Adobe Pins Hopes on Launch of Creative Suite 3

CS3 is the largest software release in Adobe's 25-year history. Often, as software makers are preparing for a major product launch or upgrade, there tends to be a lull — both in sales and the share price — as consumers wait to purchase the latest release. That was fairly evident when Adobe reported its fiscal first-quarter earnings Tuesday evening. During the quarter, which ended on March 2, revenue came in at $649.4 million, a sequential decline from the prior quarter and 1% lower than the year-ago quarter. Earnings looked more impressive at 24 cents a diluted share, up from 17 cents last year.

With the earnings announcement behind it, Adobe — and investors — are now gearing up for CS3, which is slated to debut near the tail end of Adobe's fiscal second quarter. That means the software should be available sometime in May with the release of foreign-language editions to follow in the third quarter. Adobe Chief Executive Bruce Chizen said the launch should push revenue during the third quarter "substantially higher," with it peaking for the year during the fourth quarter. The company also stood by its goal of hitting 15% year-over-year revenue growth during fiscal 2007.

That goal might prove easy to achieve. Based on results from Adobe's prior launches, Citigroup analyst Brent Thill projected in a March 1 research report that revenue from CS3 should climb 12% during the first full quarter that it's available to the public, and 27% in the following quarter. Considering that the Creative line of products comprises almost half of the company's total revenue, the new software suite should have a potent impact on the company's results overall.

What makes Creative Suite 3 so promising is that it will integrate Adobe's celebrated graphics and publishing applications, such as Photoshop and Illustrator, with the Flash technologies that it acquired from Macromedia in December 2005. The software bundles (there will be more than a dozen different versions available) cover almost every corner of the computer graphics and publishing universe, from the type used in magazines to animation on the web to inserting graphics in digital movies.

The upcoming version of Adobe's popular digital-editing software Photoshop, for example, will come in two versions: Photoshop CS3 and Photoshop CS3 Extended. The high-end Extended version will enable the rendering and editing of three-dimensional images and includes tools that will allow users to measure and analyze images like a picture of a cancer cell.

CS3 isn't the only bright spot on Adobe's horizon. Sales of Acrobat 8, Adobe's latest version of the software that allows users to create PDF (portable document format) documents, is gaining momentum. The company is also taking the lead in video and media streaming applications with its Flash technologies and has started to make inroads in the mobile device market with its Flash Lite products, with Verizon Wireless already signed on to launch Flash-enabled handsets.

Industry watchers are also excited about Apollo. Adobe just released a test version of Apollo, a platform that allows developers to create rich Internet applications. Using programming languages like Java, HTML and Adobe software and programs such as Flash and Flex, developers will be able to create web-based applications that function like desktop applications. Google's (GOOG) Docs & Spreadsheets is a good example of some of the applications that can be created using this technology.

"Apollo could be the next killer app, which will empower Adobe to win the emerging platform war for web-enabled rich applications," prophesied Citigroup's Thill in his report. Adobe's management said during its conference call Tuesday that it doesn't expect revenue from Apollo to start coming in until next year.

Thill has a Buy rating and a 12-month price target of $50 on Adobes share's, which recently traded at $42. His target translates to a price/earnings multiple of 33 based on Thill's earnings estimates for calendar year 2007. Thill notes that the multiple is a little high based on the company's historical averages, but says the new product launches and growth associated with the addition of Macromedia's technologies warrant a higher valuation for now. (Citigroup makes a market in Adobe's shares and has conducted noninvestment banking business with the company in the past 12 months.)

Jefferies & Co. analyst Ross MacMillan expressed similar sentiments. "We believe a combination of CS3 and accelerating growth in other divisions (such as Mobile) in the next 12 months could contribute to upside surprise over coming quarters," MacMillan wrote in a report following Adobe's earnings release. The analyst also has a Buy rating and a $50 price target on the company's shares. (Jefferies makes a market in Adobe's stock.)

More details about the CS3 launch and possibly another stock buyback (the company has some $2.3 billion in cash on the books) will be revealed on March 27 and 28 when the company plans to host an unveiling of CS3 and an analyst meeting. Investors willing to bet that Adobe will continue to dominate the digital design world would do well to get in now.