Wall Street Seems All In on Adobe

NEW YORK (TheStreet) -- Software giant Adobe (ADBE), which is due to report third-quarter earnings on Tuesday, has become (on many levels) a very interesting story. Without a doubt, this company still has a say not only in the world of digital media, but also in content distribution and consumption.

But it's unclear, though, whether management can effectively prioritize the company's collective ambitions.

You see, over the past couple of years, Adobe has struggled to grow revenue and margins on its once-dominant creative suite applications -- the one that includes popular titles like Pagemaker and Dreamweaver. Free offerings from rivals like Google ( GOOG) and software alternatives from Apple ( AAPL) and Microsoft ( MSFT), began eating into Adobe's market share. Not to mention, each of these companies had cloud-distribution advantages, an area Adobe had yet to adopt.

In a case of "if you can't beat them, join them," Adobe has been working to transition its business from software sold in a box to a cloud/subscription-based model. On top of that, Adobe recently announced a $600 million all-cash deal to acquire Neolane, a privately held French company France that specializes in cross-channel campaigns.

Given Neolane's capabilities in online and offline marketing, I won't dispute that this acquisition makes perfect sense. But again, given Adobe's transition, I have to question the timing. And I believe that this just might have been a case where management has bitten off more than it can chew.

The other concern is with Adobe's digital media business, which has been -- as I said --shedding revenue, including a drop of 18% in the June quarter.

I appreciate that management has decided to move away from this business. But it's still an important source of cash flow. Not to mention, this brings up a very important question:

To what extent can Adobe offset these declines, while (at the same time) implementing a new business model, given Neolane's annual revenue of (only) $60 million, which amounts to just 1% of Adobe's 2012 total sales of $4.4 billion?

To be perfectly honest, beyond the software synergies, I'm not seeing what Adobe hopes to accomplish here.

Bulls will argue that Neolane is posting 40% revenue growth, but so what.

I can give Neolane all of the credit it deserves, but it still pales in comparison to the offerings of Oracle ( ORCL) and Salesforce.com ( CRM) -- two giants with similar (and perhaps better) marketing capabilities. And the idea that this acquisition suddenly catapults Adobe as a threat to either of these companies is premature, if not entirely far-fetched.

I'm not just here beating up on Adobe. On more than one occasion, I've applauded the progress that the company has made. And given how well customers -- both current and new -- have embraced the company's new cloud platform, which now totals more than 700,000 paid subscribers, I can tell you that the transition has gone better than expected.

But that's not the whole picture. There's still the issue of profitability to deal with. Let's not forget that in the June quarter, the company posted a 2% drop in GAAP gross margin, while GAAP operating income plummeted by more than 60%.

The Street, meanwhile, does not seem to care. Betting that Adobe would eventually get its house in order and overcome these challenges, investors have rewarded Adobe with a P/E of 43, which includes year-to-date gains of 30%.

Look, I'm not saying that this level of confidence is unjustified. But, given the many simultaneous directions in which Adobe is heading, I just don't believe there are enough data at the moment to suggest that this stock should go any higher.

At the time of publication, the author was long AAPL.

Richard Saintvilus is a co-founder of StockSaints.com where he serves as CEO and editor-in-chief. After 20 years in the IT industry, including 5 years as a high school computer teacher, Saintvilus decided his second act would be as a stock analyst - bringing logic from an investor's point of view. His goal is to remove the complicated aspect of investing and present it to readers in a way that makes sense.

His background in engineering has provided him with strong analytical skills. That, along with 15 years of trading and investing, has given him the tools needed to assess equities and appraise value. Richard is a Warren Buffett disciple who bases investment decisions on the quality of a company's management, growth aspects, return on equity, and price-to-earnings ratio.

His work has been featured on CNBC, Yahoo! Finance, MSN Money, Forbes, Motley Fool and numerous other outlets.

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