Trade Recap ADBE: Sometimes When I Say “Low Conviction” I Should Probably Sit On My Hands

by Dan December 16, 2011 9:53 am • Commentary

Trade Recap Dec 16th, 2011:  ADBE reported their fiscal Q3 last night and beat expectations, while their Q4 guide was mixed to lower.  Expectations weren’t exactly high running into the print and without a significant downgrade to expectations the stock is trading higher by almost 9% exceeding the imp0lied move.  Nothing really stood out to me yesterday in the name prior to earnings and in with little conviction as stated in my post (read here) I bought a Dec Put Fly in the name to play for a slightly outsized move to the downside following the report.  With just 6hrs to expiration this position will be a total loser (barring any big reversal in the market).

For those who watch my trading closely I ask that you go back and re-read the ADBE post from yesterday.  It is important to me that we focus as much attention on losers as we do on winners in an attempt to learn from the losers.   As it relates to ADBE, I think it is fairly clearly stated that I didn’t have strong conviction to the short side but that is the way I would lean with a gun to my head.  I think it is also important to remember that position sizing is key to this whole game in and with an eye towards capital preservation.  Here is a situation where I wanted to play but without a lot of conviction I stuck to a low premium structure in an effort to define my risk.  I think it is also safe to say that when I lack conviction I do not commit the same amount of capital that I would to something that I am really geeked up about.  Trust me if you do this consistently you will be pleasantly surprised that total losers on low conviction ideas will not ruin your day, unless your trading book is littered with them and then in that case you should probably liquidated and stop trading for a bit.

 

Original Post Dec 15th 2011:

ADBE reports their Fiscal Q4 earnings tonight and the options market is implying about a 6% vs the 4 qtr of about 4.5%.

-The stock is currently down 13% ytd, under-performing it’s large cap software peers MSFT and ORCL down 5.5% and 7.5% respectively ytd.

-The street is fairly mixed on the name with 13 Buys, 11 Holds and 4 Sells with an avg 12 month price target of about $31.50, while short interest is a tad below 4% of the float.

-current valuation doesn’t appear aggressive at about 11x next year’s consensus earnings estimates (which is fairly cheap on a historical basis), but with eps and revenue only expected to be high single digits the shares aren’t fetching bargain basement prices either.

Here is a quick roundup of some previews from three analysts, one who rates the stock a Sell, one a Hold and one a Buy:

Goldman Sachs, who rates ADBE a SELL had the following to say in a note to clients Dec 13th, 2011:

Adobe will report 4QFY2011 results on December 15 after the close. We are modeling revenue of $1,076 mn and non-GAAP EPS of $0.59 vs. consensus of $1,087 mn and $0.60 and vs. guidance of $1,075-$1,125 mn and $0.57-$0.64. All in, we expect results towards the low end of the revenue range, as our field checks suggest weakness in Europe is still a challenge with sales trending slightly better in the U.S.

Expecting 1QFY2012 guide below the Street – Assuming 4QFY2011 sales are at the low end of the range, we see 1QFY2012 top-line guidance of $1.01-$1.06 bn vs. our estimate of $1.03 bn and consensus of $1.05 bn. Included in our estimate and expectations for guidance are about $40 mn in lost sales from exited businesses and a $10 mn qoq F/X headwind. As for FY2012, we would expect management to reiterate the guidance of topline growth of 4%-6% it originally offered at the November analyst day.

Morgan Stanley, who rates the stock a Neutral had the following to say in a note to clients on Dec 13th:

We remain constructive on the long-term prospects for ADBE, as the co. benefits from the focus on Digital Media / Marketing while investments in HTML5 look promising. Our Q4 checks indicated that CS5.5 demand is tracking largely at plan in the US, with some modest pull forward due to changes in CS upgrade pricing. However, our EMEA checks showed some signs of softness, Enterprise sounds like it may still be under pressure, and the Q4 rev. guide is a fairly high bar (8.6% QoQ vs. 5 yr. avg. of 6.7%). Expects are low for Q4, and the stock has shrugged off mixed results in the last couple of Qs, but we’d like to see more evidence of transitions gelling to buy the stock

Citi, who rates the stock a Buy had the following to say in a note to clients on Dec 12th:

Expecting limited upside to Q4 — Fundamental inputs suggest company is likely to report results at low-end of guidance and revenue inline with our $1.08B (street $1.09B), while a focus on costs should drive EPS of $0.61 (street $0.60). Tepid results from our VAR reseller results, modest FX headwinds and re-alignment of enterprise priorities will make any upside appear difficult.

View of shares — Shares are at trough valuation but admittedly without a catalyst until
the ramp of CS6 and Creative Cloud adoption becomes more clear (Spring 2012).
Medium term, greater annuity revenue contribution, increased volumes and richness of
online content creation and the complexity of publishing and monetizing this content
are likely to drive high single digit growth, which is not in the stock in our view.

My take and trade idea:

MY TAKE: The stock is basically in the mid point of the range this year that saw highs about 25% from current levels and lows about 20% below.  There are plenty of headwinds for the company near-term, the largest likely being that almost 1/3 of their revenues come from Europe and the middle east, but make no mistake about it their concession to back in November to abandon their Flash technology for mobile computing in place a HTML5 which has been heralded by AAPL has clearly hurt sentiment towards the company’s products and by investors of the stock.

As you read through the excerpts of the previews by a Buy, Hold and Sell it becomes apparent that expectations are not particularly high heading into tonight’s print.  I guess my sense is that anything less than a beat and raise and the stock likely goes no where….but if the company were to guide down for Fiscal 2012 the stock could see some downside to $24.00 or so.

I don’t have a ton of conviction here, but I will say that in this market stocks are clearly reacting stronger to negative news than they are to positive news…..So I would much rather play for an out-sized move to the short side by defining my risk with as low premium structure.

MY TRADE: ADBE $26.65 Bought the DEC 26/24/22 Put Fly for .39

-Bought 1 Dec 26 Put for .61

-Sold 2 Dec 24 Puts for a total of .24 (.12 each)

-Bought 1 Dec 22 Put for .02

Break-Even on Dec Expiration (tomorrow):

Profits btwn 25.61 and 24 make up to 1.61, profit trails off from 24 to 22.39, but max gain at 24 make full 1.61

Lose up to .39 btwn 25.61 and 26.00 and btwn 22 and 22.39 with max loss of .39 with stock below 22 or above 26.

I DON’T HAVE STRONG CONVICTION, WHICH IS WHY I USED THE FLY, BUT I WOULD MUCH RATHER LEAN SHORT THAN LONG.