1 Risk Investors Likely Overlooked With Adobe Systems
Adobe Systems shares are soaring to new highs on the back of an earnings report that highlights its shift to a cloud-based company with recurring revenue. Autodesk has pursued a similar strategy and has traded higher in response to Adobe's quarter. While these initiatives continue to excite investors, the real question is whether big technology companies like Oracle will throw a wrench in the plans of Adobe and Autodesk.
Let's look at the quarter
For the past few years, Adobe has been hard at work shifting from a license-based to a subscription-based model with recurring revenue. In the company's fiscal second quarter, these initiatives continued to pay dividends, as 53% of revenue was recurring from its creative and marketing cloud services.
Adobe's creative cloud segment added 464,000 new subscribers, showing an acceleration of growth, and finished the quarter with 2.3 million total subscribers. Its marketing cloud grew revenue by 23% year over year to $283 million, with bookings growth of 30%.
Taking a big bet
After a rough 2013, it looks as though Adobe has returned to growth. It and Autodesk have both experienced recent struggles to grow, but by transitioning from licenses to subscriptions, there is an increased focus on building long-term relationships with clients following the initial sale.
Investors are also showing a willingness to take big bets on this business model, as Adobe and Autodesk now trade at 35.5 and 37 times next year's earnings, respectively. With that said, Adobe is further along in the transition process, as Autodesk's recurring segment accounts for 47% of total revenue, with billings growing at just 10% year over year.
Hence, if you're going to make a big bet on either company's long-term growth prospects, Adobe looks to be the better option, with faster subscription growth and a slightly cheaper stock.
A better alternative
The problem for Adobe is that the cloud is growing quite crowded, with technology companies making big investments. Adobe has been well-protected in previous quarters due to its large presence in the digital marketing space, which accounts for about half of its cloud revenue. This marketing segment includes services for PCs, mobile, and social media marketing software, among others.
Specifically, software giant Oracle could pose a threat, as it, too, tries to grow its recurring revenue business. Currently, about 50% of Oracle's total revenue comes from software subscriptions that are mostly in the database, human resources, and factory segments.
However, Oracle has been broadening its horizons, most recently with its $5 billion acquisition to gain more share in the retail, restaurant, and hotel industries. Oracle has executed a number of acquisitions in the past few years to enter new industries, one being cloud marketing.
Late last year, Oracle paid $1.5 billion for cloud marketing software company Responsys to boost its cloud and marketing software products. Oracle also spent $871 million to buy Eloqua in 2012, a company very much like Responsys. Digging deeper, Oracle has purchased a mobile marketing platform called Compendium, social media marketing companies Involver and Collective Intellect, and most recently, Oracle paid $400 million to bolster its data services offerings in cloud marketing with BlueKai.
Through a series of acquisitions, Oracle has very quietly created a larger presence than Adobe's marketing cloud business. Clearly, Oracle sees this space as an important piece of its future, and at 14 times next year's earnings, investors might want to explore Oracle over Adobe.
Adobe and peers like Autodesk have done well creating long-term recurring relationships with customers, but as larger companies like Oracle make big investments in competing segments, investors should carefully consider their options before paying such a hefty premium. Instead, investments in the larger, cheaper old-tech companies encroaching on Adobe's turf might prove to be a better long-term investment strategy, as stocks like Adobe and Autodesk have a long way to fall if fundamentals worsen.
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The article 1 Risk Investors Likely Overlooked With Adobe Systems originally appeared on Fool.com.Brian Nichols owns shares of Apple. The Motley Fool recommends Adobe Systems and Apple. The Motley Fool owns shares of Apple and Oracle. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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