Update: Adobe to buy Macromedia for $3.4 billion

Adobe Systems has reached a definitive agreement to acquire Macromedia for $3.4 billion in stock, the company said Monday.

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The deal would combine the companies' document management, Web publishing, and online video delivery tools, putting Adobe squarely in the path of rival Microsoft, analysts said.

Between the two of them, Adobe, in San Jose, California, and Macromedia, in San Francisco, have some of the most widely-distributed software in the world. Adobe's portable document format (PDF) and Acrobat Reader software is common on most desktops, and Macromedia's Flash products are widely used to create and view animation, video, and other content.

Historically, the companies made their money selling illustration and graphic design software, such as Adobe PageMaker and Adobe Illustrator, or Macromedia Freehand.

The Macromedia name will live on as a software brand, but if the deal goes ahead the merged company will be called Adobe Systems, company executives said during a conference call with analysts and press.

While the companies hope to realize cost savings in the first year of combined operation, in the long term the deal is all about growth, executives said.

"I see this as both companies bulking up against Microsoft," said Steven Brazier, an analyst at Canalys. The first step will be both vendors supporting each other's formats, and Adobe will likely start integrating Flash into its products, Brazier said.

Company executives declined to comment on their plans for joint product development, pointing out that until the acquisition is completed, they must continue to operate as two separate companies. The merger is subject to approval from shareholders and regulators.

Adobe has traditionally been strong in the offline graphical design business, such as desktop publishing, while Macromedia has a presence in graphical user interfaces for the desktop with its Dreamweaver and Flash products. The merging of these two businesses would give Adobe new capabilities for delivering rich media tools, analysts said.

During the conference call, analysts repeatedly raised the question of a possible antitrust investigation of the market for illustration tools like Freehand and Illustrator, but company executives were dismissive of the possibility.

"There's a lot of competition in the market. CorelDraw outsells both of us in Germany, and there are open source products like Killustrator. We don't see it as an issue," said Adobe Chief Financial Officer Murray Demo.

There may be more for antitrust authorities to worry about than Demo thinks, however: the developer of Killustrator changed the project's name to Kontour after being threatened with legal action. Kontour was distributed as part of the KOffice desktop software suite, but development of Kontour has been stopped, according to the Web site of the KOffice project.

Adobe also stands to benefit from Macromedia's base of ColdFusion Wed developers, allowing it to integrate and automate new offerings, according to RedMonk analyst James Governor.

Governor predicted that dynamic forms that allow users to create, change and share information online will be one of the first products of the marriage. Graphics automation is also in the cards. Both of these capabilities would fly in the face of Microsoft's plans, according to Governor.

"Adobe's ambition in this acquisition looks like a bit of a Longhorn killer to me," Governor said.

Microsoft has been working on dynamic form technologies and a graphics system called Avalon as part of its upcoming operating system, Longhorn. By moving into these areas, Adobe may be trying to cut the software giant off at the pass, both analysts said.

"There is no doubt that this is a significant competitive threat to Microsoft and one of Adobe's goals is to predict future battles," Brazier said.

The combined company would be able to create a variety of rich media and Internet applications that use Flash, bumping into areas that Microsoft has shown interest in, said Ovum analyst Bola Rotibi.

"When you think of where Microsoft is headed with the future of its Media Player and Media Center PCs, this goes head-to-head," Rotibi said.

The difference, however, is that the Microsoft offerings are locked into one platform, whereas Adobe will be trying to get its products on multiple platforms, she added. The company is looking to deliver content and applications not just to desktops, but to cell phones and other devices.

But while Adobe and Macromedia have a lot of strengths and products between them, the question now is what the big strategy is, according to Rotibi.

"Integration of products is one thing, but creating a new lineup is something else," she said.

The deal, which has been approved by both boards of directors, will see Macromedia shareholders receive 0.69 shares of Adobe common stock for each Macromedia share they hold, Adobe said in a statement. Based on Friday's closing prices, this values each Macromedia share at $41.86, considerably above the market value of $33.45.

The top two executives at Adobe will retain their positions once the acquisition has been completed, which is expected in the second half of the year. Bruce Chizen will remain its chief executive officer and Shantanu Narayen will remain president and chief operating officer. Macromedia's president and chief executive officer, Stephen Elop, will become president of worldwide field operations at Adobe.

(Peter Sayer in Paris contributed to this story.)