Adobe (NASDAQ: ADBE) crashed after the third-quarter results were announced, although the results were more or less in line with forecasts. While the company narrowly trimmed its full-year outlook, I suspect the decline had more to do with it valuable acquisition of Figma. The deal will cost $20 billion, split equally between cash and debt. ADBE will have to borrow to fund the deal, which would pause the share buyback program until it’s paid off. While the stock remains highly valued even after this earnings reaction, the stock is still a buy here given its strong free cash flow generation and robust growth profile.
ADBE share price
ADBE peaked at $699 per share late last year. The stock has since fallen 56% amid a broader valuation pullback in the tech sector. It seems that even highly profitable tech companies are not immune to tech weakness.
I last covered the stock in June, where I gave it a Buy rating due to the ongoing share buyback program. The stock is down 19% since then, and the stock buyback program appears to be ending soon. Is the thesis broken?
Adobe Stock key metrics
ADBE’s most recent quarter saw year-over-year growth of 13% (15% at constant currencies).
Non-GAAP EPS of $3.40 beat guidance of $3.33. While ADBE saw its digital media and digital experiences revenue come in slightly below guidance, it offset that weakness with strength in its document cloud division, which grew 25%.
The strength of ADBE’s document cloud product raises the question of whether it’s taking market share from DocuSign (DOCU), which isn’t seeing nearly as strong growth rates.
ADBE ended the quarter with $5.8 billion in cash versus $4.1 billion in debt, but this net cash position should not be relied upon due to the announced acquisition of Figma.
Figma provides web design tools not too dissimilar to ADBE’s products. It actually looks like a direct competitor of the company.
The transaction will cost around $20 billion and will put half cash and half stocks at risk. That means about $10 billion in debt to add to the balance sheet, leaving the company with net debt of $8.3 billion. It also appears that there is an additional $1.8 billion in restricted stock units that would be granted to Figma employees.
In the conference call, management explained expectations for accelerated revenue growth based on:
(1) We are expanding Figma’s reach to our customers and through our global market presence, (2) Figma is accelerating the delivery of new Adobe offerings to the web for the next generation of users, and (3) we are jointly introducing new offerings to the bring to market while unlocking the possibilities of collaborative creativity.
Management also stated that its post-transaction priority would be to pay off the associated debt and only resume share buybacks thereafter. From now until the closing of the transaction, the company would also limit share repurchases to those necessary to offset dilution.
Looking ahead, ADBE forecast total revenue of $4.52 billion, representing 10% growth.
That guidance implies some reduction in full-year revenue estimates to $17.60 billion from $17.65 billion.
ADBE also forecast non-GAAP earnings per share of about $3.50, which translates to 9.4% growth.
Is ADBE stock a Buy, Sell or Hold?
Consensus estimates are for earnings per share of $13.54, below guidance of $13.62 in non-GAAP earnings per share. ADBE is trading at just 23 times forward earnings. The company is expected to deliver mid-double-digit earnings growth over the next decade.
That guidance could prove conservative, however, considering the company is also expected to post double-digit revenue growth — consensus estimates imply minimal operating leverage.
Based on a 2x price-to-earnings-to-growth (“PEG”) ratio, I could see ADBE trading at 34x earnings by next year, which would translate to a stock price of $539 per share, or up of 75% implied in the next 12 months.
However, the acquisition of Figma raises some questions. While the optimist might suggest that using cash in such a bearish tech environment should be construed as bullish, my colleague App Economy Insights astutely points out that the $20 billion implied valuation is double the valuation, which Figma raised capital in 2021 – not to mention that tech stocks have seen a steep multiple contraction since then.
Perhaps lacking context in this observation, Figma likely grew very rapidly over the past year, but even then, with an implied 50x annual revenue in Q4, this deal still seems quite rich. This kind of rating would have been expected 12 months ago before the tech crash. Is this deal a sign of desperation? Does the deal hint at competitive risks? It’s arguable that ADBE deserves the leap of faith given its strong track record, but given the bearish environment for tech stocks, it’s human nature to express such doubts. Another risk is valuation risk. Even after a sizeable pullback from all-time highs, ADBE stock remains highly valued relative to its modest earnings growth profile. This acquisition will slow the buyback program, which could have the side effect of reducing buying pressure on the stock and dampening sentiment. Stocks like PayPal (PYPL) have shown that even once-loved stocks can suddenly remain unloved by the market — with drastic consequences for the stock price. ADBE’s free cash flow generation likely won’t provide the same protection from volatility as it has in the past, at least in the near term, due to slowing buybacks. I rate ADBE as a buy for long-term investors.