We’re “Going Stealth” For Windfall Tech Profits

20 | By Michael A. Robinson

Most folks believe that the only way to pull down the really big profits in tech is to find an undiscovered small-cap and ride the high-risk pick for all its worth.

But I’m going to let you in on a secret of mine: Big-cap stocks – if you catch them at just the right point – can deliver even bigger returns than their small-cap counterparts … and often with less risk.

I sometimes jokingly refer to these lucrative tech plays as “stealth small caps.” They are one of my favorite profit opportunities to uncover. And when you can tie one of these stocks to a big trend or some other similarly powerful catalyst, the profit opportunity can be staggering.

In fact, I’m going to tell you about one such profit play today …

On Tuesday, I told you that cloud computing will generate the kind of windfall profit opportunities that investors can usually only dream about. This push to store everything from your company’s software and corporate records to your family photos out on the Web instead of on your desktop hard drive is creating a business opportunity that researchers say will explode by nearly 500% in a decade.

The fact is that cloud computing is one of those technology advances that is reshaping the business landscape. That means there will be a plethora of fast-growing, small-cap profit plays in areas like hosted data centers, computer memory systems, network security and data storage.

But a paradigm-shifting invention like cloud computing that’s powerful enough to give birth to lots of new little companies like that also has the power to give new life to some longstanding high-tech stalwarts – energizing their profit growth and causing their stock prices to rocket.

It’s like they’ve been given a dose of “digital Viagra.”

A “Target Rich” Environment

That’s good for us because it broadens our list of potential investments into a target-rich environment.

I usually think of the stocks of big tech firms as being “slow and steady.” There’s not as much risk as with a small-cap stock, but the downside is that you can’t expect the souped-up returns you expect from these small, emerging tech ventures.

But the cloud is quickly changing that dynamic. By moving data and applications either to the Web or to “private clouds” – data centers hosted by vendors – some big cap firms are being presented with completely new growth opportunities. That demonstrates the power of Rule No. 2 – ride the unstoppable trends – of my five-part system for building tech wealth.  

By reinvigorating the big-cap tech players – and giving them new markets to grow into – the cloud has created a “target-rich” environment of profit plays for us to choose from.

But there’s one in particular that you need to take a look at.

I’m talking about Adobe Systems Inc. (NasdaqGS: ADBE), the San Jose-based tech veteran that’s using the cloud to turn its business inside out.

Founded in 1982, the Silicon Valley firm is already one of the world’s most respected software firms. Most investors know Adobe as the maker of software that creates the popular PDF files found on the Internet and also used as email attachments.

Turns out, Adobe also is the world leader in software used by designers, artists and illustrators to create sales brochures, newsletters, catalogues magazines and web sites.

Its Photoshop suite is the industry standard for managing and editing pictures. Adobe Illustrator is the go-to software for creating, editing and managing graphics.

These are very complex packages with millions of lines of code that take two years to develop. And that doesn’t take into account all the other steps it has to go through to get the software to market such as burning CDs and packaging and shipping products to retailers.

Each of those steps is a profit killer …

Adobe is tapping this emerging tech venue as a brand-new, low-cost sales channel that will supercharge its growth and give the company small-cap profit potential.

Given that the firm brings in roughly $4.1 billion in sales of licensed and packaged software, just reducing costs by a mere 10% could mean a $400 million improvement in the bottom line.

By capitalizing on the benefits afforded by the cloud, Adobe will soon stop shipping physical products or allowing for digital downloads directly to customer desktops. Instead, clients will subscribe to Creative Cloud and pay a monthly fee to use a suite of software packages.

For its part, Adobe will host the software on its own computer servers and will offer customers discounts of about 40% for the first year of use. After that an annual contract for individuals will run about $50 a month.

Paying the monthly fees gives clients access to several software packages for one simple price as well as steady stream of “free” updates.

So, you can see that Adobe has a lot riding on its new Creative Cloud…

And there’s another big reason why the firm could get a big boost in sales. With Creative Cloud, Adobe will virtually eliminate piracy of its products.

The Business Software Alliance, a trade group, estimates that pirated products account for about one in five software packages in use as of 2011, the last year for which statistics were available.

Some of Adobe’s software can run $1,200 to $1,500. So, many smaller or medium-sized firms will buy one or two legal packages and then pass purloined copies around the office. You just can’t do that when the software lives in the cloud.

If Adobe just fell in with the industry’s average, Creative Cloud easily could expand sales by 20% simply by stopping all that theft in its tracks.

Add it all up, and Adobe’s move has winner written all over it…

Right now, Adobe has more than 500,000 Creative Cloud subscribers, a figure that is growing by 12,000 a week. But by the end of its fiscal year 2015, Adobe expects that number to increase to four million monthly users.

That’s a roughly eightfold increase in cloud users in just about three full years. Adobe launched the cloud platform roughly a year ago on a trial basis but announced the full switch over in early May.

The bottom line: Expect profits to start growing by more than 40% starting a few months.

And that’s just the beginning: I expect this move to the cloud to greatly improve Adobe’s profits in the long run.

But there’s a great entry point looming. As you can imagine, the shift to a new platform will hurt profits in the short term as the company ramps up spending on cloud equipment and infrastructure, allows sales discounts and takes restructuring charges.

Analysts polled by Thompson Reuters expect Adobe to earn about $311 million on about $4.1 billion in sales for the fiscal 2013 year that ends in November. That’s less than half of what it earned on roughly the same revenue the year before.

But starting in 2014, profits are set to explode…

Analysts expect earnings to more than double that year to about $697 million. After that, I’m projecting annual profit growth of about 22% a year – a 46% improvement from its 15% average over the past three years.

At that rate, profits could double in a little more than three years.

That’s a lot of earnings growth for a firm with a $21 billion market cap and whose stock trades at roughly $42 a share.

At the very least, the new cloud sales model will greatly enhance Adobe’s cash position. The company already does a great job here, bringing in more than $1 billion a year in free cash flow.

Thus, Adobe’s cloud strategy is set to make the firm into a crown jewel of the software industry. It already sells products that creative professionals working in every industry must have.

Now, its lowered cost structure and higher operating margins will turn it into a true profit powerhouse.

A little “digital Viagra” goes a long way – especially for a “stealth small cap.”

See you next week …

20 Responses to We’re “Going Stealth” For Windfall Tech Profits

  1. Sam Orr says:

    Would you expect a stock price reduction to occur after, or before, the November quarter-end reporting due to the reduced earnings it will report? That is, do you think we might have a better entry price later this year, or is now as good a time as any to accumulate shares in Adobe?

    Thank you.

    • Joe "JD" Merritt says:

      Dear Mike, Your straight-forward, no BS, reporting with no BS (like ADBE,) surely revves up my 94 year old ticker.

      Thanks for the inspiration. JD

    • Michael Robinson says:

      Hi Sam,

      Great question. Shows you’re very savvy. As you correctly surmised, getting the timing right on entry points is no easy matter. One way to do that is well beyond the scope of Strategic Tech Investor, and that’s using a charting system.

      However, the main thing to keep in mind right now is that most of the cost news should be priced into the stock at this point, which is why the price has recently recovered. Our biggest risk would be if ADBE announces weaker earning than expected or cuts its full-year growth forecast.

      Hope that helps,


  2. dionisios sabalos says:

    Good straightforward report on a firm that i have not looked at closely,
    The cloud area is highly populated with such firms such as EMC<SWI<NOW<ADSK<NVDA<………….ETC.Have you analyzed and compared ADBE with these and other firms on a risk reward basis and ranked
    ordered for investment purposes.One has choices for investment.Why is ADBE better or best.

    • Grandpop says:

      Would like your thoughts re the above two questions…….(ie: the best time to buy/accumulate; a comparison with other “cloud” firms)

    • Michael Robinson says:

      Hi Dionisios,

      Thanks for your question. It’s a great one. The point of this column was to show how moving to the cloud can bring a fresh round of growth and profits to an entrenched player, giving us a bigger list of tech stock to chose from.

      Your question is embedded with a great insight, which is just how broad the market is for cloud services. It’s a huge footprint. The symbols you cite cover data storage semiconductors, CAD-CAM design and IT management/virtualization.

      To my way of thinking, you’d have to compare players in the same segment to figure which is the overall best in class at any point in time. Having said that, I hope to follow up more on the topic of just how comprehensive the Cloud really is.



  3. Craig Miller says:

    Hello Michael,

    Sam Orr above has a great question. Could you give us your thoughts?










  6. Emmanuel Eyssautier says:

    Hello Michael, could you please answer the 2 great questions mentionned above.
    Love to hear from you

  7. steve says:

    Adobe has set off a firestorm of protest from their announcement to move to this cloud-only rental-only pricing model. There are a whole lot of people really upset about this and many professionals have already said they decided to just switch to one of the many other very good software alternatives. The main reason is the just-keep-paying-forever model is not going to work for many small shops that experience lean times in cycles of business. They depend on the ability to just keep going with what they can afford in the upgrade cycles with a license they OWN. That’s not possible with this rental-only model of licensing. It puts paying Adobe’s bakshish FIRST rather than upgrading when it’s affordable. The cloud apps like Photoshop will have a different file format than the unlimited license. If one converts Photoshop files to the cloud format, and then the bakshish isn’t paid, access to one’s files is GONE. So far there is no word that the cloud format will be backward compatible with PSD format, and that’s a deal-killer for a whole lot of people.

    Photoshop, Illustrator, InDesign and the others are very mature software packages. People can do a lot with the unlimited licenses they already own, there won’t be major upgrades coming, just minor tweaks and extras thrown in, which most people don’t need.

    Adobe may be king of the hill, but they’ve got a serious rebellion on their hands with this price gouging strategy, only the bigger more stable organizations will be willing to get locked into paying ad infinitum just to stay on the standard.

    In a couple years we’ll see which products people are switching to. Quark will pick up from InDesign. Corel is actively promoting they will NEVER stop selling an unlimited license for PaintShopPro, and Gimp will see their free web downloads swell. Even Illustrator has some serious competition, and is still second rate in usability compared to Freehand (it is still preferred in Europe). Apple will sell more Aperture and Final Cut. There will be some real winners from all this and I don’t think it will be Adobe. I think they have made a serious miscalculation.

  8. Richard Waldren says:

    As always Michael, I enjoy your teaching and wisdom. Will be looking to add ADBE. Thanks again.

  9. Yeboah says:

    Thanks Michael.

    Sam Orr’s question speaks for many of us. Please tell us what you think the best entry point is on this play.


  10. B says:

    Adobe pissed off the photography community ROYALLY. I don’t think they could have done a better job upsetting them if they tried. I know Photoshop is not much of Adobe’s revenue, but I expect the backlash will affect other products to some extent.

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