Tim Boyle/Getty Images News
Tim Boyle/Getty Images News
Recommending any software names these days is a contrarian undertaking. Investors, with a dearth of evidence, or historical analogs are convinced that somehow the business outlook for software companies is highly correlated to the business cycle. They are terrified about negative estimate revisions. And they have completely thrown out any consideration of the super cycle that digital transformation and AI is providing demand. The preponderance of sentiment is focused on Fed dot plots, with a perspective that any kind of investment that involves future growth needs to sell at a highly compressed valuation. And there is nothing on the immediate horizon that suggests that this sentiment will not continue for some time.
Recommending Adobe (NASDAQ:ADBE ) shares is an even more extreme contrarian undertaking. Adobe shares have been pummeled and the judgement of its management has been questioned in the wake of both its quarterly earnings review and its guidance, but more importantly due to its planned $20 billion acquisition of Figma. As many readers are aware, the shares of Adobe lost 25% in the wake of the announcement and have seen no bounce since that point. But even before that implosion, the shares had already lost about 30% of their value since the start of the year. So, the shares are now down by almost 50% so far this year, and are down by 59% since they made an all-time high 10 months ago. While Adobe's business, despite the macro-economic turbulence has shown some demand resilience, its stock price has been a different matter.
It's been some years now since I owned Adobe shares. I was concerned about the valuation of the shares a long, time ago, even prior to their ascent to the stratosphere. And to an extent, I was concerned about the level of complacency on the part of investors and commentators about the durability of demand growth in the company's creative cloud. I was hardly prescient; far, far too early with those concerns.
So, what next? Are Adobe shares in the process of bottoming? How much more pain might be involved in continuing to hold these shares? The market environment remains toxic to growth, and to anything involving perceived risk and uncertainty. Just today, Thursday, Sept. 22, the AAII reported that negative investor sentiment had reached record levels. Holding Adobe shares currently is an exercise in risk and uncertainty. While I believe that the valuation implosion accounts for the risks and uncertainties attendant with such a large and highly valued acquisition, negative sentiment still rules. Other than some kind of dead count bounce, I think in the short term it unlikely that Adobe shares can overcome sentiment and a market environment utterly hostile to what it perceives to be risk.
That said, the question is, can a contrarian case be made for investing in Adobe at this time. It isn't an easy case to make, of course, and it is one that a flock of covering analysts have chosen not to make. In the last 3 months there have been no fewer than 8 analyst downgrades. The problems of this company are on full view although there are still more buy than sell ratings, and analyst price targets, for what they might be worth, range from a low of $310 to a high...well that $546 number has probably not been refreshed recently.
One thing of note: Adobe is spending $20 billion to acquire Figma. Its market cap declined by more than $47 billion in the wake of the announcement. Even the most negative commentators have acknowledged that that Figma is worth something. If readers know any developers/creators, they will have heard just how strongly positive most creatives feel about Figma. So, there is something a bit dissonant in the share price reaction to the proposed merger, although given the sentiment surrounding risk and uncertainty, the reaction is hardly surprising.
The company's free cash flow yield is now greater than 5%. Of course, with the costs of acquiring Figma, and its concomitant dilution, free cash flow and free cash flow yield could be marginally pressured for a time. Still, a free cash flow yield of greater than 5% might logically be expected to put a floor under the shares, at least after investors with a shorter term perspective exit their positions. It is worth noting that Figma currently does have a positive operating cash flow, and while the specifics of a post integration track for that metric are still quite murky, the likelihood is that the company's free cash flow generation is not going to be significantly jeopardized by the integration of Figma.
For some time now, Adobe has been repurchasing shares at a rate that has seen it capitalization shrink. The purchase of Figma is going to lead to some dilution, at least initially, and it is also going to lead to the company taking on $10 billion of debt. Management has indicated that its capital allocation priority after the Figma transaction closes will be to repay the debt. So, realistically share repurchases will be on hold for close to 2 years. The company plans to continue to repurchase shares at least sufficient to offset potential dilution from SBC until the Figma transaction closes.
The company's SBC has been around 8.5% of revenues, typical for a mature software company as this one is. That suggests that there will be some dilution over the next two years, but probably in the range of 2%-3%. Given just how many other moving parts there are in analyzing the outlook for this company and how Figma might alter that outlook, that level of dilution really is far from crucial.
Did Adobe overpay for Figma? What does the acquisition of Figma imply about growth prospects for the rest of Adobe? How will Adobe do during the coming recession? And to what extent are risks and uncertainties already baked into the share valuation. One other twist to the story, as if there weren't enough already, is that Axios, a news website, carried a story to the effect that the acquisition of Figma could be challenged on anti-trust grounds. The story is really based more on conjecture and the size of the consideration being paid for Figma than substance, and my guess is that there is no "relevant market" for this combination to dominate. My analysis will proceed based on the likelihood of this merger going to completion in the next 6 months or so.
I like to provide nuanced recommendations for subscribers/readers. This is not a call to buy a full position in Adobe shares in the next day or two or even week or two. And whether the shares should be considered at all depends significantly on the time scale of an investor and on his/her risk tolerance. I rate the shares as a speculative buy, a category not explicitly recognized by Seeking Alpha. The speculative buy rating does encompass some expectation of a dead cat bounce. But I imagine any sustained rally in the price of the shares is going to have to wait until the merger closes, and the company provides specific targets for the merged business. Right now, about all that investors know is that the acquisition is supposed to be dilutive for the first two years, that it will breakeven in year three and that it will start to be accretive at the end of year 3. I am not even sure, at this point, if Adobe management considered revenue synergies of various kinds in its articulated projection, and on what basis it considered those synergies. I would also suggest to readers that is nearly impossible for IT shares whose valuation is so firmly tied to future revenues and earnings to sustain significant advances while market sentiment is so negative, and while the correlation between interest rates and interest rate expectations and valuation is so pronounced.
It will take time for the revenue synergies that are the reason for this transaction, to impact Adobe's growth rate. Some impact on just the revenues of Figma can happen quickly as more of the Adobe base gets exposed to the Figma solution and what is called FigJam, a specific Figma offering that has almost universal appeal. Other synergies will take longer as the combined company crafts and executes a product road map. In discussing the merger, on the conference call, the CFO indicated that about 2 years after its closing, Adobe EPS would start to rise at rates greater than revenue. Right now, investors are finding that waiting for 2 years before the specific financial benefits of a merger are realized is an eternity. The reality is that whether the terminal rate for two year treasuries is 4.6% or 3.8% has very little impact on a discounted present value calculation. What has the greatest impact will be just how much this acquisition can impact longer-term growth rates, and additionally, what Adobe's business model will look like as the integration proceeds.
If investors are looking for some quick gratification from Adobe shares, that seems unlikely. If investors are looking for a mature IT vendor with an acquisition that is likely to reaccelerate profitable growth for years into the future, this is a great entry point that can produce substantial returns.
The investment thesis for Adobe shares at this point rests on a few pillars. One of them is an evaluation of the demand resiliency for the creative cloud in a recessionary environment. Another is the synergistic revenue benefits that the company expects to achieve with its acquisition of Figma. A third is its admirable business model with pre-Figma free cash flow margins of more than 37%. In addition, the company has a visionary and long-serving management team that has successfully integrated several acquisitions and was one of the initial vendors to migrate its user base to a subscription model. And finally, of course, is its imploded valuation which turns the investment narrative from Growth to GARP.
At the end of the day, the real question for investors is not specifically whether or not Adobe overpaid for Figma, or even if the acquisition of Figma is a sign of competitive weakness, but whether acquiring Figma can add several hundred basis points to forward revenue growth at margins comparable to the current corporate average. That Adobe will be paying a huge premium to acquire Figma is unquestionable; the issue, however isn't that, but whether the acquisition can reaccelerate growth over a multi-year period. As outlined below, I think that is the most likely scenario. Obviously, I have no way of proving that it will happen or in trying to quantify with any degree of specificity, just what is going to happen after the acquisition is completed which is why I haven't furnished a DPV calculation here.
The odds are that most readers, unless they have specific software jobs themselves, or friends and family directly involved in collaborative design, are unfamiliar with Figma. Most commentators have been positive about the acquisition, but have been critical of its valuation. The acquisition, according to one analyst, besides being the largest ever for a private software company is also said to have the highest multiple of ARR to purchase price. The company's raison d'etre is all about design collaboration by teams. The software is a tool that allows users to share projects, files, pages and frames with all who have permission to be included in a group. The name of Figma, itself, is apparently based on a Japanese action figure produced by the Mac Factory.
The consideration for the acquisition is $10 billion in Adobe shares, and $10 billion in cash. In addition, Adobe is granting 6 million additional restricted stocks units to Figma's CEO and its employees that will vest over 4 years. As I write this on Thursday, September 22st, Adobe shares are around $287. So, the consideration in shares is around 35 million to which must be added the RSUs which probably add a further 4-5 million shares to the consideration depending on how they are precisely structured. This will raise Adobe's outstanding share count by about 8.5%. Adobe had cash on its balance sheet of less than $6 billion at the start of September. I think it highly probable that it will require a term loan to pay for the cash component of the transaction. Finbox suggests that the after-tax cost of Adobe debt is about 5%, so the interest cost of the debt could be as much as $500 million/year. To cover the cost of the debt, Adobe is going to have to earn an additional 7% above current estimates. All in, I suggest that the dilution resulting from this transaction is in the range of 14%-15%.
I want to make it clear that even with strong growth assumptions coupled with very favorable expectations for contribution margin, it is unlikely that buying Figma for the stand alone results of its business could be justified. But that is not what this transaction is about. Those analysts who hurriedly reduced their ratings on Adobe shares are reflecting the unwillingness of current investors to look a bit beyond a simplistic analysis of the state of Figma and Adobe as though there aren't substantial revenue synergies, far beyond adding revenue streams together. That has led them to what I believe to be erroneous conclusions about the value of this transaction for long-term Adobe investors. Perhaps looking at what Figma actually does, and how users and consultants evaluate it might provide some insight as to what motivated Adobe management to make this deal.
I have linked here to a study by an industry consultant, Ben Kopf. This analysis highlights the benefits of the contemplated traction for Figma users. In another link, Mr. Kopf contrasts the Figma tool with that available from another private software vendor called Sketch, also in the creative collaboration space, and strongly endorses Figma as best for collaboration. The tool works on all platforms and it eliminates what is called PNG-pong where uploaded images are bounced back and forth. The act of collaboration is easy and familiar to most potential users. Figma uses Slack to facilitate the communication of design edits. The Figma application is tightly integrated with that of Confluence. It would be tiresome, in the extreme, to go through the entirety of the analysis presented by Mr. Kopf, but as these reviews go, and I have read literally thousands of them, the articles published by Mr. Kopf-and I have by no means linked to all that are extant-are one of the more straightforward product endorsements I have ever seen. If anyone has doubts about the efficacy of Figma as a tool to enhance design teamwork, reading these article will provide a great deal of enlightenment.
I have also linked to another 3rd party analysis by Jesus Husband. His article is titled "Figma, why it's the future of design" so its tenor is pretty apparent. Use cases include applications such as the building of mockups, and the creation of new landing pages and campaigns. The use of Figma improves the productivity of most developers. One company, with the rather obscure name of Withings, said it achieves a 90% faster feature rollout because of its use of Figma. Finally, I have linked to this analysis which comes from a software partner called Lokalise about how Figma has become its most popular plug-in.
Adobe has had a similar, although less functional tool called Adobe XD. Adobe has been de-emphasizing XD for some time now; the company indicates that when the acquisition closes it will try to migrate XD users to Figma and will, of course, sell Figma as its main stream design and collaboration tool. Basically, Figma fills a significant hole in the Adobe product offering with advanced technology that is loved by users. While Adobe XD is on its way out, I have linked here to Figma's commercial regarding its advantages compared to that product.
I think that the rationale for Adobe's planned acquisition of Figma is hard to dispute. Indeed, Figma, might have been perceived as a longer-term threat to Adobe's future growth, and its acquisition by another larger stack vendor could have posed significant problems for the company. There has been some discussion amongst users that Figma's rise means that Adobe's competitive advantage was waning. Does the hypothetical really matter. For better or worse, if Figma was a threat to Adobe's dominance of the design space, now it isn't.
One of the hardest things to justify is the price that Adobe is paying for Figma. Overall, Adobe is paying the equivalent of 50X revenue current year revenues for Figma. There are simply no other software companies that I follow that are trading at that kind of EV/S multiple. The highest valuation amongst the companies that I track is Snowflake, which I estimate has an EV/S ratio of 17.6X followed by Cloudflare with an EV/S ratio of 15X. Of course neither Cloudflare or Snowflake are growing at triple digit rates, but the ability Figma really has to sustain that growth rate for some significant period is questionable.
Having said that, the people who run Adobe, in particular CEO Shantanu Narayen, the chief product officer, Scott Belsky, David Wadhwani, the president of the digital media unit, and Dan Dunn, the CFO/COO are exceptionally well qualified. Dunn has specific experience in mergers and acquisitions, having been a VP at Goldman Sachs in their Mergers and Acquisition practice. So, what are they thinking?
Long ago, this writer was involved directly in mergers for a couple of computer hardware company, and ultimately, for a short time for a computer software vendor. Just how relevant this experience might be more than 30 years later can be questioned, but it does inform some of my views on just how companies make acquisition decisions.
The real issue for readers/investors is now whether or not Figma is worth $20 billion as a standalone investment, because that isn't what it is. The real question is how much Figma and its technology are worth to Adobe. Acquisitions are frequently justified based on cost synergies. A company such as Oracle (ORCL), for example, can buy Cerner at a premium, purely based on cost synergies and its ability to achieve exceptional contribution margins. That isn't the case here.
What the case is relates to revenue synergies and what I call drag. The individuals who made this decision for Adobe believe that the combination of Adobe and Figma can sustain that company's triple digit growth rate for some years, and perhaps even enhance it. They believe as well, that because Adobe and Figma will be a combined entity with an integrated set of functionality that currently doesn't exist, they will capture additional share of the 10 million or so "creatives," particularly developers. And they may believe that with Adobe and Figma combined as a single entity, they will have additional pricing power, and will be able to raise prices.
When commentators write about how Adobe is overpaying for Figma they often either ignore, or underestimate these elements in their analysis. The Adobe officers who put together this acquisition had to satisfy a board with a set of quantitative justifications that were reasonable and well supported. Given the potential liabilities of making a decision that could be labelled as not prudent, boards are quite careful in evaluating mergers and in allocating $20 billion.
I don't claim that I have some special insight with regards to the revenue synergies that Adobe will achieve from its pending acquisition. The reality is that projecting such synergies is always more of a guess than company guidance because it involves assessing the business/competitive landscape over 5-10 years. And forecasting drag is an even more fraught undertaking. Just exactly how much additional Adobe product will be sold because users of Figma want to acquire a full Adobe stack, or what the value of new offerings that can be created by the combination, while likely quantified in some justification presentation, is pretty well impossible to forecast specifically by an outside observer.
But in answer to a question during the last conference call, I think the CEO spelled out how he sees those synergies unfolding:
So when we talk about the fact that Figma has a $16 billion TAM, that's referring to the TAM as it exist today, in terms of what they are doing, both as it relates to product design, as well as that would relates to collaborative whiteboarding and ideation, which as you know, say, FigJam this incredible product that has, I believe, a much, much larger available addressable opportunity.
But if you take a really what we think is the massive opportunity and putting this together. I think there are four aspects that are really exciting for us. First, there is going to be a next-generation of Creative collaboration that happens in the industry, and we believe that the combination of the two companies enable us to really position Adobe and deliver great value for this Creative collaboration industry.
Second, we continue to believe that we can accelerate what it means to create on the web. What Figma has done is they have delivered a really incredible technology platform and solved the number of the issues that need to be solved to allow multiple people to collaborate on the web.
Third, we think that we can advance product design and if you take the decades of Adobe technology that exists, our imaging technology, our vector technology, the video technology that we have and think about what that means to bring that to the web and dramatically increase the number of customers who can then benefit from it.
And last but not least, I think, to your question. This is now really addresses that sort of Holy Grail of anybody creating a mobile application, anybody creating a website, anybody creating an application for any device that has a screen, combining what we can do on the designers, developers and the stakeholders to make that happen.
So I think today, what we shared with you is what they talk about as their addressable market opportunity, what we talk about as ours. But I think the real benefit of this combination is creating brand new markets, much like we have done with Digital Experience and other industries that we are part of. So thank you and we are really excited about this.
By background and education, my focus is and always will be on financial analysis. I try to look at all the relevant financial data that exists. But the reality is that in evaluating something like the Figma merger, the tools of every day financial analysis are inadequate. I will take as a given that Adobe will be able to ensure that its business model, including Figma, will continue to have the attractive characteristics that it now does. On that basis, it would be possible to calculate just how much additional growth Adobe would need to justify the merger. That Adobe management has done in terms of analyzing this transaction, and presenting it to their board is a given. And based on the perspective I have tried to illuminate above, I think the chances for Adobe to achieve the required growth increase are significant. But they aren't 100%. Readers contemplating owning the shares will have to make assumptions about just what growth rate bump the combination of Figma and Adobe can create. I put a lot of stock in the ability of this management team's ability to realize the synergies that undergird the justification. While taking cognizance of the valuation metrics, I find them of far less importance than handicapping the ability Adobe has to create new markets as the CEO spoke to explicitly in the quote above.
I think that facilely asserting that Adobe is overpaying for Figma because the purchase price can never be justified by valuing Figma on a standalone basis really misses why this acquisition is being consummated. It is all a function of synergies and drag, and while I confess that I have no way of evaluating the magnitude of both components that Adobe management considered, I doubt that they cast caution and judgement to the winds in making their decision to negotiate and consummate this merger. Readers investing in the shares, as this writer intends to do, are making an explicit bet on the calculations of the company's management. I feel quite comfortable making such a bet because this is one of the better software industry management teams, in my opinion.
There are many examples of mega-cap companies which ignored emerging trends, and saw their growth rates eviscerate over time. Oracle, for example, by its failure to fully embrace the cloud in its infancy, is one such company which has taken a long time to recover from that miscue. The fact that Adobe is paying what may seem like a huge premium to acquire Figma is less of a problem for me than it is likely the case for other investors and commentators. The odds are that this is a reasonable decision for Adobe to be making. All will depend on the company's ability to execute and to achieve the revenue synergies necessary to justify this transaction but Adobe has had plenty of experience with acquisitions including such transactions as the purchases of Frame io, Fotola, Marketo, Magneto, Omniture and going back further even Macromedia.
Integration is always a major risk in transactions of this kind, and integration can go wrong quite easily. Just recently, Okta (OKTA) management spoke about the difficulty it was having in integrating the sales activity of Auth0. While the messaging about this transaction is that Adobe intends to run Figma autonomously, at least at for now, inevitably, there will be integration-that will be a requisite to achieve the revenue synergies on which this deal is based. Initially, integration will start with Figma's distribution strategy, but eventually, much of the product strategy for Adobe's Digital Media group will be a function of integrating Figma and FigJam with the many other offerings in that stack. I call these shares a speculative buy because one is speculating on the results of the Figma integration, something which cannot be precisely foretold in advance.
After Adobe buys Figma, and making some estimates for 2023, on a run-rate basis, 3%-4% of Adobe's revenue will be coming from Figma, and more than 96% will be coming from the assets that Adobe currently has. For Adobe to work as an investment, its current business will have to perform, and do so in a turbulent macro environment.
Although overshadowed by analyst commentary regarding the Figma deal, Adobe did actually beat on EPS, and revenues were consistent with the prior forecast for the quarter that was recently reported. Adobe's revenue target for its fiscal Q4 is consistent with prior expectations. Its full year revenue target is within 0.4% of prior expectations. Adobe's reported EPS of $3.40 for its fiscal Q3; it had forecast that it would achieve EPS of $3.33. It is now forecasting that EPS for its Fiscal Q4 will be $3.50, the prior consensus had been EPS of $3.45. For what it is worth, Adobe is profitable on a GAAP basis and has been so for some years. Adobe like many of its large software peers is encountering some noticeable FX headwinds that are impacting results and estimates. At this point, the FX headwind is estimated to be between 3%-4%. That said, the FX neutral growth rate in the mid-teens has declined somewhat in recent years. That is not terribly surprising given the company's scale. It is difficult for any software company with a revenue run rate of about $18 billion to achieve organic growth in the mid-teens percent, especially considering current macro turbulence and the FX headwinds.
Adobe at this point has a number of key growth areas, and some legacy offerings as well. I will just highlight as few of the faster and slower growers. One major growth driver is called the Adobe Experience Platform. It is…well it is a data repository that makes it possible to provide users with analytics about just about anything having to do with a customer. At some level, AEP competes with Braze (BRZE). This is a hot space, and Adobe is maintaining its share. AEP fits within the company's set of what it calls its Experience Cloud offerings. Essentially, the Experience Cloud has been built on a foundation of many acquisitions starting with Omniture and including most recently Marketo and Magneto. Despite the acquisitions, this is an area of Adobe's business that seems to be under-performing. The experience cloud is about 25% of Adobe's current revenues. While this set of offerings did grow by about 15% year-on-year in constant currency, it has not been a share gainer. .
The key business for Adobe remains its set of Digital Media offerings. Last quarter Digital Media's ARR reached $13 billion, growth of 16% year over year in constant currency. Within Digital Media, the Creative Cloud is the key component of the business, with quarterly revenues of $2.63 billion, growth of 14% in constant currency. These days, that principle service offering is called Adobe Creative Cloud Express. The offering is an evolution of Adobe Spark and is currently the offering that Adobe sells to users who need to create content. Express and Figma are self-evidently going to enhance each other in terms of functionality and productivity.
Also within Digital Media is the app that calls its Document Cloud. The Document Cloud includes the PDF format as well the company's E-sign business. At this point, Document Cloud is about 13% of revenues and it achieved a 25% growth rate last quarter. It looks as though Adobe is achieving some share gains vis-à-vis DocuSign (DOCU).
Overall, the company's business, while certainly not at hyper-growth levels, was performing at reasonable rates during the quarter. The RPO balance for the company grew by about 12%; 15% in constant currency year on year, and by about 2% sequentially. Q3 typically is the low point for percentage growth for Adobe of its RPO balance, and the company expected that kind of result. Q4, on the other hand, is the high point in the year for RPO growth.
The company's guidance for Q4 , adjusted for FX headwinds, was in-line, or slightly above in-line. Total revenues are expected to reach $4.52 billion, or growth as reported of 10%. FX headwinds are estimated to cost the company about 400 bps in growth. EPS for the quarter is expected to be about $3.50, which is slightly above the prior consensus of $3.45.
The question that has been raised to what extent the plan to buy Figma was defensive, and reflected management concern regarding the future prospects of the Adobe portfolio. In my opinion, there has always been lots to like about Adobe's offerings; my issues have been those of valuation, and potential market saturation. But rather than me providing an opinion, I think it better to reflect the answer of the CEO to the question during the conference call.
Brad, it's a good question and I understand that in these markets, in particular, acquisitions and maybe large ones are viewed with some skepticism. We certainly believe and I will talk about it that Figma will be a transformative deal for the customers and industries and it dramatically increases our TAM.
We can deliver great value to an increasing set of customers. But I also want to reassure all of you and if you look at our results, this in no way changes our focus or our excitement on our current portfolio. We are growing well, and we are demonstrating strength across all of our three cloud offerings and we continue to execute against our current initiatives.
And so if you look at the multiple internal businesses that are achieving velocity, whether it's Adobe Experience platform and the apps that are built natively on top of it, what's happening with 3D and immersive, what's happening with Acrobat Forms, what's happening with Frame. This is additive.
And when opportunities like this present themselves, Brad, I think it's the great companies that look at it and say, are you going to focus on the here and now only or are you going to seize on the opportunity that really positions Adobe for the next few decades.
And so it's a great question. We understand that there will be questions associated with valuation. We certainly believe that it provides valuation to our shareholders as well. When you look at what this means for us, but in no way diminishes my excitement around our current portfolio.
Needless to say, the conference call featured a question about the demand environment. It is a rare software company that isn't seeing decisioning for enterprise deals elongating. Many readers these days are highly skeptical that enterprise software companies can continue to grow and are surprised when they report numbers that suggest growth is continuing. Apparently just reaffirming guidance comes as a surprise to some cohort of investors, Shares of Salesforce (CRM) were able to rise Thursday, in what was otherwise a toxic market for IT growth stocks, simply by reaffirming guidance. Adobe management was fairly forthright in asserting that its growth is continuing, despite the turbulent environment.
On the Enterprise side, as we said, we had strong results. I mean the AEP plus apps business, that book of business is doubling, which really reflects the foundational aspects of what we are delivering.
Yeah. And on the Digital Media side, we began the year with a guide of $1.9 billion, and of course, we hope to beat that. And in the context of everything happening in the macro, if you look at Q1, Q2, Q3 and our guide for Q4, we are at $1.88 billion and in the context of everything happening in the world, we are very proud of this performance.
And of course, we are an aggressive company. We hope to beat that number. And all the leading indicators remained strong. New user acquisition is strong, engagement and retention continues to be strong, monthly active users continue to be strong. And so we feel really good about the macro -- about our ability to navigate the macro despite what's happening in the world around us.
And then in the context of as we start looking for opportunities to grow, we have so much product innovation coming out at -- and we will see a lot of it at MAX [the Adobe Sales Conference], accelerating what's happening in our flagship applications, what's happening around Express and the kinds of capabilities we are putting in there.
Yeah. No. It's playing out as we expected as we take a look at the enterprise business, closing million dollar plus deals, transformational deals as we look forward off of that momentum into Q4. Pipeline is building nicely. Team is doing a good job executing against the opportunity and it's playing out as expected.
Again, readers, and analysts can and have expressed skepticism about the prospects for Adobe during a recessionary environment, such as that suggested by the head of the Fed in his most recent press conference. Obviously, the current demand environment is and will constrain Adobe's growth. But the shares are down by about 60%. While of course, I believe that the shares were overvalued heretofore, a 60% haircut corrects many valuation excesses.
Finally, and really more for the sake of completeness, Adobe, as mentioned earlier, has had a horse in the creation collaboration race, XD. XD has not kept pace with Figma in terms of innovation and functionality. It is not terribly surprising that an upstart independent vendor such as Figma, focusing on a single market segment, and with a driven CEO has proven to be more nimble and successful. I have linked here to an article highlighting how users view the competition between XD and Figma. The odds are that over time Adobe will wind up with some kind of integrated solution that incorporates the best of both offerings.
At this point in a deep dive article, I would normally point out Adobe's very attractive business model. That seems redundant at this point as that model is going to change with opex growing faster than revenues after the merger with Figma closes. Prior to the announcement of the merger, ADBE's EV/S was elevated, but its valuation, accounting for its very strong free cash flow margin, was about average. Its relative EV/S is far less elevated now than at any time in the recent past. Without considering the merger, I am projecting that the Adobe's EV/S ratio is around 6.6X. But because its free cash flow margin is close to 40%, on a Rule of 40 basis, it scores a 50. So, its EV/S should be elevated, but it isn't.
What happens to valuation when the transaction to acquire Figma closes. Adding $400 million, or even $800 million to revenues-probably a reasonable estimate for Figma's run rate revenues 12 months after the acquisition closes- simply doesn't account for drag and revenue synergies. The consensus forecast for Adobe revenues next year is just shy of $20 billion. Just how much will Figma's drag create in incremental revenues. For the transaction to break even on an EV/S basis, and using my 14-15% dilution estimate, Adobe's run rate revenues would have to reach about $23 billion. That is not going to happen in fiscal '23. I think it might happen over the next 18-24 months. It will take a little longer before those incremental revenues achieve the same level of margin that Adobe enjoys, perhaps one or two quarters.
Just how many additional bps of growth will the combination of Figma and Adobe create. Heretofore, I think most investors had figured that Adobe's revenue growth potential was in the mid-teens. Now…As I have expressed earlier in this article making those kinds of estimates is a guess. The folks that run Adobe have both a track record of success and a reasonable record of achieving their forecasts. I suppose that this article has too many quotes from the conference call for the taste of some, but I find that they best represent my own opinion as to why buying Figma makes sense for Adobe, and is not some kind of dark exercise.
From the beginning of the conversations with Dylan [Dylan Field, CEO of Figma], the primary focus has been on things that we couldn't do individually. What are the things that we could do and bring to market that combining the two products and put -- two product sets into two companies could really enable a better-together story.
And in particular, what we see is that we have this incredible wealth of technology and expertise around illustration and video and imaging and photography and 3D, all from -- coming from the lens of our flagship applications, and as Shantanu mentioned, they have built such a rich platform for collaboration.
Bringing these things together allow us to re-imagine what the -- basically Creative -- content creation should look like in the future by taking our technology, integrating it on top of or building it on top of the Figma platform and then enabling a whole set of new use cases that would never have happened were it not for this combination
Again, this merger is not about justifying the value of Figma on a standalone basis. It can't be done and trying to do so gets investors focused on the wrong direction. The management of Adobe believes that it will create new categories, and new offerings that expand the company's TAM and its likely CAGR by several hundred basis points. I believe that the preponderance of the evidence suggests the validity of that assertion. That's why I rate Adobe shares a speculative buy, but with a very attractive entry point, given the extreme valuation compression.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Short position through short-selling of the stock, or purchase of put options or similar derivatives in ADOBE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.