Dissecting Adobe’s dumb deal

The defining technology merger of 1998 was Microsoft’s purchase of Compu-Global-Hyper-Mega-Net, Homer Simpson’s internet start-up, for an undisclosed price. Though Bill Gates conceded he had no idea what the company did, he would rather it didn’t. And, on agreement being reached, Microsoft goons immediately broke all Homer’s stuff.

This is sort of funny because it’s sort of true. Between 2015 and 2016 the big-five US tech companies (Microsoft, Apple, Amazon, Google and Facebook) bought 175 companies and shut down most of them, a 2020 paper from Axel Gautier and Joe Lamesch found.

Nevertheless, the so-called killer merger — a company taking out a rival solely to extinguish its threat — seems a lot rarer in tech than in industries such as pharma. Of all 175 acquisitions, Gautier and Lamesch classify just one, Facebook’s 2016 purchase of selfie-filter maker Masquerade, as a “killer” deal. The big five mostly stripped their acquisitions for parts, and used those parts to reinforce their existing products. M&A has been a substitute for R&D.

All of this is relevant again because Adobe on Thursday agreed to buy Figma for $20bn. Privately owned Figma makes a collaborative-design-workspace thing that’s in direct competition with Adobe’s XD. Advertising agency types talk at length about differences in user experience, but to an inexpert eye the two software packages look almost identical.

The big difference is that Figma is free for individual users. Adopting a try-before-you-buy model has allowed product teams to experiment with Figma without sign-off from an IT purchasing manager, which has allowed it to creep into the operations of important Adobe customers, including, most notably, Microsoft. CNBC.com last month ran this excellently timed profile:

The product has since become so central to how Microsoft’s designers do their jobs that Jon Friedman, corporate vice-president of design and research, said Figma is “like air and water for us.” . . . 

Figma had to start small. Like many organisations, Microsoft began using it for free. [Co-founder Dylan] Field says he remembers asking Friedman why Microsoft didn’t want to keep using the free version of Figma.

″’Look, we’re all worried you’re going to die as a company,” Field recalled Friedman telling him. “We can’t spread it inside Microsoft as a company even though we like it, because you’re not charging.”

Microsoft buying Figma was the widely predicted endgame. If Adobe was trying to block that outcome with its deal, it is paying a high price. The $20bn cost (half cash, half stock) is double the valuation from Figma’s June 2021 fundraise. It’s 50 times Figma’s reported $400mn of 2022 annual recurring revenue (ARR) and it values Figma employees at about $25mn each.

Here’s Mirabaud analyst Neil Campling:

The strategic decision appears to make sense — better to buy than build, and take out the disrupter before you get fully disrupted. However, a $20bn price tag smacks of a sense of desperation and clearly had to buy the company — before Microsoft did . . . Back of the envelope calculations suggest Adobe is paying c. 12 per cent of market cap for an additional 3 per cent of ARR.

Another problem: Figma is just one of many free alternatives that are necrotising Creative Cloud, Adobe’s cash cow software suite that includes Photoshop and Illustrator. In Adobe’s latest quarterly results, also announced Thursday, and the company predicts that next quarter’s net new ARR at Digital Media (mostly Creative Cloud) will be about $150mn below consensus expectations at just $550mn. That would continue a string of disappointments for Adobe’s Digital Media business, and management’s seasonality excuses have been wearing very thin.

Here’s how Morgan Stanley summarised the problem back in June:

We see a host of factors now pressuring Creative Cloud (CC) growth (at ~$11 billion, CC represents 83 per cent of Digital Media annual recurring revenue), including: 1) a maturation of the core Creative Professional segment of Creative Cloud, which we estimate represents $7-8 billion of the total, 2) increasing competition in the Communicator and Consumer segments from firms like Figma (Communicator) and Canva (Consumer), forcing Adobe to respond with new free and lower-end pricing tiers for their solutions, and 3) tougher compares post pandemic, particularly in Consumer, which looks to have been a significant growth driver through 2020 and into 2021. The longer-term durability of Consumer revenue at Adobe is yet to be tested, in our view.

Adobe’s purchase looks like a typical tech acquisition, in that it can fillet Figma’s best features and dispose of the husk. But it raises very big questions around strategy.

Turning Creative Cloud into a free-to-play product would be very messy for a company used to generating $7-8bn in annual free cash flow. However, without a radically different approach to pricing, Adobe’s competition problems will persist, and leave it with M&A whack-a-mole as its main defence. Is that the plan? Because at least with Compu-Global-Hyper-Mega-Net, Microsoft had a plan.