Shares of Adobe (ADBE -2.67%) cratered last week following the announcement of its $20 billion acquisition of design collaboration software firm Figma.
The price tag amounts to about 50 times Figma's projected 2022 sales. So at a time when many software-as-a-service (SaaS) stocks have seen their price-to-sales ratios cut in half or more, Wall Street analysts are almost uniformly negative on the deal, citing its high price. Adobe saw a slew of downgrades following the news.
But what if the acquisition isn't so overvalued? After all, Meta's acquisition of Instagram and Alphabet's acquisition of YouTube were also thought to be expensive at the time, yet both wound up being huge successes. Could Figma do the same for Adobe?
Why analysts hate the transaction
Adobe is buying Figma for $20 billion in cash and stock -- actually, closer to $22 billion, when factoring in the stock units granted to Figma co-founder and CEO Dylan Field and other Figma employees, which will vest over four years.
Skeptics think this is an astronomical price to pay for a company projected to make just $400 million in annualized recurring revenue (ARR) this year. The highest-valued software stock I can think of is Snowflake (SNOW -4.08%), which currently goes for 35 times sales. So the 55 times sales figure seems outlandish to many.
Some analysts fear Adobe could be overpaying for Figma as a defensive move. Figma designs web-based, multiplayer design software, which some think could have eventually become a real competitive threat to Adobe's dominant design software suite. Building collaborative software that can be accessed by multiple users requires a different architecture than software just delivered to one user, and apparently, Figma's platform is really resonating with designers. So some thought Adobe was motivated to pay an irrational price to acquire a powerful future competitor.
Why the acquisition could work -- potentially very well
While I'm not saying the acquisition was a steal, it's actually not that expensive when thinking about the synergies Figma can potentially achieve within Adobe.
First, Figma's growth rate is an eye-opening 100% year over year. That's about as good as you will find for any company at a $400 million run rate and exceeds Snowflake's recent quarterly growth rate of 83%. Figma's net retention rate -- or the amount existing customers spent relative to last year -- was 150%, which is also as good as one will find across the SaaS sector.
One key number that sticks out is Figma's 90% gross margin. Gross margin is important because since Adobe already has a global sales force, over time, Adobe should be able to rationalize Figma's sales team, either by cutting headcount or growing its own sales force more slowly in the coming years than it otherwise would have. I suspect Figma's research and development team will stick around, but again, this can be mitigated by Adobe hiring fewer engineers over the next couple of years.
Basically, Adobe may be able to either cut or rationalize all of Figma's operating expenses over time, which means Figma's 90% gross margin could actually be closer to its operating margin when positioned inside of Adobe.
Seen in that light, Adobe is really paying a multiple of post-synergy earnings. Assuming a 90% operating margin on $400 million of revenues with a 21% tax rate, Adobe is really paying closer to 70 to 77 times Figma's post-synergy earnings of around $285 million.
Would a growth investor pay 70 times earnings for a company growing earnings at a 100% clip? While not exactly a bargain, considering valuations for many publicly traded and unprofitable software companies, that actually looks almost downright cheap.
Adobe believes the transaction will be accretive to earnings per share starting in the third year after closing. Given Figma's growth and margin profile, that seems like a pretty plausible outcome.
An added bonus would be if the deal can generate meaningful revenue synergies as well, by which Adobe would sell more of its products to Figma's client base or accelerate Figma's already-impressive growth through its established sales channels.
Adobe's stock is now beginning to look interesting
Adobe had been an expensive stock over the past few years, but its P/E ratio has now fallen to below 30 -- the lowest level since 2013. Strikingly, Adobe's market cap has fallen by some $35 billion since the Figma announcement -- more than the $20 billion acquisition price!
For investors looking for growth at a reasonable price, they may want to look at Adobe's stock today. While the success of Figma isn't guaranteed, the possibility of this actually being a good acquisition, combined with Adobe's stock having fallen nearly 25% in a week, certainly has this investor's attention.
