Adobe Q3 Earnings: Acquisition Too Expensive (NASDAQ:ADBE)

Adobe (NASDAQ: ADBE) just reported its third quarter earnings and the company is soaring, down more than 10% so far. I believe the earnings are not what drove the stock price down here, but rather the announcement of its acquisition of Figma, which I will discuss below. However, despite the company now falling significantly from its all-time high, I still don’t think investors should pull the trigger on it. While fundamentals remain strong, the current valuation offers little upside and the company continues to face strong currency headwinds. I believe investors should hold and wait for a better entry point before plunging.

Q3 Revenues

Adobe’s Q3 financial results appear decent considering how volatile the economy is. The company reported total revenue of $4.4 billion, up 13% YoY (year over year) from $3.9 billion. Digital media segment revenue was $3.2 billion, up 13%. Creative revenue was worth $2.6 billion, up 11%, while document cloud revenue was worth $607 million, up 23%. Growth was largely driven by strong demand for photoshop and lightroom offerings, as well as video-related products. Adobe Sign continues to see strong traction, with new customer wins including Amazon (AMZN), Boeing (BA), ServiceNow (NOW), etc. On the cloud side of the experience, revenue for the quarter was $1.1 billion, up 15%. This correlates with strong momentum for the Adobe Experience Platform and Adobe Commerce.

The bottom line is pretty disappointing. Operating income was $1.48 billion versus $1.44 billion, up just 2.8%. This was due to a significant increase in operating expenses, which increased by 18.5%, outstripping revenue growth for the quarter. As a result, diluted EPS also decreased by 4% from $2.52 to $2.42. Operating cash flow was $1.7 billion, up 21.4% from $1.4 billion. I’m not too worried about the decline because revenue should rebound once operating costs stabilize. RPO at the end of the quarter was $14.1 billion, up 12% YoY. The company’s balance sheet remains very healthy with $3.9 billion in cash and only $3.6 billion in debt (before the acquisition).

Getting Figma

The vocal point for the quarter was definitely the company’s acquisition of Figma, a leading web-first design platform. The deal is worth about $20 billion, made up of about half cash and half stock.

Figma is a company that offers collaborative design tools for teams to enable better workflow. It is currently used by many large enterprises such as Block (SQ), Spotify (SPOT), Twitter (TWTR), and more. Like Adobe, Figma has strong gross margins of around 90% and is already generating positive cash flow.

While the acquisition will certainly eliminate some competition and further enhance Adobe’s product suite, the deal seems desperate in my opinion. Yes, they successfully eliminated a major competitor, but is this really a viable long-term solution for dealing with the competition? They still face competition from Canva and other emerging companies. The acquisition may actually signal that Adobe’s competitive advantage is now deteriorating.

From the press release, Adobe said that Figma is expected to add $200 million in ARR (annual recurring revenue) by 2022, and exceed $400 million in ARR by the end of fiscal year 2022. This implies a valuation of 50x fwd P/S, that is absurd . For example, even Snowflake (SNOW), one of the most expensive SaaS stocks on the market, is trading at a fwd P/S ratio of around 29. This is a huge overpay in my opinion, especially when considering how bad the equity market has been lately.

While the top line will contribute immediately, the bottom line is not expected to be accretive until 3 years later. I don’t like the terms of the deal either. Adobe is financing the acquisition with half cash and half stock, which means it will need to issue about $5 billion worth of shares. Using the current market cap, this stock offering will result in a dilution of approximately 5.8%. Overall, I don’t think this is a good deal coming from Adobe.

Is Adobe a Buy, Sell, or Hold?

While I don’t like the Figma acquisition because it seems too expensive and dilutive, Adobe’s fundamentals remain intact. The company continues to report double-digit revenue growth despite facing a challenging macro environment. Demand for products like Adobe Sign and Magneto continues to grow. The bottom line saw a slight decline but should recover soon as operating costs stabilize. Continued buybacks will also provide some support for the EPS figure as well. After a big drop in share price since late last year, the company is now trading at a P/E ratio of around 31.5. The valuation is fair in my opinion when considering the market leading position and strong double-digit growth rate. However, this leaves the company with little upside as expansion multiples are unlikely. Investors should also be aware of currency headwinds. The strong dollar has posted a massive headwind on Adobe. In the most recent quarter, the company already had a 2% currency hit to revenue due to FX. If the dollar continues to rise, its finances will likely continue to suffer. Therefore, I rate Adobe as a hold at the current price.

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