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The Art of Adobe's Deal

Investors await the first-quarter effects of the publishing software maker's Macromedia acquisition.

Adobe System's

(ADBE) - Get Adobe Inc. Report

acquisition of


made a lot of sense in the abstract.

Investors will get their first glimpse of how well the deal is working Wednesday afternoon, when Adobe reports its first-quarter results.

It's not that Wall Street seems terribly nervous that things have gone sour in the little more than three months since the acquisition, but that investors want an update on how the two software makers are meshing.

"This clearly brings their business to a much greater scale," says Darren Chervitz, research director at Jacob Asset Management, which is long Adobe. "It will be interesting to see how that is playing out."

The near-term impact is likely to be more than $100 million in incremental sales in the first quarter and an assortment of merger-related charges.

Longer term, the acquisition has the potential to juice sales of Adobe's suite of programs for creative professionals and to give it a leg up in the fast-growing market for Web video creation and delivery.

On the whole, investors seem sanguine about the acquisition. Although Adobe's shares have traded off in recent weeks, the company's stock has risen 3% since Adobe completed the merger and is up about 9% over the last year.

Indeed, investors seem to be focusing on the potential upside of the Macromedia deal than on any possible problems. With the recent appreciation in Adobe's stock, it's now trading at a relatively pricey 25 times fiscal 2007 earnings.

"I don't think there's a burning question" about Adobe or how the integration with Macromedia is going, says Tony Ursillo, a buy-side analyst at Loomis Sayles, which is long Adobe.

"I'm just looking for confirmation that the combination is working and the company feels good about the numbers going forward."

Both Adobe and the Street are fairly bullish on what those numbers will be.

On average, analysts polled by Thomson First Call are expecting Adobe to post pro forma earnings of 29 cents a share for the first quarter on $650.3 million in sales. The consensus estimate excludes 14 cents to 15 cents a share in expected charges, stock options compensation, amortization and restructuring costs.

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Adobe officials, meanwhile, have predicted earnings of 13 cents to 16 cents -- 28 cents to 30 cents a share excluding charges -- on sales ranging from $630 million to $660 million.

In the same period last year, before the Macromedia merger, the company earned $151.9 million, or 30 cents a share, on $472.9 million in revenue.

Looking forward, Wall Street is expecting Adobe to post a full-year profit of roughly 79 cents a share -- or, not including expenses, $1.29 a share -- on $2.72 billion in sales. For 2007, analysts are looking for $1.48 a share in pro forma profits on $3.1 billion in sales.

The San Jose, Calif., company has predicted 2006 earnings of 74 cents to 82 cents a share, or $1.26 to $1.30 a share excluding charges, on sales of roughly $2.7 billion. In fiscal 2005, Adobe earned $602.8 million, or $1.19 a share, on $1.97 billion in revenue.

Assuming that Adobe meets those expectations, there's likely to be little market-moving data from its earnings report, Ursillo says. But that doesn't mean investors will be tuning it out.

First there's the hunger for information about the Macromedia acquisition. Adobe officials have said that there is only limited crossover between the two companies' customers.

In other words, Adobe believes that it likely gained new customers through the acquisition and that it has the opportunity to sell more products to many of its customers.

But then there's the potential for flash, Macromedia's widely used format for Web-based multimedia applications. Many companies already use flash for Web advertisements and many are starting to use it to deliver Web-based video. Should that become a standard, Adobe could see significant sales of its flash-creation software.

Web video "is going to be a pretty high-growth area in the next few years," says Chervitz, adding that Adobe "has the chance to be a major player in there."

Those factors could help mitigate the expected slowdown in sales of Adobe's creative suite later this year. The company has said that it plans to launch a new version of its software bundle early next year, and customers may delay a purchase until it's released.

That transition could also weigh on Adobe's stock price in the near term, Ursillo says.

But the company usually sees a windfall when it releases new versions of its popular programs, and this time should be no different, Ursillo says, adding that the stock should rise later in the year in anticipation of the release.

Recent personnel issues could also have an effect, Ursillo says. Murray Demo, the company's longtime CFO, announced his resignation in December. Adobe has yet to announce a replacement but could use the call to update investors on the search.

Last week, Adobe announced that had hired John Loiacono, formerly the executive vice president of software at

Sun Microsystems

(SUNW) - Get Sunworks, Inc. Report

, to head its division in charge of the creative software suite. Ursillo says he's hoping that the company will address its reasons for the hire.

"That was a substantial hire," he says. "I'm curious what the hole was at Adobe for such a senior person. I would have thought

Adobe and Macromedia would have had all their bases covered."

Shares of Adobe closed Tuesday's regular session off 20 cents at $36.35.