Adobe Systems’ Acquisition of Macromedia1

On April 18, 2005, Adobe Systems announced the acquisition of Macromedia in a deal valued at $3.4 billion. The deal offered 0.69 shares of Adobe for each share of the target, thus valuing Macromedia at $41.86 per share, based on Adobe’s previous day’s closing price of $60.66. The offer represented a 25% premium to Macromedia’s previous day’s closing price of $33.45.

Upon the announcement, Adobe’s stock fell 12%; Macromedia’s stock rose 8%.

Adobe Systems

Adobe is a company in the electronic document business. It owns the popular “pdf” (portable document format) standard which can be used to exchange documents in a platform-independent manner. The ‘look and feel’ of documents, even those with very complex, graphically intensive, foreign alphabets or unusual fonts can be distributed to users on different operating systems with the assurance that it will be reproduced on the computer screen.

This is achieved by giving away for free the ‘Adobe Acrobat Reader’ software. Revenue is generated by selling software which will allow document publishers to create documents in the first place. This free distribution of the Reader software has resulted in Adobe taking ownership of the standard format for electronic documents, namely ‘.pdf.’

In fiscal year 2004, Adobe had revenues of $1.67 billion, and was highly profitable, with net income of over $450 million. (See Exhibit 1). Adobe’s revenues and earnings had grown at annualized rates of 9.0% and 16.5%, respectively, during the previous 5 years. Analysts expected Adobe’s revenues and earnings to grow at annualized rates of 14% and 18%, respectively, for the next few years.

Macromedia

Macromedia produces software called “Flash” which allows web browsers to display moving images and movies in a seamless fashion. These movies often take the form of advertisements similar to those one would see on commercial television.

1 This case was developed by Steven J. Little (T’06) under the supervision of Professor Anant K. Sundaram at the Tuck School of Business at Dartmouth College, as a basis for class discussion. © 2006.

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Flash is often downloaded invisibly by users when they visit a website, and thus has become ubiquitous. Given the competitive nature of this industry segment, however, Flash is only one of several competing standards for web-browser movie display. Key competitors include Microsoft (Windows Media Player), RealNetworks Inc (RealPlayer), Apple (Quicktime), and Sun Microsystems (Java).

Macromedia generates income by selling a production suite called ‘Creative Studio MX’ which is used to put together the audio/visual elements of the web presentation. This is similar to the ways in which a film or video producer would use a traditional recording studio or video production suite. Macromedia also offers complimentary products, including the web-authoring software ‘Dreamweaver.’

At the end of the 2004 fiscal year, Macromedia had revenues of $436 million, and net income of $42 million. (See Exhibit 2). During the prior year, Macromedia’s revenues had grown by 18%, and analysts expected such growth to continue into the next few years.

Expected Synergies from the Acquisition

With the acquisition of Macromedia, the combined company would offer a full product suite of electronic publishing and distribution software, and provide the potential benefit of one-stop-shopping for publishers of all types. Adobe dominated the market for portable documents. Competitors such as Microsoft, Apple, and H-P had all previously tried to innovate in this segment, but Adobe had won the race. Thus, the company was regarded as having great skill in identifying emerging technologies having the characteristics of a “market standard,” as well as being aggressive in its ability to defend against imitation even in the face of much larger, resource-rich competitors.

Analysts expected Adobe to bring to bear these skills in its acquisition of Macro- media. Both revenue- and cost-synergies were anticipated from the acquisition. On the revenues side, given Adobe’s stronger relationship with developers and wider customer base, analysts felt that the company could increase Macromedia’s revenue growth rate by at least a few percentage points relative to its pre-acquisition level. Given Macromedia’s Profit-to-Sales ratio (which was less than 10%, compared to Adobe’s 27% and the industry average of 20%), the acquisition also provided opportunities for cost-savings. Analysts expected that, within a few years, Adobe could bring the target’s expenditures to its own levels (as percentage of sales) in such key areas of spending as cost of goods sold, R&D, and SG&A. Analysts also noted that Macromedia had extremely bloated levels of

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working capital, and that there was considerable opportunity for cash flow generation from being able to bring working capital down to Adobe’s much lower levels. Further, Adobe could obtain considerable capital expenditure savings at Macromedia, by limiting its growth to recent industry averages of 5% to 6% per year.

At the time of the acquisition, stock markets were pausing following a strong bounce from the bear-market lows of 2002. In the 12 months leading up to April 2005, the S&P had risen by 0.71%, and the NASDAQ had fallen by 4.39%. Long-term US Treasury-bonds (T-bonds) were yielding 4.60%. The market risk premium for US investors in early 2005 was generally estimated to be about 5%.

Despite the seeming opportunities for synergies, and the enthusiasm of Adobe’s CEO and board towards this acquisition, some observers were wondering if the offer of nearly $42 per share for Macromedia represented a give-away from the acquiring company’s shareholders to the target’s shareholders. (Data from a few recent comparable acquisitions are shown in Exhibit 3).

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Exhibit 1: Financial Data for Adobe Systems (Data in US$ ‘000 unless otherwise noted)

1Q 2005 FY 2004 1Q 2004 FY 2003

Sales 472,882 1,666,581 423,281 1,294,749 Cost of Goods Sold 25,097 96,065 22,425 85,885 R&D Expense 86,686 311,296 75,071 276,980 SG&A Expense 175,433 606,618 149,085 503,967 Depreciation & Amortization 14,954 60,808 13,438 48,470 Non-operating Income 6,073 16,851 3,001 1,045 Income Before Taxes 176,785 608,645 166,263 380,492 Taxes 24,891 158,247 43,228 114,148 Net Income 151,894 450,398 123,035 266,344

Cash and ST Investments 1,467,103 1,313,221 1,313,221 1,096,533 Accounts Receivable 166,540 167,440 167,440 174,042 Total Current Assets 1,699,939 1,551,029 1,551,029 1,329,028 Total Assets 2,122,810 1,958,632 1,958,632 1,555,045

Other Current Liabilities 445,613 408,216 408,216 399,093 Accounts Payable 38,575 43,192 43,192 37,437 Total Current Liabilities 484,188 451,408 451,408 436,530 Long Term Debt 0 0 0 0 Stockholder's Equity 1,624,565 1,423,477 1,423,477 1,100,800

Period-end Stock Price (US$) 63.76 62.31 36.45 41.65 Market Value of Equity 15,501,969 14,881,435 8,689,097 9,756,346 Capital Expenditure 11,512 63,226 14,444 39,454 Total Shares Outstanding 243,130 238,829 238,384 234,246

Price-to-Earnings (P/E) Ratio NM 32.97 NM 36.54 Market-to-Book (M/B) Ratio 9.54 10.45 6.10 8.86 Earnings per Share (US$) 0.62 1.89 0.52 1.14

Beta 1.51

Note: Cost of Goods Sold and SG&A Expense are net of depreciation.

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Exhibit 2: Financial Data for Macromedia (Data in US$ ‘000 unless otherwise noted)

FY 2004* FY 2003*

Sales 436,168 369,786 Cost of Goods Sold 31,493 29,314 R&D Expense 98,410 91,895 SG&A Expense 205,548 174,400 Depreciation & Amortization 25,697 24,120 Other Expenses 19,172 2,010 Non-operating Income 6,730 3,625 Income Before Taxes 62,578 51,672 Taxes 20,277 13,097 Net Income 42,301 38,575

Cash and ST Investments 106,854 92,662 Accounts Receivable 57,582 38,210 Total Current Assets 459,534 349,733 Total Assets 843,881 683,063

Other Current Liabilities 134,825 116,814 Accounts Payable 5,355 5,311 Total Current Liabilities 140,180 122,125 Long Term Debt 0 0 Stockholder's Equity 670,247 537,330

Period-end Stock Price (US$) 33.50 20.06 Market Value of Equity 2,681,039 1,291,463 Capital Expenditure 74,000 25,700 Total Shares Outstanding ('000) 80,031 64,380

Price-to-Earnings (P/E) Ratio 55.83 33.43 Market-to-Book (M/B) Ratio 4.00 2.40 Earnings per Share (US$) 0.60 0.60

Beta 1.92

Note: Cost of Goods Sold and SG&A Expense are net of depreciation.

* Fiscal year ends in March 4, 2005 and March 3, 2004, respectively.

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Exhibit 3: Recent Comparable Transactions*

Target Acquirer Date Deal Value Value/Sales Value/Net Income 1-Day 1-week 1-month ($ millions) Premium Premium Premium

Group 1 Software Pitney Bowes 4/13/04 417.06 3.51 43.78 39.5% 33.1% 58.2%

Netegrity Inc Computer Assoc 10/6/04 449.51 4.99 84.26 38.7% 55.6% 86.6%

Inet Technologies Tektronix 6/29/04 498.74 4.71 42.58 15.1% 18.6% 40.0%

Retek Inc Oracle Corp 3/8/05 648.67 4.34 107.44 87.5% 88.8% 79.1%

Barra Inc Morgan Stanley 4/6/04 825.56 5.43 27.50 9.0% 17.3% 24.1%

Ascential Software IBM Corp 3/14/05 1119.98 4.12 74.91 17.8% 17.0% 16.8%

Veritas Software Symantec Corp 12/16/04 13519.67 6.91 29.30 9.5% 23.5% 35.8%

* Prepackaged software industry, SIC code 7372

Source: Thomson Financial, SDC M&A database.

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