It's an ugly day for Adobe. The company's fiscal fourth quarter outlook disappointed, shares are getting hammered and analysts are questioning whether Adobe will really garner much growth from its latest Creative Suite, CS5.
And those questions loom large considering the CS franchise accounts for 55 percent of Adobe's revenue. In a nutshell, Adobe is seeing flattish growth for CS 5 upgrades after just two quarters on the market. Analysts originally believed there was pent-up demand and customers would jump to CS 5 from CS 3. Creative Suite 4 demand was muted to the recession.
But here's the big question. Can Adobe go from being a company mostly about the Creative Suite to one focused on enterprise collaboration, a potential growth driver?
It's unclear. Shantanu Narayen, CEO of Adobe, blamed the CS 5 revenue on weakness in Japan and the education market.
Creative Solutions segment revenue was $549.7 million, compared to $400.4 million in Q3 fiscal 2009, and $532.7 million last quarter. Comparing similar periods of availability, CS5 revenue continues to exceed what we achieved with CS4, by approximately 15%; and is only slightly behind what we achieved with CS3. The suite rank order by revenue was consistent with prior periods. Design Premium, Design Standard and Master Collection remain the best selling suites. And CS5 products containing Flash authoring and output as a product component continue to perform well with revenue growth of 20% version-over-version to date. Although our overall creative business was strong in Q3, our education business in the US was below expectations, as was our overall creative business in Japan.
Narayen said freelancers appear to be using CS 5 and the company signed big licensing deals with companies like Target.
However, analysts weren't impressed. Adobe was hit with a bevy of downgrades. CS revenue in the third quarter was below the $567 million expected by Wall Street and on an adjusted basis fell 8 percent from the previous quarter. Oppenheimer analyst Brad Reback said he was "concerned CS5 could meaningfully underperform CS3."
Jefferies analyst Ross MacMillan summed up Adobe's challenge well.
Clearly the thesis that CS5 could be bigger than CS3 is not playing out. Adobe looks to be a company that is going through a transition from where the creative business was the primary growth driver, to one where other areas (such as enterprise collaboration) will need to become a bigger driver of growth. Adobe has made transitions before, but clearly there is risk and the sheer size of the business makes it harder.
Indeed, Adobe has some collaboration mojo, but it's a crowded enterprise field. What software vendor isn't talking collaboration?
Adobe's best bet for CS 5 sales may be to hope that Apple's decision to ease App Store policies will juice sales. With Apple's move, Adobe can put back in features that will allow Flash apps to be ported to devices like the iPad and iPhone.
However, the jury is still out on what Apple's App Store rules really mean for CS 5. An analyst asked Narayen about whether Apple's easing of restrictions could boost sales of CS 5. Narayen said:
What we did see was that the day Apple announced the removal of the licensing restrictions that a number of people who had created products using our tool submitted that to the Apple Store and were approved. I think it just continues to reflect the opportunity which we have with our tools, which is to help designers and developers continue to develop their applications and content in our tools and repurpose it to multiple different output media. In the short run, I would say the impact was muted.
In the meantime, Adobe is going to have to grow its enterprise business. JMP Securities analyst Patrick Walravens said Adobe can navigate the challenges.
We maintain our rating because (a) we believe the weakness in these areas may simply push part of the CS5 cycle out to FY11, (b) Adobe's drive to do more enterprise business looks promising, and (c) we think Apple's recent change of heart regarding its developer rules puts Adobe back in the game of expanding its user base to include more developers.
Walravens' take was a relative oasis of optimism about Adobe. Shares were down about 20 percent in early trading Wednesday.