Adobe Pre-earnings: Cloud Growth Across Creative And Marketing In Focus

Adobe (NASDAQ:ADBE) is set to announce its fiscal Q4 2014 earnings on December 11th. (Fiscal year ends with November). While the company delivered non-GAAP earnings per share of $0.28 that exceeded both its guidance and market expectation in Q3, the  revenues were $1.005 billion in revenue, just $10 million below consensus. However, Adobe’s core cloud business continued to deliver results as cloud adoption remained robust across both its Creative software and marketing solutions. For Q4, we believe the growth trend in cloud adoption continued, which likely drove revenues for Creative cloud and marketing divisions. However, we believe revenues from the LiveCycle and Connect business declined as that of the Print and Publishing business remained flat during the quarter.

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Outlook For Q4

Adobe has guided for revenues of $1.025 billion to $1.075 billion for the fourth quarter of fiscal 2014. It indicated GAAP EPS would be in the range of $0.05 to $0.11, and non-GAAP EPS between $0.26 and $0.32.

Adoption of cloud services continued to remain strong and the company expects to have nearly 3.3 million paid CC individual and team subscriptions by the end of fiscal 2014. (Fiscal years end with November.)  According to our calculations, this means it will need to add over 38,100 paid users per week in the final quarter of FY2014. The company has also disclosed that it expects to end the year with over $2.5 billion of digital media revenue at a growth rate of 20% year over year. Furthermore, Adobe expects revenues from its digital marketing cloud to grow by a 25% rate for the 2014 to 2016 period. However, it expects the LiveCycle and Connect business to decline further, while the print and publishing business is expected to remain flat in 2014.

Growth In Cloud Services To Continue

According to our estimates, the Creative Cloud division is the biggest of Adobe’s operating segments and makes up approximately 59% of its value. We expect the company to report $1.35 billion in revenues for this product family in 2014, which is roughly more than double the prior year level.Offsetting this to some degree will be a corresponding decline in packaged software sales.

Over the past year, Adobe’s cloud subscription service has witnessed robust growth as clients have increasingly adopted these services to drive collaborative development efforts across their companies. The primary reason for this has been new additions to its Creative cloud offering as the company added more features to it. While we expect that the share of revenue from Creative Cloud (CC) will continue to grow in Q4 2014, its adoption will continue to negatively impact the revenues and profitability as use of subscription service is generally spread over the period of the software’s use.  In Q3, the company added 500,000 new subscribers, and 96% of the creative cloud subscribers have signed up for annual contracts. Additionally, the growth in licensing came from enterprise term licensing agreements (ETLA), which usually have tenure of three years. This indicates that CC will continue to drive revenue over the next couple of years. The company reported over 2.81 million paid subscribers for the CC services at the end of third quarter. We expect growth trend to continue in Q4 and estimate that the company is well underway to add 3.3 million subscribers in 2014. We believe that the company will continue to report traction for its cloud services in this earnings announcement.

Revenues From Marketing Cloud To Grow

Adobe’s cloud marketing division is the second biggest division and makes up 21% of its value. Over the past few years, Adobe has built a comprehensive digital marketing platform that addresses most of the needs in digital marketing. The company has scaled up the functionality and product offering of its marketing platform through organic and inorganic growth. Furthermore, it has recently extended its marketing platform to mobile marketers. ^[1] We believe that this platform provides a cost effective digital marketing solution for companies that can manage marketing campaigns across different channels and devices. According to the CEO of Adobe, Shantanu Narayen, the marketing cloud is easily a $10 billion opportunity. ^[2] We expect Adobe’s marketing platform to continue to lead the digital marketing solutions market in the short term, as it enjoys strong brand recognition. Adobe is aiming to increase its revenues from cloud based marketing solutions by expanding in new geographies and verticals where it has a strong presence. Currently, we project revenues from its digital marketing division to reach $3.89 billion by the end of our forecast period in 2021. We expect that, as Adobe continues to develop its marketing solutions capabilities, this division will emerge as an important driver for revenue growth. In this earnings announcement, we expect the company to report growth in revenues from new vertical, especially from mobile. Additionally, since many of Adobe’s digital marketing solutions cater to the growing big data analytics, mobility and social media industries, we expect the company to post incremental revenues across these industries.

Acrobat Family Revenue To Grow

Acrobat family is the third largest division and makes up 9% of Adobe’s estimated value. In the past few quarters, revenues from this division have been on a decline, primarily due to launch of document cloud services that have subscription fee spread over the period of usage. The company has amassed over 2 million subscribers for document cloud service. We expect this trend to continue in Q4 as well, and forecast the subscriber base to grow to 8 million by the end of our forecast period. We expect revenue to grow from $768 million to $1.21 billion by 2021.

We currently have a $57.70 price estimate for Adobe, which is 20% below the current market price.

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1. Read Adobe Augments Its Marketing Platform With Mobile Enhancements [↩]
2. Digital Marketing, Adobe and $10 Billion Worth of Opportunities, August 18 2014, www.mobilemarketingwatch.com [↩]