In September 2022, it was announced that Adobe would be buying Figma in a $20bn half cash, half stock deal. Not only was it going to be the biggest acquisition in the company’s history, comprising 13% of the company’s own market cap, but at 50 times forward ARR and 100 times trailing ARR, Adobe would also be paying one of the highest prices ever for a SaaS firm.
The market didn’t take the news lightly. On the day of announcement, Adobe stock dropped 17% and continued falling for several days until it finally recovered after months. You’d think, then, that shareholders would find salvation if regulators were to try and block the deal. Not exactly. Last month, on February 24, when the news broke that the DoJ was preparing to block the deal, the stock again dropped almost 8%.
Empathy for the existing shareholders is warranted. Evaluating the deal is a tough one, and calling it “reaching for valuation” would be an understatement. What’s going on? Why would Adobe, the once untouchable design software monopolist, pay such a high price for a company that seemingly did the same thing as Adobe’s own XD product? To get the human capital? To merge Figma with the Experience Cloud business? Or to simply get a market challenger out of the way before a bigger whale (I’m thinking Microsoft) scoops it up? If the latter were the case, this might be your evidence that Adobe’s moat isn’t as impenetrable as once seen. I have reason to believe that this would be the case, and in this write-up, I’ll argue why that is. But first, to get a measure of Adobe’s decision, you would also have to understand the company’s path to its current position.
Adobe’s history
As every Silicon Valley storyteller expects you to believe, the one place where startup idea flourishes is the architectural symbol of the garage. Adobe did actually start in a garage—John Warnock’s garage—in 1982, and the company’s first logo was designed by Warnock’s wife. While named after Adobe Creek in Los Altos, Adobe is also Spanish for “Mudbrick”, alluding to today’s creative nature of the company’s mission.
As their first invention, Warnock, together with co-founder Chuck Geschke, created PostScript, the first international standard for computer printing that paved the way for the desktop publishing industry in the 80s. It was such an important invention that at the outset, Steve Jobs attempted to buy the entire company for $5mn. Instead, the two founders let him buy 19% of it, including a 5- year license for PostScript in advance, making Adobe the first first-year profitable Silicon Valley company in history at the time. Apple Computers became Adobe’s most important customer.
After PostScript, Adobe developed proprietary digital fonts in the format they called Type 1. Then, when Apple followed suit and developed a competing font standard by the name of TrueType, which was fully scalable and gave precise control of the pixel pattern at the font’s outlines, Apple and Adobe started competing in Adobe’s tight space.
It took a break in the mid-80s with Steve Jobs, after he sold his Adobe stake, to diversify the company’s offerings and find the company’s path to the design mastodon it is today. Ironically, when Adobe released Illustrator, a vector-editing program, it was designed exclusively for Apple’s Macintosh. Invented on the company’s font-development software, Illustrator significantly helped popularize PostScript-enabled laser printers, creating a feedback loop that made Illustrator ever popular, spurring a growth rate of >100%/ year in Adobe’s first 7 years of operations until the end of the 80s. By then, Adobe introduced what was to become its graphics-editing flagship software by the name of Photoshop.
Then came Premiere in 1993, and Adobe slowly began to dominate the market for creative software. In that same year, Warnock launched a paper-to-digital revolution idea that he called “The Camelot Project”, in which the goal was to enable anyone to capture and share documents from any application and print them on any machine, entirely digital. That project became the PDF, the Portable Document Format. As ubiquitous as the PDF format is as an international standard today, its trajectory wasn’t a straight line. Adoption in the early days was slow, and Adobe’s board wanted to kill the project. The original version of the PDF had no support for hyperlinks, its larger size compared to plain text files required longer download times over, at the time, slower internet speeds, and even rendering a PDF was a hassle on the low computer power of the early 90s. It was only when Adobe began distributing its Adobe Reader for free that things started picking up, and it particularly picked up with one specific target group: the IRS. When the IRS started using PDF to digitize tax filings and began distributing tax forms digitally as opposed to physical mail, PDF adoption went from there.
From the early 90s, Adobe embarked on a series of acquisitions including OCR Systems, LaserTools Corp, Compution Inc., Frame Technology, Ares Software, and Aldus that added PageMaker, After Effects, and the TIFF image format to its product line. But one significant acquisition that squashed all previous acquisitions combined occurred in 2005 when Adobe bought its main rival, Macromedia, in a $3.4bn all-stock deal, primarily to add Flash to the portfolio. (After living high on Flash for a while, once logging >1bn installations worldwide, Flash’s closed nature failed to live up to HTML5 internet developing standards, was excluded from iOS in 2010, ended its support for Android in 2011, and was officially deprecated in 2017).
Despite all efforts to branch out, with an integration here and there, by the mid-00s, it was evident that Adobe’s business was coalescing around its creative applications and document (PDF) business.
And the same was the moat. During this period, Photoshop et al. had become the de facto standard in digital design. Whether you were editing a photo, making a poster, or designing a website, it happened in Photoshop. Photoshop had not only become a brand but a verb too (“that pic looks Photoshopped!”), which, if you think about it, is a remarkable feat for a software product considering the obsolescence risk software generally faces as newer and better software enters the scene, or worse, as customer needs change (which I’ll get back to). But brand value isn’t the only thing that lies behind its success. As “designer” had become more than just a fashion profession but someone that every company on the Internet needed, network effects came in as designers using Photoshop compelled more designers to use Photoshop which in turn made new and aspiring designers require companies to use Photoshop before applying for a job (Adobe smartly distributed its software for free to schools and universities, defending this network effect moat). And, as other use cases became important, such as video, audio, or webpages, Adobe offered software that looked and felt similar to Photoshop (the learning curve on creative software is generally high), locking the customers in the ecosystem.
When Shantanu Narayen took over as CEO in 2007, that’s when Adobe took on the transformation into the company that we know Adobe as today. Narayen is a leader who’s made some bold bets that have paid off. One of the big ones was to take a high-ticket (the entire Creative Suite went up to $2,6k/perpetual license in 2010) monopoly business and courageously change it to a lower-priced SaaS model.