Why Adobe Is Heading to $80 (Earnings Preview)

NEW YORK ( TheStreet) -- You will be hard pressed to find a hotter stock in the software space than Adobe ( ADBE). Shares are up 12% year to date as of Friday's close, and currently trade at $68.42.

While this may not be a spectacular premium, consider that since the middle of October Adobe stock has surged 35%. Adobe has posted exceptional growth. But with the stock carrying a P/E of 119, which is three times the industry average of 39, according to Yahoo! Finance, Adobe is not cheap.

As it stands, investors want to know if it's time to flip share of the maker of the popular Acrobat software. I say no, at least for now. Management has set some pretty remarkable targets that, if achieved, could propel this stock towards the $80 range.

The company will report 2014 fiscal first-quarter results Tuesday. Analysts already appear convinced management will deliver where it matters. That's what the company has done the past two years as it transformed the business from a software sold in a box to a cloud subscription model.

The consensus estimate calls for earnings of 25 cents per share on revenue of $973 million. Management  previously guided for revenue to be in the range of $950 million to $1 billion, while projecting the company to earn between 22 cents and 28 cents per share. The numbers appear in alignment. There likely won't be any surprises.

The main driver of the stock, however, will be what management says about the progress of its Creative Cloud business. The company has not been shy about its ambitions. Nor has management held back about its aggressive growth in the cloud.

By the end of 2014, Adobe says it will have roughly three million paid subscribers on its Creative Cloud platform. Given how difficult business model changes are known to be, three million is not a conservative target.

For management to achieve this number, the company has to get more than 30,000 per week to subscribe. This number almost doubles the 21,000 weekly signups for all of 2013. Assuming that Adobe does reach this goal, this would provide the company with almost $2 billion in recurring revenue. No less, for a platform that is still in its infancy.

After exiting its traditional box software model, Adobe was deservedly credited for the quick pace of its makeover. But the progress of Creative Cloud has taken management's execution to another level.

Even more impressive is that fact that the company expects to have over $2.5 billion in Digital Media revenue by the end of 2014. This puts Digital Media to grow at a rate of 20%.

Likewise, the fact that subscription revenue accounts for roughly 30% of Adobe's total business makes it tough to bet against this management team. Customers continue to embrace the service, which is used to deliver cooperative project-based services across their network.

If there is any drawback to this story, it's with Adobe's margins, which have been on the decline as operating expenses have gone up. I say this with full understanding that management is still in the midst of transforming the company. At some point earnings will start to matter again.

Adobe is rebuilding itself, but the company is far from a startup. Investors should pay attention to what management says on the conference call about the future cash flow and when the company will return to profitability. This is what will spur things like share buyback and a possible dividend.

For now, there's no measurement that can be used to say that these shares are cheap. Even so, at around $67 per share there's still upside. Assuming the company can generate around $5 billion in combined revenue for Creative Cloud and Digital Media, a 20% premium seems fair, and $80 per share seems the likely next target.

At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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