Adobe: clouding over

Adobe is famous for giving birth to the PDF and Photoshop 25 years ago. These days the company is all about selling software subscriptions in the cloud: subscription sales were two-thirds of revenues in the last quarter, up from 40 per cent the prior year. The market seems overjoyed with Adobe's transition to the cloud - shares trade at 35 times forward earnings today, up from 29 times two years ago.

But the new business model is very different from the old one, which was based on selling one-time, perpetual licenses. Take 2011, the year before Adobe released its "creative cloud" subscription, as a baseline. Revenues then were on par with revenues in the past 12 months, but earnings (before interest, tax, depreciation and amortisation) were 70 per cent higher than today and earnings per share were nearly three times higher.

Part of the reason is that in the cloud, the cost of goods sold can be higher (think of the data centre costs). General and administration expenses have also risen. Plus, average selling prices for software subscriptions tend to fall over time, so more subscriptions must be sold to keep revenues flat. Despite these challenges, Adobe's revenues are expected to rise 17 per cent this year, according to S&P Capital IQ, as more users buy subscriptions to replace licenses that are now outdated. The company itself forecasts annual growth of about 20 per cent between 2014 and 2016.

If that happens, Adobe's progress in the cloud will be the envy of other mature software companies. But disclosure about the cloud business is still, well, cloudy. The company does not publish its churn (or renewal) rate, an important metric for any software subscription business. It also discloses billings, crucial for understanding growth, only once a year and does not break down the billings for product segments such as creative and marketing. To be taken seriously in the cloud, Adobe needs to start reporting like a cloud company, too.

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