What happened
Shares of PDF pioneer Adobe Inc (ADBE -0.37%) got pummeled last week, falling 24% through Friday after announcing plans to acquire online design platform Figma at its $400 million in current-year revenues for $20 billion (i.e., 50 times sales).
The stock's continuing to slip in the new week as well, falling a further 1.7% through 12:05 p.m. ET as the cavalcade of negative analyst notes on the deal continues.
So what
In today's news, Wells Fargo and Edward Jones both downgraded shares of Adobe to "equal weight" and "hold," respectively, and the Figma acquisition placed front and center in their explanations for why.
"Adobe shocked the software world announcing its intent to acquire Figma for ~$20Bn," commented Wells. While acknowledging the "strategic fit" of the deal, the banker questioned the price Adobe is willing to pay to own Figma. Edward Jones agreed that the price represented a "significant premium."
So why did Adobe pay it? That's actually the more interesting part of these notes. According to Wells, the fact that Adobe would pay such an obviously excessive price is evidence that this was "a competitive process," i.e., there were other companies bidding against Adobe to own Figma. And if that's the case, then Adobe shareholders can anticipate "increasing competition on the digital media side of the business [will] only intensify."
Now what
Why is that a problem? Well, consider that last year as the economy started to pull out of its pandemic nosedive, Adobe's business soared 23% year over year. But over the first three quarters of this year, that sales-growth rate has been roughly halved to just 12%. Earnings growth, too, has been under pressure -- down 8% last year, and down again (albeit only a fraction of a percent) so far this year in comparison to 2021 as competition mounts.
While acquiring fast-growing Figma may help to goose Adobe's growth rate and give it an edge over rival software companies, the huge purchase price being paid -- equivalent to one-seventh of Adobe's own market capitalization and six times its price-to-sales (P/S) ratio -- is likely to take a toll on profitability. This could be especially true if, at some point in the future, Adobe is forced to admit it overpaid, and write down goodwill from the Figma transaction.
At the same time, the fact that Adobe felt compelled to pay this high price for a company that didn't even exist a decade ago illustrates the fast-changing nature of the software industry and the risk that whatever advantages Adobe may have bought for itself with its $20 billion may not last long.
