Photoshop and Flash: Potent Combo

By Sarah Lacy The only surprise about the Apr.18 announcement that Adobe Systems (ADBE), the Silicon Valley software maker and member of the latest BusinessWeek 50, plans to buy Macromedia (MACR) for $3.4 billion in stock was how long it took to happen.

Rumors of an Adobe-Macromedia deal have been circulating for the better part of this decade because analysts always thought the two graphic-design software specialists could make a powerful combination to take on the likes of Microsoft (MSFT) and just about anyone else who ventured onto their creative turf. "In 10 years of software research this is probably the easiest deal I've ever seen in terms of explaining why it's going on," says Gene Munster, an analyst at Piper Jaffray.

STICKER SHOCK. The two businesses have the same goal: Break out of their successful little niches, sell publishing software to bigger companies, and duplicate their enviable success on the desktop computer in the growing market for so-called smart phones and other wireless devices.

More than half of Adobe's $1.7 billion in annual revenue come from selling its popular Photoshop and Illustrator products to creative types, most notably photographers and graphics designers. Macromedia makes 80% of its $370 million in annual revenue selling Web-design software Dreamweaver and Flash to the same clientele. In fact, nearly every PC sold today ships with the Flash software installed. Yet the two companies, both growing more than 20% per year, are selling to the same customers with barely any overlap in products -- a rarity in techdom.

If Adobe CEO Bruce Chizen manages the merging of the two companies well, analysts say the deal has little not to like, except its cost. Investors were initially put off by it -- Adobe shares lost 9.7%, to close at $54.77, on Apr. 18, while Macromedia shares gained 9.8%, to close at $36.72.

MOBILE OPPORTUNITIES. So what took so long to make this marriage a reality? Chizen said in an interview with BusinessWeek Online that it was a matter of timing (see BW Online, 4/19/05, "Macromedia and Adobe: Finally One"). He admits to talking with Macromedia executives about merging for years, but Adobe had been too focused on building its intelligent-documents business, anchored by the ubiquitous Acrobat software, which allows documents to be protected, collaborated on, and sent over the Web.

In the first quarter, Acrobat sales were up 42%, helping boost Adobe's overall revenues 12%, to a record $472.8 million (see BW Online, 3/21/05, "Adobe Keeps Surprising"). Profits were up 23%, to $151.9 million. "In a short period of time we've both been able to accomplish a lot," Chizen says.

But many analysts suspect the icing on the cake for Adobe was Macromedia's recent strides in the mobile handset business. Its popular Flash software, used for video and animation, has already been installed on 20 million handsets, and the San Francisco company just inked new agreements for Flash to be installed on Samsung's and Nokia's (NOK) new smart phones (see BW Online, 2/24/05, "Macromedia Looks Flash in Cell Phones").

It's a small business today, but a lucrative one. These handset makers are paying Macromedia as much as 50 cents per phone for the software. With more than 700 million cell phones expected to ship this year -- half of them with enough memory to use Flash -- those numbers could get big fast.

A BARGAIN? While Adobe has also made some deals to get its Acrobat software on cell phones, Macromedia's Flash is arguably a more compelling sell to telecommunications carriers because it helps them hawk more video, games, and other entertainment. In the PC world, Flash is already the dominant program for designing these applications. Acrobat could be a valuable tool for reviewing documents on a smart phone, but analysts expect that more money can be made delivering games, video, and animation.

Macromedia is a few deals away from having the same kind of ubiquity on handsets that it enjoys on PCs. That's why, despite the 25% premium Adobe is paying for Macromedia, some analysts think it's a bargain. "It's obvious what Adobe gets out of this. I was surprised Macromedia didn't play harder to get," says Martin Pyykkonen, senior analyst at Janco Partners.

That said, the mobile market is a small but growing piece of the pie right now for both outfits. While analysts expected the segment to make up a quarter of Macromedia's $370 million in annual revenues within two years, it may take five or six years to make that big a mark on the much bigger $2.5 billion combined company.

TRICKY BALANCE. In the meantime, there's still plenty of growth in Adobe's document-sharing and publishing business, a more recent addition to the traditional creative software. Chizen is slowly building a sales force that's closing multimillion-dollar deals with big businesses and governments, like Germany's post office and Britain's equivalent of the Food & Drug Administration, the Medicines & Healthcare Products Regulator Agency.

Adobe is one of the few software companies, like Microsoft and Symantec (SYMC), that's proving it can sell to consumers, small businesses, and big enterprises. Macromedia also has tried to sell versions of its software to bigger information-technology departments, but at a quarter of Adobe's size, it has fewer resources.

The documents business and the mobile-handset market could easily push growth into the 30% range, roughly double the expansion of both companies' core businesses. But it will be a tricky balancing act to keep those sectors growing fast while management takes on the integration.

SOFTWARE POWERHOUSE. Chizen says it's too early to detail much of the combined concern's product roadmap and is mum on the merger's layoff implications. But Macromedia will keep its hip San Francisco offices and, execs hope, its innovative culture. "Hey, that's why we bought Macromedia," says Chizen.

But if he can make the pieces fit the way many think they can, Adobe could be a software powerhouse for years to come. Lacy is a BusinessWeek Online reporter in Silicon Valley

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