A quote widely attributed to famed investor Benjamin Graham calls the market a voting machine in the short term and a weighing machine in the long term. Put simply, stocks often trade based on popularity rather than fundamentals in the short term, but in the long run, the most successful companies with the best results rise to the top.
Adobe (ADBE -0.77%) stock has been slaughtered this year, falling more than 50%. Part of this is the result of the excessive tech valuations in 2021, part is the weakening economy, and now the acquisition of Figma has soured investors even more.
The voting machine spoke loud and clear; however, when it comes to high-quality companies, buying when everyone else is selling is often a profitable long-term strategy.
What's the deal with the Figma acquisition?
Figma is a user interface tool designers and developers of digital products use to collaborate efficiently and effectively. Projects are shared and changes are saved automatically to the cloud. Figma has become a favorite and is used by well-known software companies like Airbnb, Uber Technologies, and Microsoft, along with smaller companies and independent developers. Its popularity persuaded Adobe to make the offer.
And what an offer it is! Adobe has agreed to pay $20 billion, 50 times the expected annual recurring revenue of Figma at the end of fiscal 2022. This is tremendously expensive, and many analysts have panned it. Did Adobe overpay? Maybe. But here's why.
- Established companies need to stay on the cutting edge. Sometimes it's more efficient to buy successful start-ups than to spend billions doing the research and development themselves.
- Figma is a competing product. Bringing it into Adobe's ecosystem adds revenue and reduces attrition.
- Revenue at Figma is growing 100% annually right now, the gross margin is an incredible 90%, and the company is cash flow positive.
- Adobe's resources and vast customer base could supercharge Figma's growth.
What looks like a ridiculous price today could look like a genuine bargain several years down the road.
How will Adobe pay the $20 billion?
The deal calls for $10 billion to be paid in cash and $10 billion in stock. Adobe has about $5.7 billion in cash and investments on hand and generated $1.7 billion in cash from operations in the third quarter of fiscal 2022, which ended Sept. 2. The deal is expected to close in 2023, so the cash should not be an issue. If necessary, Adobe shouldn't have any problem obtaining a short-term loan.
The stock portion is paid by issuing shares, which will dilute existing shareholders. That $10 billion is about 7% of Adobe's current market cap. However, Adobe repurchased 5.1 million shares for $1.2 billion in Q3 alone, so shareholders are not hung out to dry here.
Why Adobe; why now?
The market reaction to the Figma price has actually saved investors money if they start accumulating Adobe stock now.
As shown below, the nosedive trimmed more than the $20 billion price tag from Adobe's market cap in the last five days.
ADBE Market Cap data by YCharts
Adobe is exceptionally profitable with an operating margin of 35% this fiscal year because of its unique must-have products like Photoshop, Illustrator, and Creative Cloud. Adding Figma will further solidify this dominance -- albeit at a high cost.
Adobe's price-to-earnings (P/E) ratio has fallen to its lowest level in five years, as shown below.
ADBE PE Ratio data by YCharts
This doesn't mean everything is rosy. The company still needs to navigate through the current inflationary environment, which threatens to send the economy into a recession. Because of this and other risks, it is always vital that investors use dollar-cost averaging or different risk-reducing strategies and prepare in case the stock falls further. Nailing the exact bottom isn't easy.
It's always darkest before dawn. And darkness has descended on Adobe's stock price. Now could be the time for long-term investors to accumulate shares in this beaten-down tech giant.
