Adobe Acquisition Of Figma – Post Mortem Analysis

Adobe Acquisition Of Figma – Post Mortem Analysis

It is over a month since Adobe acquired Figma for $20 billion. A lot has happened since then, with the probability of a potential recession increasing every day, valuations of technology firms coming down, and the multiples for M&A drastically coming down. In this post, I do a post-mortem analysis of Adobe’s acquisition of Figma by considering the market’s reaction to Adobe’s stock and customer feedback on this transaction.

Adobe and Figma – Business Overview

Adobe is a software company providing digital marketing and media solutions. It operates in three segments:

• Digital Media offers creative cloud services.
• Digital Experience offers products such as analytics, social marketing and targeting.
• Publishing and Advertising combine legacy products/services for eLearning solutions and technical document publishing.

As of September 2022, the revenues contributed by the above segments are as follows:

Adobe’s market cap as of yesterday is $137 billion. After the deal announcement, its share price has taken a 25% hit from $394 on September 15th to $294.

Valuation metrics for Adobe are as follows:

EV/ARR = 7.7x

EV/Forward Revenue = 6.8x

Revenue Growth rate = 12.7%

Gross margin = 88%

LTM FCF Margin = 40.2%

When I compare the valuation metrics above with other cloud companies, Adobe trades at higher multiples than median companies. Its gross margin and cash-generating capacity are the best among its peers; however, what Adobe lacks among its peers is a low growth rate.

Adobe faces the following challenges:

• Its products –  Adobe Photoshop and Adobe Illustrator are not the favourites among its users. Users complain that Adobe’s products are difficult to use and lack the collaboration tools that Figma and other tools offer.
• Adobe has not adapted rapidly to the high demand for cloud services, and this delay has impacted its new subscription sales connected to the creative cloud service.

Overall, Adobe has growth issues and is losing market share against companies like Figma, offering better collaboration tools.

Figma Overview

Figma is a design platform that helps teams collaborate and develop projects together. The company, founded in 2012 by Dylan Field and Evan Wallace, is headquartered in San Francisco. Figma’s strength lies in its features that make the design process faster, more efficient and more stimulating than other design platforms. In addition, more UI/UX designers used Figma as it comes with new browser design products with a free trial basis that millions of designers globally can access. As a result, Figma expanded its TAM from enterprise to students/designers resulting in a potential threat to Adobe, the leader in digital software.

Figma’s rise even surprised Silicon Valley executives. Figma’s valuation in 2018 was $115 million; in 2019, its valuation jumped to $10 billion when it raised an additional $200 million in financing. At the same time, other tech companies’ valuations declined. Figma’s exponential rise in valuation was due to high growth in Figma’s customer base, especially during the pandemic when remote work was prevalent. Figma penetrated new markets that leaders like Adobe have never addressed.

Industry Analysis

Adobe and Figma are critical players operating in software development, maintenance and publication businesses in the software industry. We can divide this industry into the following segments:

• Programming Services
• System Services
• Open Source
• SaaS

Programming and System services were the most significant growing segments traditionally. Adobe was the leader here. However, the growth rate has recently declined in the above segments, whereas Open Source and SaaS are experiencing rapid growth due to their collaboration features. Open Source software helps developers access and modify an existing code and then redistribute it to the cloud for better reusability. The demand for SaaS has exploded due to the advent of cloud computing.

Regarding the leading players in the Product and Design stack, Figma leads the designer stack and is at the top in the product manager stack. Figma’s leadership position reflects its dominance in the SaaS business, while only a few of Adobe’s products fall under the SaaS domain.

A recent customer interview indicates that Adobe XD is no longer a substitute for Figma because Figma is more of a designer tool. Thus, Figma has replaced Adobe XD as more Adobe users move towards Figma.

The leading enterprise software firms like Microsoft, SAP and Oracle are also moving towards SaaS business models because SaaS now constitutes 33% of the software market and is expected to grow at 11% CAGR for the next five years. However, as enterprise software companies still have legacy issues and difficulties adapting quickly to the SaaS business model, they have resorted to acquisitions. For example, in 2021, Oracle offered $28.3 billion to acquire Cerner; however, the regulators didn’t approve this deal. Similarly, IBM acquired Redhat for $34 billion to boost its presence in the hybrid cloud market.

Deal Valuation

Now that we understand the strategic rationale behind Adobe wanting to acquire Figma let us look at the price that Adobe offered. In an M&A deal, valuation is subjective and depends on the buyer. There are instances where the target’s intrinsic value is less than the purchase price, and the buyer justifies it by synergies and how it is the best owner of the combined firm.

Figma’s sales projections for 2022 are $400 million

Purchase price = 20 billion

EV/Forward ARR = 50x

When we compare EV/Fwd.ARR against other software companies, the median multiple is 4.4x.

Snowflake, which trades at 23.7 EV/Fwd.ARR’s revenue growth rate of 82.7% and gross margin of 65% is a proper comparison to Figma. Further, the revenue multiples for software companies have come down in the last month due to the fear of recession.

Considering the economic slowdown and the challenges for Figma in monetizing its customers, as most of its clients still operate on a free trial, it is challenging for Adobe to justify this high price.

Adobe will pay $10 billion in cash and $10 billion in stock. The stock price arrived at the average closing price of Adobe stock of 10 trading days ending on September 10th 2022. Further, Adobe will deposit $65 million in escrow for any indemnification, post-closing purchase price adjustments and other liabilities. Figma’s shareholders will receive 6 million Adobe’s RSU following the transaction’s closing. Adobe will do a share buyback to prevent any dilution of additional share issuances for this transaction.

Closing Conditions: 

1. Figma’s shareholders must vote for this transaction.
2. NASDAQ must approve Adobe’s additional RSU issuances as consideration to Figma shareholders.
3. This transaction must get approval under the Hart-Scott Rodino Antitrust act.
4. Dylan Field, CEO of Figma, must continue as Figma’s employee at closing.
5. All the existing stockholder agreements of Figma must terminate.
6. Absence of any material adverse effect concerning Adobe/Figma on/after the announcement but before closing.

Further, if the regulators do not approve this transaction, but if other closing conditions are satisfied, Adobe must pay $1 billion in cash as a reverse termination fee to Figma’s shareholders. The W&I insurance covers reps and warranties with indemnification limited to $40 million, except for fundamental reps.

Final Thoughts

Despite the market shifting towards the SaaS model and the increasing need for collaboration, does Figma deserve a $20 billion price?

In my view, it is not, but Adobe must have thought about this deal, and if they are paying a high price, it is for other reasons.

A part of the premium is for the revenue synergies when Adobe integrates Figma’s products into its service offerings. Figjam (Figma’s best offerings) will drive revenue synergies in the shorter term.

Another reason for this overpayment is that Adobe wants to kill the competition quickly. Figma is a direct competitor to Adobe XD. Many Adobe users are swiftly shifting to Figma partly because it operates as a freemium model and because you don’t need a license. Thus, Adobe’s profitable products like Photoshop have got impacted due to Figma.

This type of merger is prevalent in pharma industries where the buyer acquires the seller to decimate the target’s threat. However, this type of merger is rare in the technology sector. In tech M&A, the buyer acquires a target to take advantage of its capabilities.

As Adobe was unable to change its pricing, nor was it able to develop a strategy to compete against Figma, it had no alternative but to acquire it. Further, Figma was in the process of going public, and competitors like Microsoft approached Figma for acquisition. Thus, there was also time pressure for Adobe to react quickly and consummate this deal.

Though the market reacted negatively to this deal partly because of the high price and partly due to the threat of recession, there was a sell-off of Adobe’s stock. However, looking at this deal from a long-term perspective, especially where you are killing your primary competition, this deal looks rational. However, there is a risk of this deal not getting approved by the regulators as killing competition implies Adobe will charge a higher price for its products.