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Shares of Cadence Design Systems (NASDAQ:CDNS) traded with losses of around 4% halfway through Tuesday's trading session. The leader in global electronic design innovation and silicon intellectual property announced that it has entered into a definitive agreement to acquire Tensilica.

The Deal

Cadence Design Systems announced that it has agreed to acquire Tensilica, a leader in dataplane processing IP, for a total consideration of $380 million in cash. Combined, the firms will deliver more optimized IP solutions for mobile wireless, network infrastructure, auto infotainment, and home applications. Tensilica employs some 200 workers who serve more than 200 licensees, including seven of the top 10 semiconductor companies. Since its inception, the company has shipped over 2 billion IP cores. CEO Lip-Bu Tan commented on the deal:

With Tensilica, we will be able to provide designers with a more complete SoC solution that will speed the development of innovative and differentiated products, while reducing time to market. We look forward to working with Tensilica's dedicated employees as one team to bring even more value to our customers.

The company anticipates to finance the deal with cash at hand and an existing credit facility. The purchase price includes a net cash position of $30 million, held by Tensilica, putting the effective price tag down to $350 million.

Tensilica reported full-year revenues of $44 million for the year ended December 2012. As such, the deal values the company at roughly 8.0 times annual revenues. Cadence did point out that revenue growth averaged some 35% over the past two years, and that the company was profitable for the year. As a result, the deal will be slightly dilutive to non-GAAP earnings for fiscal year 2013 due to merger-related costs. The deal is expected to be accretive to full-year 2014 earnings.

Cadence expects to close the deal in the second quarter of its fiscal 2013. The deal is furthermore subject to normal closing conditions, including regulatory approval.

Valuation

Cadence ended its fiscal year of 2012 with $827.0 million in cash, equivalents, and short-term investments. The company operates with $447.0 million in convertible notes outstanding, for a net cash position of $380 million. Cadence reported full-year revenues of $1.33 billion for 2012, on which the company net earned $439.9 million, or $1.57 per diluted share. Earnings were severely inflated as a result of a negative income tax provision of $251.7 million. Excluding this and other one-time charges, net income came in at $216.7 million.

The market currently values Cadence around $3.9 billion after Tuesday's declines. This values operating assets around $3.5 billion, which values the firm's operating assets around 2.6 times annual revenues and 16-17 times 2012's non-GAAP earnings.

Cadence Design Systems does not pay a dividend at the moment.

Some Historical Perspective

Shares of the company have been suffering for a long time, with the exception of the last years. Shares peaked around all time highs of $37 back in 1998, and have traded in a wide trading range between $10 and $30 for the next decade. Shares hit lows of $3 during the 2008-09 recession, but have gradually made up some of its lost ground, currently exchanging hands around $14 per share.

Between 2009 and 2012, the company has aggressively grown its revenues again, as 2009's performance was severely impacted by the recession. Revenues grew a cumulative 55% over those years to $1.33 billion, while the company returned to profitability in the last three years. At the same time, convertible offerings resulted in a 10% dilution of the shareholder base over the period.

Investment Thesis

Cadence stresses that the deal with Tensilica is one of a strategic nature. The purchase price, at 8.0 times annual revenues, represents a massive premium compared to Cadence's own valuation at roughly 2.6 times annual revenues. Given that Cadence is willing to spend up to 10% of its market capitalization, it is understandable that investors of Cadence are cautious. A 5% decline in the share price suggests investors think the company is overpaying for Tensilica.

Yet CEO Tan stresses that the combination will accelerate IP development and integration, while providing more extensive support network covering IP and tools. The deal would also lead to shorter time-to-market lead times and an optimized power performance. As a result of the deal, the full-year revenue guidance of $1.405-$1.445 billion for 2013 will translate into a guidance of roughly $1.45-$1.50 billion. The guidance for GAAP earnings between $0.58-$0.68 per share and non-GAAP earnings between $0.82 and $0.92 per share for 2013 will become a little too optimistic.

Overall, shareholders have their concerns, but have already disapproved the deal by sending shares lower on Tuesday. The deal will most likely have long-term benefits. However, at the current valuation of 2.4 times 2013's full-year revenues and roughly 20 times annual earnings, there are few reasons to pick up shares with a convincing argument.

Source: Cadence Design Systems - Shareholders Not Applauding Strategic Acquisition Of Tensilica