One less publicly traded EDA company soon

Just saw the news that Synopsys bought Synplicity for $227 million, a 50% premium over its closing price of $5.3/share.   So the number of publicly traded EDA companies continue to shrink, and thankfully there’s no more rumor of private equity firms taking EDA companies private (as if they would!…).

I actually bought SYNP a month ago ~$4.15/share, but sold it a few days ago to lock in a 25% return.  After the selling, I was wondering why SYNP was holding on to its price while all markets were tanking.  I guess SNPS now gives us the answer.   Could have made much better return if waited a few more days, but then again, if I can predict that well, I would rather having bought puts on Bear Sterns early last week!

Blood on the streets – EDA Sector III

A lot had happened in the past week: USD tanked, Bear Sterns was essentially given away to JP Morgan, and Fed just cut another 75 bps this morning. Nonetheless, none of these really changed the picture of the EDA sector much, so that will be another blog entry to come. For now, let’s turn the focus back on the EDA sector.

In my last entry I mentioned PDFS enterprise ‘cash value’. Please understand that they are not just ‘cash’ but consist of ‘cash’ cash, short term securities, and account receivables. However, one of the things that people found out these days is that ‘cash’ may not be what it seems. Also, if your clients go bankrupt, it would be hard to get any money on your receivables. Nonetheless, I don’t think PDFS is in any liquidity crunch, and none of their clients are fly-by-night semiconductor manufacturers (as if there’s any now given how costly it is to build or maintain a fab), so EVEN if they have ‘non liquid’ cash right now, their cash position should be fine as time pass.

Also, in my last blog entry, I mentioned only the enterprise ‘cash’ value for PDF stock, but mentioned nothing about their earnings. This is actually deliberate, as I am not counting on PDF doing any great business in the short term or even long term. That does not mean that earnings are not important. They are actually very important. It’s just that I don’t want to paint a picture that makes the readers of this blog believe that I have clear ideas of what their earnings can be or will be. That’s a question that’s best for readers to find out themselves. To do that, one can get analysts’ reports, or do their own analysis from the company reports. Nonetheless, people should remain highly skeptical of what analysts write, as they are mere projections, and projections only. One can pick up all kind of analyst reports on Bear Sterns in the past few months, and I can guarantee you that none of them ever projected it to be $2/share. Similarly, if you read analysts reports when PDFS was at $15/share a little more than a year ago, I sincerely doubt that they projected that PDFS would be at ~$5 today.

With that said, why would someone invest in PDFS then? For me, it’s the enterprise value that gives them the buffer to weather the current rough environment in the semiconductor industry, and the expertise they have in the DFM area. As long as they can stay in business, and that DFM is getting more important for designs, and that PDFS management do not make too many mistakes (like blowing their cash away), PDFS has a fighting chance to see its stock goes higher. I don’t know how high it can go, but I would not be surprised to see it going to $7/share (~40% higher than today, but still a tad below its rapid drop from $8/share to $6/share in one day). Of course, it can also go a lot higher, or cut to its enterprise value (or much below that). However, I think the chance for it to go higher is good, although I have no idea when that will be, or what will trigger that.

This brings us back to the other two cut-in-half stocks, CDNS and MENT. These two do not have as good as the ‘enterprise cash value’ as PDFS, but they have product franchises that people are unlikely to switch in the near future. CDNS has place-and-route, simulation, and many more, while MENT has great DRC and PCB franchises.

CDNS, along with SNPS, are currently the only two vendors that can provide an all-you-can-eat product mix, all the way from front-end design to back-end design and beyond, for semiconductor vendors. People might criticize this pricing model, but this is a great model for CDNS and SNPS to shield themselves from more agile and innovative smaller companies, while in the same time allowing them to purchase smaller rivals. In a downturn, this pricing model is particularly attractive to large clients and hurtful for smaller EDA vendors. Engineers might love smaller vendors with more innovative tools that make their jobs easier, but in a downturn, unless those tools can provide very significant differentiation and benefits, it would be very difficult to justify purchasing a new tool versus getting something from the salad bar that CDNS or SNPS provide which might not be the best tools, but could somehow get the job done.

The all-you-can-eat model is a potent model that only CDNS and SNPS have, and that defines the intrinsic value of CDNS. Also, CDNS has gone through this cut-in-half cycle many times now, and if the rumor was true that they depleted their revenue due to their talk with private equity (I have no idea if this was true, and have no way to verify it), they can gradually build that up again although it will take time.

Like PDFS, I have no idea how CDNS can turn things around or what they would do for growth. However, at ~$10/share, I think it could be a good bet that they are close to a bottom, and if semiconductor industry becomes healthier, they can at least ride the tide and get a better pricing, like ~$12.5 (mid way between the one day drop from $15 to $10). Again, it can go much higher, or much lower, and only time will tell.

The last cut-in-half stock is MENT, and to me it’s the hardest to assess the risk/reward potential. MENT has a great DRC franchise which provides it with steady and growing revenue. However, MENT had not been able to grow much more beyond that in the last few years. Also, unlike CDNS, it cannot offer a buffet style product mix, which is a disadvantage in the eyes of large semiconductor clients. Furthermore, if the DRC franchise somehow comes under furious attack, MENT does not have many other growth areas to buffer the blows it may suffer. From that perspective, the risk is therefore potentially higher for MENT.

Nonetheless, the DRC had been a great franchise, and there’s no imminent threat that I know of that MENT currently faces which might displace Calibre in the near term. MENT also has many smaller products which have potential, although they do not currently provide as much meaningful revenue and growth like DRC for MENT. In addition, financially it does not have nearly half of the stock price in cash as PDFS does, and it has quite a bit of long term debt as well. (Not that these should matter at all if MENT continue to excel in business)

The strategy I have for MENT was to write puts at $7.5, which means that I am fully willing to hold MENT if it ever falls below that. This allows me to get the premium from the puts, but does not give me the upside if MENT stocks continue to advance. It will be much better if I can write puts at $5, but I don’t get any good premiums from that, though. I am however, quite comfortable with the current strategy.

An upcoming part IV will conclude the EDA subject.

Blood on the streets – EDA sector (II)

Since my last entry on EDA, Synopsys has reported earnings, and the results was quite good. Compared with the cut-in-half crowd, i.e. CDNS, MENT, and PDFS, this should show that the problems for the cut-in-half crowd were mostly company related, not a dramatic change in the industry. There might be many structural problems for the EDA industry, but it does not just suddenly get worse and overwhelm all candidates in the industry. If that’s the case, Synopsys would not be able to escape it.

Almost all the cut-in-half companies had experienced the ‘cut-in-half’ phenomenon before, and so industry followers should not be too scared by this, and as long as there’s no sudden change to the entire industry (e.g. silicon has just been replaced by a new material, and all design methods have changed; or semiconductor companies suddenly form a new consortium, and vow not to buy software from EDA vendors anymore; or a new startup is on the horizon and will nullify the entire design methodology from front-end to back-end, and affect all the cut-in-half crowd, etc.), the companies could just be repeating their previous cycles.

The EDA industry has many problems, with the biggest problem in growth of the entire industry revenue base. However, this is an industry that won’t go away as semiconductor companies are not keen on setting up their own shops to replace the EDA vendors. Except for the FPGA vendors, it just does not make sense for most semiconductor companies to have an internal EDA group to design software so customers can use their chips. Even for FPGA vendors, they depend greatly on EDA companies to help them design their own chips.

For the cut-in-half crowd, the most interesting one to me is PDFS. In time of crisis, the best thing to look into is the balance sheet. In this case, PDFS has a strong balance sheet. Ignoring all else, and using only total current asset to account for its asset base, and subtracting all liabilities, PDFS has > $60 million. Assuming the absolute worst case that PDFS will not get any revenue (i.e., $0) in subsequent quarters, and assuming that it will spend the same amount as in last year, PDFS will still be able to survive for at least 1 more year. Basically, the amount is ~$2.25/share in (cash – liability), assuming no significant dilution in the future. Current share price is $4.81.

Another intrinsic value for PDFS is the DFM expertise it has. It’s always difficult to find good employees, no matter if you are looking for a design engineer, a nurse, or a maid. However, in the DFM space, even mediocre workers are hard to come by. There’s just not many people who has experience in semiconductor manufacturing yet wanted to work in the EDA industry. And while the DFM space has promised for quite some time that the time will come for great need for DFM but yet not there, it’s certainly closer to that point than a few years ago with 45mm fab now being built and operated. This pool of experienced employees are therefore of good value to large EDA vendors such as CDNS and SNPS, or to semiconductor equipment companies, or semiconductor manufacturing companies.

While it’s easier to establish a floor price for a stock, it’s much harder to say when is the best time to sell. That highly depends on how much risk one is willing to take, the overall environment at that time, and what one think is the fair value for a stock, and that’s different for different people of different personality and faith.

Some will argue that PDFS will go lower, or we can wait until the stock price comes down to the cash value of the stock, as it happened with Numerical Technologies before, and it’ll be better to buy at that time. That may very well be, but it does not have to be either. In hindsight, we will all be able to say what’s the best price of entry, but without knowing the future, it will only come down to whether one wants to take the risk or not. I am currently averaging down, but only time will tell if that’s a right decision.