On news of its latest earnings report, shares of Adobe Systems (Nasdaq:ADBE) have fallen more than 6% on Wednesday. The Street believes there will be some headwinds for the company – at least for the next quarter or two.
Adobe has had a rocky performance over the past year, with the stock off 3.4%. And the average annual return for the past three years was -7.6%.
Can Adobe get its footing back? Let’s take a look at the pros and cons:
Pros
Great solutions. Since the early 1980s, Adobe has been building software tools that help create content and develop better applications. Some of its products include Photoshop, Flash, Acrobat, Illustrator and Flex.
Adobe also is a player in analytics, with its Omniture segment. The technologies help to measure the effectiveness of online advertising.
Big trends. Over the past few years, there has been an explosion in new technologies. The main ones include cloud computing, mobile apps and social networking. No doubt, this means there will be high demand for new developer tools, and Adobe has been at the cutting edge.
Strong financials. In the second quarter, Adobe posted a 54% increase in net income to $229.4 million. Revenue was up 9%, for a total of $1.02 billion. The business is fairly solid, despite weakness in Europe.
Cons
Competition. Adobe has many rivals, including players like Microsoft (Nasdaq:MSFT), Apple (Nasdaq:AAPL) and Sony (NYSE:SNE). There are also threats from open-source alternatives, which are essentially free software offerings.
Economy. Adobe gets more than half its business from global markets. However, there are signs that economic growth is slowing in places like India, Brazil and China. If so, this will likely hurt Adobe.
Disruptive technologies. Some of Adobe’s products are vulnerable, such as Flash. While this technology is ubiquitous – and at the core of huge sites like YouTube – there is a threat from a new standard, called HTML5. It could represent a better way to develop rich mobile applications. In fact, Facebook is focusing heavily on HTML5.
Verdict
When looking at the long haul, the prospects of Adobe certainly look bright. It has the scale and expertise to benefit from fast-growing markets like the cloud, mobile and social networking. Of course, the company has high margins, so the cash flow generation should be substantial.
Keep in mind that Adobe has the advantage that its products have become standards. Thus, it has a high degree of customer lock-in.
Interestingly enough, the recent weakness looks like an opportunity to pick up a marquee tech company at a reasonable valuation, at roughly 17 times earnings. In other words, the pros outweigh the cons on the stock.
Tom Taulli’s latest book is “All About Short Selling” and he has an upcoming book called “All About Commodities.” You can find him at Twitter account @ttaulli. He does not own a position in any of the stocks named here.
