Adobe Systems Inc. (ADBE, Financial) is one of the largest software companies in the globe, with software and services for content creation and digital advertising and marketing. Moreover, the company picks up licensing fees for customers, and offers technical support and education. It basically operates through three segments: Digital Media, Digital Marketing, and Print and Publishing.
The Digital Media segment enables small businesses and customers to create highly compelling content and deliver it across diverse media. It includes Creative Cloud, Creative Suite, Dreamweaver and Photoshop. The Digital Marketing segment includes Adobe Analytics and Media optimizer, and allows users, mostly digital marketers, advertisers, publishers and web analysts, to follow and evaluate the performance of marketing initiatives. The Print and Publishing segment provides technical support through a special printing and imaging page description language and a PDF-based workflow regulation platform, and includes PageMaker and Shockwave Player products.
Adobe’s products are sold through different distributors, retailers and software developers. The company has various competitors within the market, but its main peers are Microsoft Corporation (MSFT, Financial), Eastman Kodak Co. (KODK, Financial), Sony Corporation (SNE, Financial), Yahoo! Inc. (YHOO, Financial) and Apple Inc. (AAPL, Financial), among others. The firm has recently shifted to a subscription model of the core creative business. Reported revenues regarding the first quarter 2014 were of $1.0 billion, down 0.8% year over year. The continued decline in perpetual license revenue was balanced by growth in subscriptions, keeping GAAP gross profits flat year over year, despite revenue drop, and earnings of 16 cent per share exceeded the estimated consensus.
Adobe has compelling product lines, including CS cloud initiative and digital media products, and a strong market position, therefore its new subscription model is likely to succeed in restoring revenue growth in the short term. Still, analysts are watching the stock’s performance in order to evaluate future performance.
New Subscription Model
Adobe Systems Inc. (ADBE, Financial) has recently changed its business model from licensing to a cloud-based subscription model. The launch of Creative Cloud allowed the company to move its market-leading graphic design and productivity offerings to the new system, enabling consumers to pay a monthly fee to subscribe to different Creative Suite Adobe applications. Through this transition to the cloud system with a subscription model, the company will increase its pricing options and flexibility, while guaranteeing up to date tools with more frequent product updates. Moreover competitive position is likely to improve, as monthly pricing model lowers the price of entry for potential customers in contrast with the perpetual license figures. This model is expected to boost revenue growth and make it more predictable, despite impacting near term revenue.
Developing New Products
The Acrobat product line is one of the company’s most successful products. With the increased digitization of workflow, every day more paperwork and record-keeping functions are being carried out online. This has increased the number of users and contributed with high revenue but has also generated high margins. Moreover, Adobe has increased investment in HTML5, enhancing its set of tools (Dreamweaver) which support HTML5, simplifying the creation of HTML-based websites and increasing the focus on the development of apps for the mobile segment.
Adobe’s focus has been put in one of its most important products: Creative Solutions platform, which has been made fully Cloud. Through the new Creative Cloud, Adobe has introduced a new way of developing creative process. Users can explore, create, publish and share their work across devices, the desktop and the Web, with the ability to sync to any device, and accessing as well to a global creative community while receiving exclusive updates on Adobe products. The recent acquisition of Behance allowed the introduction of new features such as public sharing and communications to Creative Cloud, strengthening Adobe’s position in the Cloud space. Cloud based model is likely to lead to a more stable revenue stream for Adobe, with growing subscription driven by its attractive pricing and service enhancements. Furthermore, new cloud-based platform provides the company the possibility to diversify into digital marketing services, offering data mining services, and allowing marketers to deliver personalized web experiences across multiple devices, manage multichannel campaigns and optimize media monetization.
The company has recently announced its plans to update the video apps in Creative Cloud, and showed these innovations at the NAB 2014 show in Las Vegas. Innovations will include major updates to Adobe Premiere Pro CC and Adobe After Effects CC, as well as new features for Adobe Anywhere, the collaborative workflow platform. As part of its marketing campaign for the new Creative Cloud tools, the company announced that Academy Award-winning editor Kirk Baxter A.C.E. is cutting David Fincher's upcoming feature film “Gone Girl” exclusively with Adobe Premiere Pro CC. Adobe Video will include: Timesaving editorial features in Premiere Pro CC, updates to After Effects CC such as Keying effects and Typekit integration with Premiere Pro CC and After Effects CC. New updates on Adobe Anywhere were also unveiled: Hot real-time Backup, rough cut support and After Effects CC media processing for direct integration between Anywhere and After Effects CC. These features will complement Creative Cloud applications and enable teamwork for large organizations working with video, including broadcasters, educational institutions and government agencies.
Bottom Line
Indeed competition amid this industry is fierce, and Adobe faces competition from multiple competitors. The new cloud-based subscription model aims to expand customer base while providing a more consistent user experience. Some doubts where raised, as Adobe provided weak revenue guidance, as it accelerates the transition to the Creative Cloud subscription model and term-based enterprise term license agreement (ETLAs). Nevertheless, the subscription model is more appealing because the user has the option to spread out payments over time. Still, Adobe needs to keep the customer subscribed for at least two years to be more profitable than its original product, being essential to stay innovative and competitive. Some analysts think Adobe may face technical obstacles in the process of transformation to the new cloud model. Moreover, the growth in Adobe's digital marketing business is likely to weigh on margins over the longer term. Furthermore, some bearish analyst are reading the current return on equity, lower than its ROE from the same quarter one year prior, as a sign of weakness within the company. Still, Adobe's products are the industry standard for creative professionals, creating a network effect and high switching costs and the more affordable monthly subscription pricing model will allow a steadier stream of revenue and potentially increase user base.
Disclosure: Damian Illia holds no position in any of the stocks mentioned.
