Adobe Inc. (ADBE, Financial) stock has declined 48% this year, reaching lows not seen in nearly three years. The downward trend has a lot to do with the weakening economy and missing revenue projections in the fiscal third quarter, but it is also being driven in part by Adobe's intention to acquire Figma, a UI/UX design platform. Its goal with the acquisition is to control the entire digital creative process, but investors don't seem to be buying it.
Recent earnings results
On Sept. 15, Adobe announced financial results for its fiscal third quarter of 2022, beating bottom-line estimates but missing Wall Street predictions for revenue. The company reported record revenue of $4.43 billion, up 13% year-over-year. This was, however, the slowest growth the company reported since 2015.
The Digital Media segment, which includes the Creative and Document Clouds, accounted for 73% of Adobe's revenue, while the Digital Experience segment, which includes enterprise-oriented marketing, analytics and digital workflow services, accounted for 25% of revenue.
The slowdown in revenue growth was primarily because of slower enterprise spending and currency headwinds. The company expects the slowdown to continue and projects only 10% revenue growth in the fiscal fourth quarter compared to analyst expectations of 12% because of macro headwinds and the stronger U.S. dollar.
However, Adobe is not the only software company facing currency headwinds, and therefore, decelerating revenue growth was not as surprising to investors as the acquisition announcement for Figma was.
Investors were shaken by Adobe’s Figma bid
Adobe is expanding its presence in the creative economy to maintain its leadership position, and acquiring Figma does not appear to be a poor decision from that perspective.
The price of the acquisition seems to be the primary concern among investors. Adobe announced on Sept. 15 that it has agreed to pay $20 billion to acquire the design and collaboration software company. Investors were not pleased with the deal because the purchase price is 50 times the $400 million in annual recurring revenue Figma is expected to generate this year.
Although Figma has grown in popularity, it is still not highly profitable, which means that when the deal closes in 2023, Adobe's operating margins are likely to feel some pressure. Adobe anticipates paying $10 billion in cash and $10 billion in stock for the acquisition. The company currently has approximately $5.7 billion in cash and investments, which is offset by $4.13 billion in debt, and it generated $1.7 billion in cash from operations in the fiscal third quarter.
Adobe stated that it may need to finance this transaction with debt, which would put a strain on its balance sheet at a time when tech stocks are already reeling as a result of rising interest rates. The company will issue shares worth 7% of Adobe's current market capitalization to complete this transaction as well, resulting in notable dilution for existing shareholders.
Adobe's primary creative cloud products - Photoshop, Premiere Pro, After Effects and Lightroom - continue to be industry-standard photo, design and video production tools, and the company is attempting to break into the UX/UI design market with the release of Adobe XD. While Adobe XD has some unique features, Figma has gained popularity among designers due to its free services for individual designers as well as its effective collaboration tools. Well-known software companies such as Airbnb Inc. (ABNB, Financial), Uber Technologies Inc. (UBER, Financial) and Microsoft Corporation (MSFT, Financial) use Figma today.
Based on the reactions of designers in recent weeks, it seems reasonable to conclude that Figma is gaining traction faster than Adobe XD today. The most common reason stated by developers is that Figma is a web-based design platform that eliminates the need for cloud syncing and challenges related to transferring files between work and personal computers.
Adobe's thesis for acquiring Figma
As the threat of competition was increasing in recent years, Adobe's decision to add Figma to its ecosystem makes sense because it will get rid of a key competitor. This transaction could increase company revenue in the long run as designers will have one less solid free option (unless Adobe decides to keep a free option for Figma, which is extremely unlikely). Figma's net dollar retention rate currently exceeds 150%, and if all goes well, the platform could generate substantial growth in two to three years.
However, both companies face a significant challenge. Investors were not the only ones who reacted negatively to the announcement. Designers, who are the primary users of Figma, were also disappointed, and public forums on social media platforms were flooded with memes showing the challenges users incur with Adobe products and their concerns about the acquisition.
One Tweet by a user following the announcement emphasized how important it is for Adobe and Figma to follow up on how they integrate the software tools while keeping things simple. "I just hope the new interface would not be so complicated. I like how simplified Figma is."
The reaction of the design community, the high acquisition price and Adobe XD's inability to gain users raised investor concerns about whether Adobe's moat in design software is impenetrable and whether its innovative days are over. It is natural for a large company to become mature at a certain point in its journey. However, Adobe continues to make internal changes to make its products more user-friendly and to meet market demand. Adobe has effectively monopolized the creative and design markets, and it continues to dominate the filmography and photography segments as well.
Adobe has created an ecosystem that connects each of its creative cloud products, making work easier and more efficient, and this is difficult to replicate. However, this ecosystem comes at a cost: it puts the company on the radar of its customers and investors, waiting for the company to introduce innovative products consistently that are either unique or superior to its rivals. Furthermore, Adobe has received a lot of criticism for its integrated products, which cause work delays as they continue to run and update in the background. Users must frequently sync the files to upload them to the cloud, and collaborative work is another challenge.
The over-complexity of other options is one of the main reasons why Figma has become the platform of choice for UI/UX designers. The real-time collaboration tools offered by Figma are far more streamlined and powerful than those offered by Adobe XD. It is fast, simple to use and allows users to collaborate with others on the same project in real time, with projects automatically saved to the cloud. Since Figma is likely to help Adobe address the shortcomings in its existing product portfolio, this acquisition could create value for long-term-oriented shareholders, though hopefully not at the expense of Figma's quality.
Takeaway
Adobe remains a high-quality company, as well as one of the largest and most prominent software-as-a-service providers catering to the booming creator economy. The company contributes to the growth of this new market by meeting the needs of design professionals. Adobe has a track record of making smart acquisitions, and while the Figma acquisition is unlikely to generate shareholder value in the short run, I believe it is likely to strengthen Adobe's moat in the long run, despite the challenges.
