Last week, Adobe (ADBE) announced its plans to buy cloud-based design platform Figma for about $20 billion – its biggest ever acquisition to date. However, the news did not go down well with the investors as they were disappointed with the hefty price paid by the tech giant for a smaller rival. Adobe’s shares fell 17% after the announcement, wiping off $29 billion from its market capitalisation.

What makes Figma deal pricey?

Adobe, one of the most acquisitive companies in the tech space, is known for buying out its competition. In 2018, Adobe purchased marketing software maker Marketo for $4.75 billion, its most expensive purchase prior to Figma. However, the $20 billion Figma deal has raised a million eyebrows. 

In a funding round last year, Figma was valued at $10 billion only. While Figma’s annual recurring revenue is estimated to exceed $400 million in 2022, Adobe is paying 50 times of that. The Photoshop-owner will pay one half of the price in cash and the other half in stock. Investors may also be worried about share dilution. It is because approximately 6 million additional restricted stock units (on top of the $20 billion purchase price) will be granted to Figma’s CEO and employees that will vest over four years subsequent to closing.

Exhibit 1: Adobe’s billion-dollar acquisitions so far

Source: Company Press Releases

Strategy behind Figma acquisition

On Figma, designers can share projects and collaborate efficiently as changes are saved to the cloud automatically. Besides small firms and independent developers, big techs like Microsoft (MSFT), Uber Technologies (UBER) and Airbnb (ABNB) use Figma. While Adobe is the king of content designing tools, it aims to gain access to new-age programmers and content creators and expand its user base by adding Figma to its army of innovative offerings, specialising in the cloud.

In its defence, Adobe said Figma has gross profit margins of nearly 90% with positive operating cash flow. Additionally, Figma’s total addressable market is expected to reach $16.5 billion by 2025. Adobe expects the acquisition to be earnings accretive three years after the deal is completed. By buying a successful business like Figma, Adobe will not just kill the competitive threat but also save itself billions of funds that it would have to spend developing a similar product.

It is quite natural to compare Adobe’s Figma deal with that of Microsoft’s $26 billion acquisition of LinkedIn in 2016, where Microsoft left the social media company to be run independently by LinkedIn’s then CEO Jeff Weiner. By retaining Figma’s co-founder and CEO, Dylan Field, the PDF inventor is likely trying to replicate the success model of LinkedIn. 

While the transaction is expected to close in 2023, it is highly likely to invite strong regulatory scrutiny as Figma and Adobe are direct competitors to each other. Even though Figma will continue to be available as an independent product under Adobe, the deal kills the competitive threat and limits customer choice, and that is what worries the regulators.

Adobe reports record revenues in the third quarter

For the three months ended 2 September, Adobe reported record revenue of $4.43 billion, up 13% from a year ago. In the fourth quarter, Adobe expects to generate total revenue of $4.52 billion. However, in the short-term, the company’s overseas sales face headwinds from a strengthening greenback as the U.S. dollar index nears a 20-year high. As a result, the company’s quarterly net income declined over 6% to $1.14 billion in the most recent quarter. Even though Adobe’s third-quarter earnings could not live up to the expectations of Wall Street, adjusted earnings per share at $3.40 were up 9% year-on-year.

Exhibit 2: Adobe’s 3Q2022 revenue by segment

Source: Company Financials, September 2022

Adobe: tech giant with strong fundamentals 

Adobe is a company that boasts of strong fundamentals. Its subscription-based model contributes over 90% to Adobe’s total revenue, ensuring consistent cash flows. Moreover, its flagship offerings like Photoshop, Illustrator and Acrobat, among others, enjoy a clear competitive edge over others in terms of their strength and scale. According to FactSet Research, Adobe’s free cash flow margins are expected to remain steady at about 42% through 2025 and are among the top 5% of all global companies. Net margins are also likely to hover around 37% through 2024.

Has Adobe stock bottomed?

Timing the stock bottom with absolute certainty is quite impossible. As Adobe stock is down almost 50% so far this year, it seems like an opportune time for long-term investors to accumulate shares of this battered tech giant. The stock is currently trading around 20 times forward earnings – its cheapest in nearly a decade – and below the 10-year average of 33. 

Thanks to the unparalleled popularity of Adobe’s product offerings and effective management, the company should be able to navigate the troubled macroeconomic environment in the near term. Here are analyst ratings suggesting brokerages are bullish on the company’s strong fundamentals.

Exhibit 3: Analyst ratings on Adobe stock

Source: marketbeat.com, Data as of 22 September, 2022