Share tip of the week: well-placed software giant
By
Paul Hill Jan 09, 2009
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Staff at some of Silicon Valley's biggest firms are having unusually long festive breaks as the technology industry responds to the economic slump with longer office shutdowns, not to mention redundancies. Yet although the credit crunch is biting now, the long-term fundamentals for web 2.0 services, e-commerce and online advertising remain intact. Just look at Play.com, the UK's third most-visited internet store. Last week it reported that turnover leapt 24% over the holiday period, while according to consultant Cap Gemini, online purchases are set to account for as much as 50% of UK retail sales by 2014.
Adobe Systems (Nasdaq:ADBE), rated a BUY by Deutsche Bank
One beneficiary of this enduring trend is Adobe Systems, a global leader in internet software with a market capitalisation of more than $12bn. Its flagship products – Acrobat (document management), Photoshop and Dreamweaver (website design) – are crucial to next-generation web services and are used by many of the world's most popular sites, such as AOL and Disney.com. Like its peers, Adobe isn't immune to the recession and last month warned near-term profits would miss Wall Street expectations, sending the shares to near-five-year lows. Still, the sell-off looks over-done.
Firstly, the board is slashing costs, cutting headcount by about 8% and sharpening its competitive edge. Secondly, part of the weaker performance has been caused by temporary budget freezes. Customers have deferred but, importantly, haven't cancelled purchase orders. In fact, in this more frugal environment, if businesses are successfully to exploit their brands online, I believe they will have to embrace rich-media technology. Interactive, eye-catching websites like those created by Adobe's software offer a far more compelling user experience than bland, static ones. Lastly, it enjoys substantial barriers to entry – its leading Flash player software runs on 98% of all PCs, while its Acrobat Reader has been installed on more than 600 million computers – hence delivering high switching costs and robust economies of scale.
That said, the stock is not risk-free. The length of the downturn will clearly have an impact on the company. Then there are competitive challenges from Microsoft to contend with. A full 54% of turnover is derived from outside the US, so the stronger dollar is another threat. The firm also has low recurring revenues (at around 6% of sales) to shield it from the downturn.
Yet these issues seem to be more than reflected in the beaten-up rating. Wall Street expects underlying earnings per share (EPS) of $1.80 and $2.00 for the next two years, putting the stock on undemanding earnings multiples of 12.8 and 11.5 respectively. And the balance sheet is resilient enough to weather even the severest of storms, sporting net funds of $1.6bn as at the end of November.
Recommendation: BUY at $23.00
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.
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