Stock of the Day TARGET 140 Adobe: Surprises Without Acrobatics
by Adam Lowensteiner 9/21/99
People like to say that larger ships are harder to turn around than smaller ships.
That may be true in the marina world, but Adobe Systems (NASDAQ:ADBE - news) continues to defy this rule. After last Thursday's close, it said it crushed quarterly analyst estimates, sending the shares up $7.13, or 7.3% on Friday alone, closing at $105, just shy of its 52-week high of $107.25.
A pretty strong move, given that Adobe has been regularly beating the Street estimates for a couple of years now and has exceeded the projections by double digit rates for the past four quarters.
Adobe also announced that it will split its shares 2-for-1.
Adobe is the fourth largest U.S.-based personal software company, and produces wares like graphic design, publishing and imaging software for Web and print production. Specifically, Adobe's products enable users to create, publish and deliver visually rich images and documents across all print and electronic media.
And thanks in part to its Internet operations, Adobe plans to deliver more surprises in the future. Management said that it expects fiscal (November) 2000 revenue to rise by 20% over 1999, and operating margins to come out to 30%. Analysts were previously expecting Adobe to grow revenue by 16-17% into next year, and produce an operating margin in the high 20's.
Why is Adobe on such a roll? For one thing, it has recently been focusing its efforts on its application products, and pulling back from its licensing revenue. Adobe's application products now comprise 88% of total sales, and those sales grew by 27% in the third quarter.
That compares much more favorably to its licensing revenue, which fell by nearly one-third in the quarter. Although it only accounted for 12% of sales, it did stunt the company's total sales growth to 21%.
Of these application products, there have been several new Web publishing products that have helped the segment achieve healthy sales growth. During the quarter Adobe began shipping Photoshop 5.5, a new Web publishing solution. The company has also been thriving off of Internet products like its Adobe Acrobat, Adobe InDesign, and Adobe GoLive suite of products.
Even so, several analysts prefer not to treat Adobe as just an Internet play. For example, Adobe is still a leader in the high-end publishing industry. '[Adobe] got its largest backlog from these new [publishing] products,' says Aaron Scott, an analyst with Advest who rates Adobe a 'strong buy.' One reason: He notes that customers of competitor Quark "are not totally satisfied' with what Quark has to offer these days. This is significant because until recently Quark has enjoyed a cult-like following among the publishing set.
Keep in mind that Scott is one of the more aggressive sell-side analysts covering Adobe. He carries a 12-month price target of $150 per share, pre-split. Scott derived his price target by using a multiple of eight times Adobe's sales, or 40 times his $3.75 a share estimate for fiscal 2000. 'Management has successfully turned this company around,' says Scott.
Adobe also has a strong balance sheet. It carries over $7 in cash per share, or $481 million. The company has tended to use some of its funds to buy back stock. In addition to the cache of cash, Adobe is debt free, and even lowered its receivables from last year.
'[Adobe has a] phenomenal balance sheet,' notes John McPeake of Prudential Securities. 'They are a cash machine.' McPeake raised his estimate for fiscal 2000 to $3.65 a share from $3.35.
Even so, he retained his 'hold' rating on the stock. Why? 'Call me old fashioned,' he says, referring to Adobe's p/e of 40 times trailing earnings.
Bottom Line:
Management gave guidance to higher revenue growth and further margin expansion for fiscal 2000. With that in mind, Adobe should be able to carry its 40 multiple into next year, giving it a chance to climb to $140 a share, on a pre-split basis.
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