Adobe: a dream deferred Premium

Focus on the cash flow statement of the US software business

When Adobe Systems switched to selling software subscriptions instead of licences, investors knew that its revenue would take a hit for the first few years. No matter. As a “cloud” or “SaaS” provider of graphics software, Adobe could count on the halo above those buzzwords to cushion the drop in profits. Sure enough, quarterly results have sagged. And as predicted, investors love the transformation and have sent Adobe’s shares up 60 per cent over the past year.

Investors appreciate that Adobe’s business is now more predictable and that in time it will grow again. But they also know the business is in better shape than it would appear. The old Adobe software licence was “perpetual”. The customer pays (a lot) up front for a box of software that they are free to use forever. Upgrades are released every few years, of course, but those require another hefty outlay.

The “software as a service” (SaaS) model delivers programmes over the internet for a monthly fee; subscribers receive free updates as soon as they are ready. Over the average life of a subscription, revenue should be greater than under the perpetual model. For example, Microsoft’s Office cloud option costs $8 per month. The perpetual licence for Office costs $180 up front, and Microsoft estimates that customers update it every five to seven years. That same $180 comes in less than two years under the cloud model.

At Adobe, third-quarter net income fell 60 per cent, but cash from operations was only down 18 per cent since deferred revenue – which has been received but not recognised on the P&L – was worth $35m. Only a fraction of the deferred revenue comes from the Photoshop/Acrobat side. Most subscription revenue there is booked as the cash arrives. But Adobe’s fast-growing web analytics business gets most of its cash up front. A nice hedge to have while the subscription business takes hold.

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