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Adobe Systems (Nasdaq: ADBE) is best known for its Acrobat Reader program. The popular format is used to create, distribute, and print electronic documents, and it has become ubiquitous on the Internet. The company also has two other major business lines: Creative Suite and Flash. Creative Suite includes programs such as Photoshop and Illustrator, applications used by creative professionals like graphic and website designers to create and manipulate images electronically. Creative Suite is the dominant player in its industry. Through its acquisition of Macromedia, the firm also owns Flash, which is the standard program used to publish online video content. For example, Flash is the driving force behind the popular YouTube website that allows users to share videos online. Competitive Advantages Adobe has defensible advantages in all of its major markets. Creative Suite, for instance, has long been the dominant program in the graphics design business. That means that most creative professionals have been trained on Adobe's products. Since they're familiar with the program, switching to different software would require significant expenditures for retraining. This high switching cost is a major advantage for Adobe. Acrobat and Flash also have readily apparent advantages. Flash has become far and away the dominant technology for publishing online video content. The popularity of YouTube and other websites built on Flash technology have further solidified Adobe's lead in this market. The company estimates that more than 97% of all computers have a Flash player installed. Since most computer owners have Flash and have used the program to view online videos, publishers want to push content in this particular format. Doing so ensures the widest possible audience. And finally, while there are certainly competing formats for electronic documents, Acrobat reader is installed in well more than 90% of all computers globally. The program has become the de-facto standard for publishing electronic documents. Like Flash, publishers want to make their documents available in Adobe format so that more users can access them easily. Growth Drivers and Vista Impact Like Microsoft's upgrade with Vista, Adobe is in the midst of its own software upgrade cycle. In late March, the company unveiled Creative Suite 3, the latest version of the popular program. CS3 has been widely anticipated over the past year, and its launch will be the largest product release in company history. Over the next few months, Adobe will be introducing 13 new or updated applications and 19 new product configurations through a staggered release schedule. Design professionals will have many reasons to upgrade to CS3. The new product includes enhanced capabilities that allow designers to manipulate more complex images and digital photographs. In addition, Adobe is also launching a new version of the program that allows users to make Flash videos. As the leader in the design market, Adobe's existing customers are likely to upgrade to CS3 to take advantage of the new features. The timing of the CS3 launch is no mistake -- the product is likely to benefit from the simultaneous release of Vista. Specifically, PC users upgrading to a new computer to run Vista are also likely to update other programs, including Adobe Acrobat and Creative Suite. In a sense, Vista's release pushes demand for other software packages. Even better, computer users are increasingly taking advantage of faster Internet connections and more powerful computers to view graphics-rich web pages and online content. The rapid growth of YouTube's popularity is just one manifestation of that trend. As users upgrade their systems to more modern Vista-enabled machines, this trend is likely to accelerate. All this plays right into Adobe's hands -- as its suite of programs is used to create just such web content. Finally, Apple has also slated the release of a new operating system dubbed Leopard for later this year. The company clearly wants to have a viable competitor for Vista. The launch of a new Apple operating system is likely to prompt an upgrade cycle for Apple that mirrors that of Vista. Since Apples are highly popular with design professionals, that's another potential growth catalyst for CS3 and Adobe. Valuation and Outlook Adobe trades at roughly 25 times next year's earnings estimates and sports a long-term projected growth rate of about +15%. That means ADBE trades at a price-to-earnings-to-growth (PEG) rate of 1.7. While that's not exactly a cheap valuation, the company's growth projections could well prove conservative if the new CS3 reaches its true potential. In any case, high-growth companies with market-leading positions typically deserve to trade at a premium. Good investing!
Paul Tracy founded StreetAuthority and became Chief Investment Strategist in 2001. Prior to that he spent several years as Managing Editor at a multi-million dollar financial publishing firm with over 150,000 subscribers. In addition to his role as managing editor and lead financial writer, he was also responsible for equity research and managing a team of seasoned professional financial writers, researchers and market commentators. Paul's previous experience includes a position at Robert W. Baird & Co.'s full-service brokerage operations as well as economic research work on a Money and Banking project funded by the National Bureau of Economic Research. He has also spent time doing outside consulting and research for the University of Virginia, has appeared as a guest expert on several prominent financial radio shows, and has been a featured speaker at various investment conferences across the U.S. Paul graduated with a B.S.
in Finance and Management from the McIntire School of Commerce at the
University of Virginia.
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