Adobe (ADBE 0.89%) recently announced solid quarterly earnings results that met management's forecast. The software giant also affirmed a bullish full-year outlook that calls for strong sales and earnings gains through late 2022. But the stock still fell hard immediately following the report, which also included the surprise announcement that Adobe is making a significant acquisition.
Let's examine why Adobe has decided to shell out $20 billion for Figma, a web-based collaborative design platform, and whether the market's harsh response to this news was warranted.
Slowing growth
The main benefit a Figma acquisition brings is another growth avenue. The collaborative work and design platform is positioned in an attractive niche that could grow to around $16 billion in annual revenue by 2025. Adobe expects the deal to boost its subscription-based revenue by $200 million this year before reaching an annual pace of $400 million by early 2023. "The combined company," executives said in a press release, "will have a massive, fast-growing market opportunity."
That's good news because growth in Adobe's core business has been slowing. Sales rose 15% in the most recent quarter after adjusting for currency exchange rate shifts. Investors had seen over 20% year-over-year gains in earlier phases of the pandemic.
Solid profitability
Figma's financials are fairly impressive, too. It is cash-flow positive and boasts a roughly 90% gross profit margin. Furthermore, its customers are eagerly renewing their contracts and adding more services. As a result, Figma's 150% net dollar retention rate is among the best in the industry, according to Adobe.
Adobe is excited about the benefits it could accrue by cross-promoting these complementary services. The company has been looking for ways to extend its cloud platform deeper into the web. This acquisition will achieve that goal faster than it could have managed through organic product development.
The price was right
Adobe isn't going into debt to fund this purchase, either. It held roughly $8 billion in cash on its books in early September and is generating nearly $2 billion in operating cash flow each quarter. Those factors will make it easy for Adobe to shell out roughly $10 billion in cash for the purchase. The remainder of the $20 billion will be paid in stock.
It will likely be several years before Figma starts boosting Adobe's annual earnings, even if sales growth will accelerate almost immediately. Acquisitions of this size often bring unpleasant surprises as companies try to integrate large operations into their established corporate structure. Okta, for example, is reeling due to unanticipated costs and logistical challenges from its 2021 purchase of Auth0.
If Adobe can avoid those types of issues, then the buyout should deliver solid returns for investors. It will give the company a bigger platform and deeper reach into attractive hybrid-work niches. And owning Figma next year will speed its annual sales growth again, just as it was dipping to nearly 10%.
The $20 billion price tag might seem high at first blush, especially with economic growth slowing and a recession potentially on the way. But the purchase indicates that Adobe's management sees a long runway ahead for growth in the digital creative sector. It shows that the company is willing to make bold bets to position itself to continue leading in that space.
