Before You Buy the Adobe Stock Dip, Take a Hard Look at Microsoft

Before You Buy the Adobe Stock Dip, Take a Hard Look at Microsoft

Both companies are trying to make blockbuster acquisitions, but one looks better positioned to do so.

Adobe ( ADBE -1.64%) is getting clobbered on Wall Street after announcing its intention to acquire Figma for $20 billion. While the deal gives Adobe access to a fast-growing digital creation and collaboration tool (and eliminates an up-and-coming competitor), the fact that it’s paying more than 50 times Figma’s expected 2022 revenue has some investors scratching their heads. Adobe’s stock price is down some 20% since the deal was announced Sept. 15.

Adobe is the team to beat in digital content creation and management tools, and many shareholders maintain it has an impregnable lead in its software department. Because of this, you might be tempted to buy the dip, but I say not so fast. Take a look at Microsoft ( MSFT -1.44%) first, which has a truly defensible business model in software technology. Two big price tags, but one may be an admission of weakness

I’m a happy Adobe shareholder, but the Figma acquisition has me asking hard questions. Paying such a hefty premium (50 times sales would have been eye-popping in high-flying 2021, but it is even more so in 2022’s bear market) seems like an admission of sorts from Adobe. Specifically, what many thought was an untouchable (and highly profitable) business that can play defense against upstart competitors might not actually be the case. Figma was clearly onto something in the digital collaboration space, and its rapid growth obviously had Adobe worried.

The biggest concern for me is how Adobe said it plans to pay for this deal: $10 billion in cash, $10 billion in new Adobe stock, plus some added ancillary payouts over the next few years to Figma’s founder and employees.

At the beginning of September 2022, Adobe reported having $5.76 billion in cash and investments, offset by $4.13 billion in debt. Basically, Adobe will have to finance the Figma buyout with more debt, which will flip its balance sheet from cash net of debt positive to negative. Plus $10 billion in new stock represents 7% of Adobe’s current market cap, which is a significant dilution to existing shareholders, all for a deal that will likely only increase Adobe’s total revenue by about 2% to 3% in the first year. In fact, that dilution will reverse all of the outstanding share count reduction (via stock buybacks) Adobe has made over the last five years! Basically, it will be many years before we know if buying Figma was a good idea because of the steep premium being paid right now.

While such a big deal is something new for Adobe, Microsoft is no stranger to massive acquisition proposals. It wants to buy video game studio Activision Blizzard ( ATVI 0.37%) for $68.7 billion in cash!

To be fair, there are flaws with Activision Blizzard as a company, and it’s hardly the growth business Figma is. However, what Microsoft gets for $68.7 billion is very different from what Adobe gets for $20 billion. In a good year, Activision Blizzard might haul in close to $9 billion in sales (like it did in 2021); in a bad year (2022), it will bring in close to $6 billion. Good year or bad, though, Activision Blizzard is profitable. It’s generated $1.93 billion in free cash flow over the last 12 months.

Not only is Microsoft buying a profitable asset that will greatly bolster its video game segment, but the acquisition price will be easy for the tech titan to digest. While $68.7 billion isn’t exactly pocket change, Microsoft reported $105 billion in cash and short-term investments on balance at the end of June 2022, offset by debt of $47 billion. Microsoft could fund its big gaming purchase with a combination of cash on hand and new debt and still easily be cash net of debt positive by the time it’s all said and done. Of course, this deal still has to pass regulatory scrutiny.

An analysis of the two deals shows Microsoft is making an acquisition from a position of strength. Adobe, maybe not so much. Two storied software giants from the 1980s, but one’s a better buy

Both Microsoft and Adobe have been incredible businesses since they made their publicly traded debuts in the 1980s, but Microsoft is obviously the winner as far as all-out growth goes. And in spite of its size (market cap of more than $1.8 trillion as of this writing), it still expects to grow by a double-digit percentage in the coming year. Far smaller […]

source Before You Buy the Adobe Stock Dip, Take a Hard Look at Microsoft

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