point of switching over to a subscription model was to recharge the growth potential of products like Creative Suite. Large upfront costs were an impediment to adoption, and the company had struggled to produce consistent organic growth for multiple years.

This switch does not resolve the company's challenges in driving more use/adoption of Flash, nor is it going to make companies like Google (Nasdaq:GOOG), Apple (Nasdaq:AAPL) or Facebook (Nasdaq:FB) any friendlier to Adobe. What it should do, though, is widen/deepen the moat around what has been a lucrative source of cash flow for quite some time.

Investors Seem OK with Guidance
Judging by the after-market/pre-market activity in Adobe's stock, it doesn't look like investors are too concerned about the company's guidance. That is in spite of the fact that management discussed a first quarter revenue target of about 9% below the prior estimate, and a similar revision to full-year expectations. The company's EPS revisions were likewise fairly steep - with a 50% cut in first quarter EPS expectations and a 40% cut to full-year fiscal 2013 EPS targets.

Again, this is a byproduct of the company's model transition, and investors are buying into the theory that lower recognized revenue and earnings in the near-term are going to pave the way for better numbers down the line. Ostensibly that is true, and while the company's sub growth guidance is pretty aggressive, Adobe did add about 10,000 subs a week during this past quarter.

SEE: Can Earnings Guidance Accurately Predict The Future?

The Bottom Line
Outside of making Flash a go-to standard against offerings from rivals like Microsoft (Nasdaq:MSFT) and Oracle (Nasdaq:ORCL), I'm still not entirely sold on the growth potential of the Digital Media business, though I do believe it will continue to be a lucrative business for Adobe. By contrast, I think Digital Marketing is where the future growth needs to come from, and with companies like Facebook, Groupon (Nasdaq:GRPN) and Pandora (NYSE:P) still trying to close the revenue-per-user gap between desktop and mobile users, I think there is a lot of opportunity here for Adobe (as well as rivals like Google, Microsoft and Oracle).

I'm not really changing much with my long-term cash flow model at this point, which means I still see fair value for Adobe shares in the low $40s. Given the stock's double-digit outperformance relative to the S&P 500 over the past quarter, that's not as impressive of a target as it used to be. Accordingly, I think Adobe is still a very worthwhile hold, but there are better-priced software and tech stories to choose from right now.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Tickers in this Article: ADBE, MSFT, ORCL, GOOG

comments powered by Disqus

Trading Center