Can Adobe Maintain Its Momentum?

TheStreet.com

NEW YORK (TheStreet) -- There's nothing that Wall Street hates more than uncertainty, and investors may be wondering about Adobe as it makes a major transition in its business model.

Adobe -- still the dominant leader in the multimedia software market -- has been working to transform its business from the traditional "software sold in a box" to an online/cloud subscription-based model. So far the transition has gone well.

On Tuesday, the company will report results for its second quarter, and investors will be watching closely to see if the company can continue its momentum after a strong start to the year. The stock, trading at around $43, is up 25% so far this year.

Given the early struggles that Microsoft experienced with its Office 360 subscription, analysts had doubts that Adobe would make its transition as well as it has.

Microsoft was looking for a cloud-based subscription model to save on distribution costs and make it easier for users to update their software. Likewise, Adobe saw this conversion as inevitable. The only question was how long the transition would take.

Not only have customers responded favorably to the subscription model, but management's acrobatic moves have brought new life to Adobe's Creative Suite franchise, which added 153,000 Creative Cloud service customers in the first quarter.

Investors want to know if this streak can continue or is it time to cash in. I don't believe that Adobe has been just lucky -- not when the level of execution has been this consistent. The company had a great start to 2013 as it reported first-quarter revenue that beat estimates for the second consecutive quarter. That was during a period when other software companies were missing estimates and lowering their outlooks.

Adobe's management said that the results were helped by higher subscriptions, as revenue doubled from the same quarter a year earlier. Even more impressive: profitability has remained strong during the transition.

It seems as though management discounted its own talent and appeared to be stunned by the higher rate of conversion of customers to the subscription platform.

I don't believe that Adobe's management team has gotten enough credit, nor do I believe that investors fully appreciate how rare this sort of transition is. Besides the impressive results for the first quarter, management raised its earnings and revenue estimates for the year.

On the earnings conference call, management said the company expects to reach 1.25 million paid subscribers by the end of this year. That's an aggressive target, considering that the company ended the first quarter with 479,000 subscribers. Adobe has about 2 million users on free trial.

Companies don't set goals they don't feel is really achievable. And so investors can expect roughly 775,000 additional paid subscribers by the end of the year, which amounts to roughly 260,000 per quarter. That is an important number to keep an eye on in Tuesday's earnings report.

Given the recent challenges that other software companies such as Oracle and Red Hat have experienced, investors will be eager to hear what Adobe's management says. What's more, since the first-quarter report, the company's chief technology officer, Kevin Lynch, left to join Apple .

Other questions will be answered in the second-quarter report, and so investors will learn whether the company can maintain its momentum.

In the meantime, there is no debate about the quality of Adobe's management team and the direction it is taking this company. I still rate the stock a strong buy and expect shares to reach $50 in the second half of the year.

At the time of publication, the author was long AAPL and held no position in the other stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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