Building a moat around your business is a very profitable thing to do. When that alligator-filled ditch is wide enough, you have guaranteed yourself steady income in good times and bad. And if the stuff you're selling is absolutely essential to someone's work, you have a serious cash cow on your hands. That's the only kind of cow I'd recommend building moats around.
Case in point: Adobe Systems (Nasdaq: ADBE ) . The digital media maven just reported strong GAAP earnings of $0.30 per share on $786 million in sales. Both of those numbers are down a fair bit from the comparable quarter of last year -- 21% lower earnings and 12% weaker revenue.
But the numbers that matter the most came in stronger. Free cash flow landed at $350 million, just 6% below the year-ago take. Think about that for a second -- Adobe collected $350 million of free cash on $786 million in revenue, for a massive 45% FCF margin. And it happened in the midst of the worst economic crisis in living memory. Remember that proper stock valuation depends on cash flows, not on "discounted earnings." Mr. Market’s clearly been impressed with Adobe’s numbers; the stock is trading up 12% despite a broader market malaise.
Adobe's customers really need Flash, Photoshop, Fireworks, Acrobat, and all the rest of the company's core products. There are plenty of alternatives available from Corel (Nasdaq: CREL ) , Microsoft (Nasdaq: MSFT ) , Apple (Nasdaq: AAPL ) , and even Google (Nasdaq: GOOG ) , and some of them beat Adobe's offerings on price or features. But those customers prefer to stick with Adobe, despite the budget crunch.
More evidence comes from a straight-up 15% increase in service revenue to $44.2 million. Content producers and information management specialists like Walt Disney (NYSE: DIS ) and Level 3 Communications (Nasdaq: LVLT ) may be delaying their software upgrades and new IT infrastructure investments right now -- but they still need support contracts for the plethora of Adobe products they already use.
So milk that cash cow, Adobe. The moat you built around it will keep the competition away.
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