This Just In: Upgrades and Downgrades

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At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
As we learned last month, Adobe Systems (Nasdaq: ADBE) intends to lay out $1.8 billion in cash to acquire Web-metrics calculator Omniture (Nasdaq: OMTR). It's a deal that, for better or worse, has so few overlaps (or in Wall Street parlance, "synergies") in it that federal antitrust regulators have already bestowed their blessing. And now, banker R.W. Baird has come out with a blessing of its own -- and a buy rating on Adobe stock.

What's got Baird feeling bullish? Noting that Adobe's "Creative Suite 5" is due out next year, Baird predicts the composite of upgraded functionality for Photoshop, Flash and Dreamweaver will drive sales growth at Adobe in the near future. Longer term, the analyst avers that Adobe will reap "a longtime benefit" from Omniture. But is Baird right?

Let's go to the tape
Judging from its record, I think you have to give Baird the benefit of the doubt on this one. Ranked in the top 15% of investors tracked by CAPS, Baird may be best known for its bold backing of quality franchises in the midst of recessionary panic. Picking Starbucks (Nasdaq: SBUX) back in June netted Baird 28 percentage points' worth of market outperformance; its recommendation that investors buy into JP Morgan (NYSE: JPM), back when the entire financial industry seemed to be imploding, turned out even better -- nearly doubling in value over the past seven months.

But Baird's no slouch when it comes to software stocks, either:

Stock	Baird Says:	CAPS Says (out of 5):	Baird's Picks Beating S&P By:
salesforce.com  (NYSE: CRM)	Outperform	*	103 points
McAfee (NYSE: MFE)	Outperform	**	46 points
Red Hat (NYSE: RHT)	Outperform	**	16 points

In fact, fully 67% of Baird's software recommendations have outperformed the market over the last three years, lending confidence that when this analyst says Adobe will speed past the S&P -- it very well might.

But doesn't it cost too much?
I can see why you might think so. Selling for a 28 P/E, and trading for more than 16 times its annual free cash flow, Adobe isn't an obviously cheap stock. Adding Omniture's minimal free cash flow and its GAAP loss to the mix isn't going to make Adobe look any more of a bargain, either.

But here's what the Omniture acquisition does give Adobe: growth. At nearly $40 million in annual cash flow, Omniture's business is currently just a tiny fraction the size of Adobe proper -- but it is also growing a whole lot faster than its new parent company. Ask any analyst what kind of growth they expect to see out of Adobe over the next five years, and they're likely to quote you a number somewhere in the low-teens. Ask 'em about Omniture, though, and most people on Wall Street expect to see annual growth upwards of 24%.

Foolish takeaway
Now, what happens if you take Adobe's copious free cash flows, and marry them to Omniture's ability to juice growth prospects? I submit you wind up with a company selling for roughly 15 times its combined annual free cash flow, and growing in the mid-teens. Account for the fact that Adobe has positive net cash even after the Omniture acquisition, and the company looks even better.

To me, that's not a screaming bargain. But it does appear value-priced.

Long story short, between the reasonable-seeming valuation and the endorsement by a star software analyst like Baird, I'm willing to give this upgrade the benefit of the doubt. Adobe's worth a look.