I'll say this for traders, when they take the ball and run with it, they often get carried away. The mere mention that Microsoft's (NASDAQ:MSFT) Steve Ballmer and Adobe's (NASDAQ:ADBE) Shantanu Narayen met Thursday sent ADBE shares soaring on acquisition assumptions. And why not? After all, it's not the first time Microsoft has been rumored to be interested in buying Adobe. Surely now - with the definition of "antitrust" being updated by time and Google (NASDAQ:GOOG) - such a union could actually transpire.
But before any of us start wondering if it can happen, maybe it's worth asking if it should happen. The ins and outs show the possibility isn't quite as exciting as it sounds.
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As of Thursday's post-pop price, Adobe's market cap was about $14 billion. The company earned a little less than $400 million last year on a GAAP basis, which was roughly half of what it had been earning in prior years. However, on an operating basis, last year's income only dipped by about one-fourth. And a near-full earnings recovery is anticipated for the coming year, putting annual earnings back in the $800 million area.
In a good year, Adobe generates a bottom line of $800 million. Companies with such impressive numbers come with an obligatory purchase premium, which could put the sale price somewhere in the $15 billion to $18 billion range.
Oh, Microsoft can more than afford it. It's sitting on $37 billion that's been idle for a few years now. Affordability isn't the question, though. The question is one of impact; does the benefit meaningfully outweigh the expense? Some might say 'yes', but based solely on the numbers, I'd have to lean towards 'no'.
Microsoft's annual revenue has been rolling in around $60 billion per year, with annual earnings steadily increasing to last year's $18.7 billion profit. Adding another $800 million per year to that would only be about a 4% bump, yet it would wipe out about half of Microsoft's cash.
Of course, the whole point of a merger or acquisition isn't a quid pro quo - it's the creation of synergy, where the whole is greater than the sum of its parts. It's here where the M&A chatter should really start to sizzle, but frankly, the end result will be more of a frizzle.
Not Quite a Win-Win
On the surface, the relations between the companies is obvious. Both are tech companies with a huge interest in desktop and web-based applications and a great deal of expertise in document creation and management. They also share a pair of foes: Apple (NASDAQ:AAPL) and Google. These common adversaries are likely at the core of this possible partnership.
As a testament to Microsoft's disdain for Apple, some of Microsoft's key executives recently held a mock funeral for the iPhone. Sure, it's weird and childish, but it's also decidedly anti-Apple.
Adobe's loathing of Apple is a little more seasoned, and for a reason better than mere jealously over iPhone's success. Remember, Apple initially blocked Adobe's Flash software from being installed on iPhones and iPads. Though the restriction was partially lifted a few days ago, Flash is still limited in functionality on iPhones and iPads.
As for the other enemy, Google, the threat is a little clearer: Why buy software from a developer when Google gives it away for free? Google Docs does a great deal of what Microsoft Office can, including saving and printing documents in PDF format. And, given more time, Google will undoubtedly keep adding to its library of free apps and web-based utilities, further chipping away at Adobe and Microsoft's market share.
But the question remains - how is Microsoft better with Adobe in its pocket? Microsoft's Silverlight, though not as prolific, is a decent alternative to Flash. And, while Adobe put the PDF format on the map, there are now dozens of free websites that can covert documents to PDFs. Adobe's other programs in the Acrobat office suite look a lot like Microsoft's equivalent or the software of other developers (and some of it's available at no charge). You get the idea.
The Bottom Line
One major corporation acquiring another doesn't necessarily equate to immediate or long-term gains for anyone. The obvious question with Microsoft's rumoured acquisition of Adobe is where's the really big synergy? That $18 billion is an awfully large price tag for an extra $800 million per year, particularly when Adobe doesn't have anything Microsoft couldn't create on its own. (To learn more, see What Makes An M&A Deal Work?)
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