Adobe's shift to cloud is going to hurt at first

Summary:Lost in the mobile Flash hubbub is Adobe's big shift to cloud computing and software as a service.

Adobe's business model and focus is shifting significantly to software as a service and the transition, which will play out over multiple quarters, could hurt.

Ahead of its analyst day, Adobe outlined a series of broad shifts.

  • First, Adobe is dropping mobile Flash development for HTML5. Jason Perlow outlined the changes last night and Adobe just confirmed. Adobe's bet is that HTML5 will dominate on the small screen. Desktop Flash will be used for gaming, video and "advanced PC Web experiences.
  • Adobe also outlined a shift to focus on the cloud. The company will focus on its Digital Media unit and the recently announced Creative Cloud. The broader theme here is that Adobe is shifting from upfront licensing to software subscriptions and that move will hurt growth in future quarters.
  • And the company laid off 750 workers as it focuses on its Digital Media business and reiterated its fourth quarter outlook.

Of those three items, Adobe's shift to a cloud model is the biggest issue. The shift away from mobile Flash is notable, but as long as Adobe can sell the authoring tools to make apps it'll be fine. The shift to a cloud model has more risk. Adobe said fiscal year 2012 will feature revenue growth in the 4 percent to 6 percent range when analysts were expecting 10 percent. The slower growth will occur as Adobe shifts to a recurring revenue scheme. In fact, Adobe went from projecting fiscal 2012 revenue of $5 billion in a stretch goal to something more like $4.33 billion to $4.41 billion. Wall Street was expecting $4.52 billion for fiscal 2012.

Why the slower growth? Subscriptions will cannibalize license revenue.

Deutsche Bank analyst Tom Ernst said in a research note:

It has been our experience that transition from license to subscription revenue is not an easy one. We have witnessed Intuit successfully navigate through such a change, but this was an exception rather than the rule. Typically, the transition creates the optical problem of significantly slower growth on the income statement, while cash flow leads, but still is depressed for much of the average purchase cycle, in this case a couple of years.

Adobe's plan is to take its lumps in 2012 and then grow at a double-digit clip in future years. Analysts were mixed on Adobe's prospects:

Jefferies analyst Ross MacMillan said:

We continue to believe that the Creative Suite franchise has a growth opportunity based around: i) re-tooling of the portfolio around open standards such as HTML5; ii) new subscription services, such as the Adobe Creative Cloud; and iii) the potential to capture more developer mind (and ultimately dollar) share with tools such as PhoneGap. We also believe that more focused investment around Omniture and other assets in the Digital Marketing category can drive growth. Adobe anticipates that beyond FY12 it can achieve double digit growth with an increasing percentage of recurring revenue. The company still has much to prove, but we are optimistic on the opportunity.

JMP Securities analyst Patrick Walravens said:

We believe the shift to more of a recurring revenue model may result in a fundamentally more attractive and manageable business for Adobe but remain on the sidelines on this stock as these shifts are often difficult and take longer than expected.

Morgan Stanley analyst Adam Holt said Adobe is likely to lose enterprise revenue as it moves to a subscription model. Adobe's moves make sense in the long run, but the transition is likely to be tricky.

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Topics: Enterprise Software, Banking

About

Larry Dignan is Editor in Chief of ZDNet and SmartPlanet as well as Editorial Director of ZDNet's sister site TechRepublic. He was most recently Executive Editor of News and Blogs at ZDNet. Prior to that he was executive news editor at eWeek and news editor at Baseline. He also served as the East Coast news editor and finance editor at CN... Full Bio

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