With Flash Under Fire, Adobe Shares Charm Analysts

The new year began harshly for Adobe Systems (ADBE). Shares of the maker of Photoshop, Flash, and other widely used software have dropped almost 8% in 2010, after big gains last year, amid speculation that Adobe's Flash Web-video software will be eclipsed by a competing technology backed by Apple and Google.

Apple (AAPL) has fanned the concern, saying it won't let videos and graphics created with Flash play on the iPhone or on its upcoming iPad computer, introduced by Apple Chief Executive Steve Jobs in January. Adding to the bearish outlook, some technology executives ask whether Adobe, which has traditionally specialized in software for the desktop, is adapting quickly enough to the emerging mobile computing realm. Adobe's products "have a lot of competition," says Carl Bass, chief executive at design software maker Autodesk (ADSK), which uses Flash to power a Web site that helps consumers remodel homes.

For all the negativity aimed at Flash, Wall Street analysts are surprisingly bullish on Adobe, the world's No. 5 software maker by market value. No less than 19 of 29 analysts covering Adobe recommend its stock, according to data compiled by Bloomberg. Some analysts dismiss talk of Flash's demise as overblown, saying that this year's share decline should be measured against a 73% gain in 2009. "Adobe was this darling company that could do nothing wrong," says Brent Thill, a software analyst at UBS (UBS) who favors Adobe shares. "Now the king of tech, Steve Jobs, is throwing rocks at them on the playground. This is overdone."

Another reason for optimism, analysts say, is Adobe's plan to release a new version of its Creative Suite, which accounts for a majority of its sales, in the first half of this year. Analysts surveyed by Bloomberg expect Adobe's sales to rise 22% to $3.59 billion in 2010, following an 18% drop in 2009. Net income may more than double to almost $942 million, the analysts say.

"organic growth" for Creative Suite?

Apple's decision to bar Flash from the iPhone and iPad have given investors "an entry point" to purchase Adobe shares, Walter Pritchard, an analyst at Citigroup (C), wrote in a research note on Feb. 16, when he kicked off coverage with a "buy" rating. "Thanks Mr. Jobs," he wrote. This year's stock decline has outpaced a 1.1% descent in the Nasdaq Composite Index. On Feb. 19, Adobe climbed 64¢, to 33.88.

Economic recovery may also help Adobe. Companies are increasing budgets for advertising and marketing materials that can be created with Adobe's software, and worldwide PC sales are expected to increase by 10% this year. "Adobe this year will be a classic case of a new product leading to organic growth," says Andy Miedler, a senior technology analyst at Edward Jones who recommends Adobe's shares, about the release of Creative Suite. "Investors should pay up for that."

Overdone or not, concerns over Flash are putting pressure on Adobe to improve the software that it says is used to create three-quarters of Internet video clips and 70% of online games. On Feb. 16, Adobe released to developers a test version of its upcoming Flash Player 10.1, which is designed to run well on smartphones and other mobile devices.Adobe senior director Danny Winokur says Flash 10.1 "is producing excellent performance on a wide variety of devices that are no less powerful than an iPhone." Adobe is also improving the security of its software, which had been vulnerable to computer viruses.

Is Apple protecting iTunes?

To compete with Flash, Apple and Google (GOOG) are backing technology called HTML 5, whose proponents say that it better combines online video with information from other parts of the Web. Analysts say Apple doesn't want another company's software between its customers and the content sold through the iTunes store. "They don't want Adobe to own the media distribution business," says Ted Schadler, principal analyst at Forrester Research (FORR). Apple's big customer base and its ability to set the agenda for software developers could put Flash's lofty market share at risk.

Apple may also be trying to prevent Adobe and other vendors from creating online stores that compete with iTunes, says an executive who was once involved in discussions between Adobe and Apple over including Flash on the iPhone. Apple's Final Cut video-editing software competes with Adobe's Premiere product. Apple also has an incentive to promote its own QuickTime video playback software rather than Flash as a way to make Macs more compelling than computers running Microsoft (MSFT) Windows.

Speaking in an interview with Bloomberg News in Barcelona on Feb. 17, Adobe Chief Executive Shantanu Narayen said that Adobe has a "powerful ecosystem" of partners for Flash and that Apple is "trying to maintain a proprietary lock" on the technologies used in its products. Apple spokeswoman Natalie Kerris declined to comment, as did Adobe spokeswoman Jodi Sorenson.

Flash may prove difficult to displace. The HTML 5 technology is still nascent. It lacks copy protection and other features important to commercial distributors of online video. Adobe has long fended off competition from bigger rivals, including Microsoft and Apple, analysts say. And Adobe, a maker of products prized by Web designers, video editors, and other creative professionals, won't rise and fall on the fortunes of Flash. "Is Adobe under some level of duress from these industry shifts?" says UBS analyst Thill. "Absolutely. But they've been in these waters before and they know how to navigate them."

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