Adobe (ADBE 1.78%) has been among the best and most consistently performing software investments over the past decade. However, investors' confidence in the company's management was shaken after it announced its plans for a $20 billion acquisition of Figma in September. Shares sank by 17%.
Since then, the stock has recovered some of those losses. But after news broke last week that the Department of Justice is planning on filing a lawsuit objecting to this acquisition, the stock fell another 8%.
This challenge shouldn't surprise investors, but it has left many wondering what they should do with the stock.
Both sides of the acquisition argument seem to have left the stock
What makes zero sense about the stock movement is that it was sold off on both pieces of news. If the stock fell on news of the acquisition, it would make sense for it to rise based on regulatory opposition to the move. But it fell both times. Both events occurred on some of the top days for Adobe's trading volume over the past six months, so these moves weren't driven by relatively small numbers of traders either.
This makes me believe that both those who favor the deal and those who don't have left the stock, leaving the door open for long-term investors to scoop up Adobe at a cheap valuation: Its price-to-free-cash-flow ratio is near its lowest point in a decade, since it switched to a software-as-a-service (SaaS) business model. And the pessimism here likely isn't warranted. Adobe's more recent financial results were quite strong.
ADBE Price to Free Cash Flow data by YCharts.
Adobe's free cash flow use will change depending on the acquisition result
In its fiscal 2022 fourth quarter, which ended Dec. 2, Adobe grew revenue 10% year over year to $4.53 billion. Management also issued relatively strong guidance, forecasting that revenue would grow by about 9% in fiscal 2023 despite a challenging economic backdrop. Management's guidance didn't include any addition from Figma, so if that deal gets approved, it will only add to its growth.
Free cash flow also continued to march higher in Q4, continuing a trend that has helped make Adobe a top stock pick over the past decade.
ADBE Free Cash Flow (Quarterly) data by YCharts.
Adobe produced an outstanding $7.4 billion in free cash flow in fiscal 2022. If it kept that up, it could digest the Figma acquisition in under three years, assuming it devoted all of its cash flow to doing so. In the meantime, Adobe continues repurchasing shares with its free cash flow -- $1.75 billion worth during fiscal Q4 alone. Since Adobe embarked on its stock buyback campaign in 2016, it has reduced its share count by 8.6%, but the Figma acquisition threatens to undo that.
This was one of the primary reason investors were upset about the deal in the first place: The number of shares Adobe would need to issue to fund the purchase would wipe out all of its stock repurchases over the past five years. If this deal doesn't go through, Adobe could continue repurchasing stock at its current pace.
Conversely, growth investors may be excited about Adobe acquiring Figma as it would add a dynamic growth arm to its slow but steadily growing business. They couldn't care less about the outstanding shares if it means greater growth.
I think Adobe will still be a top-tier company regardless of whether or not the acquisition goes through. But now that the stock has been punished by pessimism from both sides, you can take advantage and pick up shares at a historically cheap valuation.
