Adobe's slowing sales and sinking share price resulted in its rival Quark, producer of publishing software Quark Xpress, attempting last week to acquire Adobe for an unstated premium over the current share price.
Adobe rejected the approach, saying that it was not in the interest of its customers. This was largely based on Quark's statement that, if it bought its rival, it would divest the flagship Adobe Pagemaker product to avoid antitrust problems.
Quark's next step was to threaten a hostile bid to shareholders if Adobe did not reconsider the offer. The company - at around $100 million net income considerably smaller than its prey - told 'VNU Newswire' that it suspected that Adobe's board was having additional discussions.
But Adobe insists it wants to rely on its own turnaround programme for recovery, rather than a takeover. It had previously put in place a 'poison pill' mechanism that would make it very expensive for any company to acquire more than 20 per cent of its shares. This action pushed Adobe shares up 13 per cent, which suggests that Wall Street is sceptical about the likelihood of an acquisition succeeding, since a 30 per cent premium would have been expected.
A difficulty for Adobe is that the board has a fiduciary obligation to obtain the best results for shareholders, and should Adobe's future performance not exceed the specific terms of any offer from Quark, the possibility of a shareholder suit increases.
Adobe's woes came to the fore earlier in August when it said it expected to announce at best break even results or a small third quarter loss - described as "unacceptable" by co-founder John Warnock. Revenue was expected to be in the $220 to $225 million range.
Charles Geschke, the other co-founder, said that in Q3, Japanese sales were expected to drop 40 per cent or $25 million.
Adobe probably chose to use the anticipated disappointing quarter as the reason for a cost reduction exercise. A terse announcement noted that three executive vice presidents had resigned, the operational divisions were being reorganised, and that the workforce of 2,700 was being reduced by 240 to 300 people. The saving is expected to be $50 to $60 million, or eight to 10 per cent of revenue.
Warnock is clearly determined to turn Adobe's fortunes, and is giving up his three external directorships to devote all his time to the company. Warnock and Geschke (both were at the Xerox Parc lab and founded Adobe in 1982) will continue as co-chairmen, with Warnock looking after day-to-day issues and Geschke concentrating on external relationships.
Alasdair Boyle, Adobe's managing director UK, told 'Newswire': "A substantial part of Adobe's revenue comes from new products that are brought to the market, and from sales of new versions of existing products - upgrade sales. In Q3 we did not have a substantial new version upgrade. We have just announced that we will be shipping Illustrator 8 in Q4. If people take a very short term view, you can get distortions."
With revenue of $787 million in 1996 and $912 million in 1997, the current fiscal year should have seen Adobe become a billion dollar a year company, but that milestone will probably not be reached this year. With flat income for the first three quarters of 1998, Adobe can take some comfort from its $400 million in cash and short term investments.
In 1994, Adobe acquired Aldus, followed in 1995 by Ceneca Communications and Frame Technology - the latter acquisition proving to be less successful.
Adobe developed a novel investment strategy in 1994 by setting up venture capital partnerships managed by Hambrecht & Quist. Adobe laid down the condition that the investments should be in software sectors strategically aligned with Adobe. The advantage, Warnock says, is that this allows Adobe to "keep a very good finger on the pulse of innovation".
In some cases, Adobe's business has benefited directly - for example, Electronic Submission Publishing Systems, funded by Adobe, uses Acrobat for the pharmaceutical market.
In other cases, the opposite is true: although Adobe invested $17 million in Netscape's shares in April 1995 - four months before it went public - Netscape adopted the rival Bitstream technology. Adobe Ventures has increased Adobe's revenues by 10 to 15 per cent a year since the funding programme was started, yielding a profit of more than $100 million.
When Adobe decided to pass some of the dividends to its shareholders, Wall Street was critical. Warnock expresses his frustration, saying: "We've made a ton of money, but the Street gives us no credit for it because they view it as non-repeatable income."
As a consequence, Adobe used its income to repurchase three million of its own in Q1, which has Street approval - except that this has turned out to be a poor investment as the share price recently reached a 12-month low, and has halved in the last six months.
Adobe is not a favourite of Wall Street financial analysts. Mary McCaffey of BT Alex Brown criticises Adobe for not responding to the Internet and marketplace sufficiently quickly. Boyle retorts that "financial analysts are not in the microcomputer software business" and that their response to news often appears to be irrational.
Postscript, Adobe's key technology for desktop publishing, was launched in 1985 (1989 in the important Japanese market), and became the standard industry imaging model for electronic documents. It was extended in 1993 to enable the electronic delivery of documents in Acrobat format, to preserve the typefaces and graphics.
So far as relations with Microsoft were concerned, Boyle told 'Newswire' that "there are some areas in which we compete, but by and large in terms of professional publishing, graphics publishing, and digital image manipulation Microsoft allow us that we are the market leaders there."
However, a warning in an Adobe document filed with the US Securities and Exchange Commission tells of Adobe's concern for the future: "Microsoft Corporation has stated its intention to increase its presence in the digital imaging/graphics market by mid-1999."
Ten years ago, Microsoft had wanted to incorporate Adobe's font technology in Windows, without Adobe receiving any royalties. Adobe declined the invitation. Adobe subsequently found that when its fonts ran under Windows they would only run at half the speed of the Truetype fonts used by Microsoft.
In a rare admission in 1991, Gates confessed that Microsoft had harmed Adobe: "Our entry into the printer software business has not succeeded... We overestimated the threat of Adobe as a competitor and ended up making them an enemy."
Boyle says that Adobe will continue in four product areas - professional publishing and graphics - its heritage; business publishing - aimed at large corporates that either do a lot of publishing in house or currently outsource it and are considering doing it inhouse; digital image manipulation, a market that he sees expanding very quickly, especially in the consumer area; and very high end publishing for major corporates - magazines, newspapers, working with Vars and systems integrators.
Last year, the Windows revenue stream overtook the Mac stream. Boyle rejects the canard that Adobe was slow to shift its focus from the Mac to Windows. "It was pretty obvious some considerable time ago that 90 per cent or more of the opportunity going forward would be in Windows. We rewrote Pagemaker eight years ago to run under Windows, so its not something that suddenly crept up behind us and caught us by surprise. All of Adobe's main products are on both platforms."
Macintosh software sales for Adobe were down 36 per cent in the first quarter compared with a year earlier, although Warnock said the Mac market created a viable revenue stream for Adobe. "Mac users are fiercely loyal. You will continue to see them upgrade," he observed.
He also pointed out that "If the Mac has any upside, it's just gravy for us."
Adobe faces the problem of needing to produce both low cost, scaled down consumer titles and fully featured products for the professional market. The low end of the market is fiercely competitive, but Boyle says that Adobe will not abandon it because of the halo effect: "It is important to us that if people coming in to the low end of the market and the educational end of the market very early on start to use Adobe entry level products, they are more likely to migrate upwards." Graphic artists tend to stick with the system they first used.
From time to time, Adobe is urged to combine its product lines, but although this strategy would suit retailers, it would undermine Adobe's efforts to attract Vars if the margin were reduced.
XML, the extensible markup language for Web authoring that offers greater flexibility than HTML, is being used by Adobe for the vector graphics format (precision graphics markup language, PGML) it proposed with IBM and Netscape in April. PGML is based on Postscript and PDF, and is going through the W3C accreditation process. However, the file compression needed has yet to be specified.
XML support will be built into future browsers, so that plug-ins will not be required. XML is an alternative to pixel-by-pixel definitions such as GIF and JPEG formats.
Because there is more upside potential in the enterprise market than the consumer market, Adobe is now keen to develop better licensing programmes for corporate customers, although it cautions that the strategic refocusing is expected to increase licensing revenue in the long term rather than immediately.
Because US copyright protection does not include fonts, Adobe has found that some companies have marketed minor variants of Adobe fonts. A current case against Southern Software may redefine the law however. Judge Ronald Whyte in the San Jose district court has said that intellectual property protection covers Adobe's font display software, even though the fonts themselves are not protected. However, as is so often the case in litigation, it will be too little too late, since only about four per cent of Adobe's revenue comes from fonts.
Late last year, HP began to ship non-Adobe clone software in some printers, which is resulting in lower licensing revenues to Adobe in fiscal 1998. Adobe anticipates that its licensing revenue in the remainder of fiscal 1998 will be below 1997 levels.
Some financial analysts consider that a more fundamental change is required than the cost cutting exercise that Adobe has put in place. Adobe's view is that new and updated products will lift its income. The new executive team, which reports to Warnock, is considered to be better aligned to Adobe's business strategy and long term growth.
According to Fred Snow, Adobe's executive vp of worldwide sales, Adobe is shifting its focus to high end publishing applications and midrange Internet applications. Quark was clearly concerned at this repositioning towards the higher end market, which Quark dominates at present.
Some companies ride the crest of the wave, and other companies, like Adobe, are the wave. Adobe has to prove that its wave has the power that its shareholders expect.
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