Mentor Graphics Leads in Chip Software - Barron's

Mentor Graphics (MENT) may be surprisingly insulated from the semiconductor slump, writes Barron's Jay Palmer, and the firm's earning power could help shares jump 30%.

Not all investors are enthusiastic about the stock. Mentor lost money in three out of four quarters last year, is carrying a large debt load, and faces weakness in the global semiconductor industry. Little surprise then that the stock is trading around $6.76/share, down from a 12-month high of $16.

However, the company may see its fortunes turn around more quickly than rivals' when the economy starts to recover. An unusually large number of the company's three-year contracts are up for renewal this year, and analysts think many customers will not only renew their contracts but increase the size of the contracts as well. The increases are expected to average around 10%. Mentor's single most important product, its Calibre software for verifying that a chip design works, has become the industry standard, and the company has 1,000-odd diverse applications for designing and testing chips and circuit boards.

Mentor is the No. 3 player in the field, behind Synopsys (SNPS) and Cadence Design Systems (CDNS), but Mentor looks more appealing for multiple reasons. Unlike rivals, it books sales as soon as the orders come in, so its bottom line should improve more quickly when the economy rebounds. Its stock is also cheaper than rivals on the basis of enterprise value to sales. Mentor could also become a takeover target; Cadence tried to buy the company last summer, and could try again when the economy settles down.

Mentor's earnings are likely to rise to $0.36-0.40/share this fiscal year, potentially doubling last year's $0.20/share. Earnings could rise to more than $0.60/share in 2010 and 2011. As a result, the stock could climb around 30% over the next 12 months.

One clear negative: recent acquisitions have pushed Mentor's long-term borrowings to $220M, or 31% of its capital. However, very little of the debt comes due in the next few years, and the company has $96M in cash and untapped credit lines.

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• Mentor Graphics: FQ4 EPS of $0.35 misses by $0.04. Revenue of $242.6M (-14.8%) vs. $248.3M. (PR)

Comments

[WJS:]

Some considerations:
- The 12-month high of $16 happened when Cadence offered $16 a share for Mentor. Outside of the acquisition window the high is more like $12.
- Mentor has a great franchise with Calibre and probably will renew most of the contracts that are up this year. However, their customers' revenue is down 20% - 50% y/y. Assuming a 10% average increase in contract size makes no sense in this semi environment. Mentor will do well to maintain the current annual run rate.
- "Unlike rivals, it books sales as soon as orders come in". True, but that makes the stock unattractive. SNPS, CDNS, and LAVA have gone to a model where revenue is recognized over the life of the contract, not upon booking. These companies have 90%+ of next quarter's revenue sitting in backlog today while Mentor has more like 50%. Mentor may get a big revenue pop when a bunch of contracts renew, but quarter-to-quarter predictability is poor.

May 04 11:39 AM

[han kim:]

Cadence still trying to buy Mentor? No way. Mentor will never sell unless the price is 200% of what Cadence may ask.

Cadence, instead, should strenghten themselves with acquiring sign-off tools like ExtremeEDA (to compete with PrimeTime) and
then try to integrate into SOCE. Also, intergrate the RTL compiler
into the backend tool as much as possible to smooth out the
transition from the front to backend.
I hope that the top management can understand the bottom-up approach.

May 15 09:07 PM

[airbossnj:]

I concour with both above sernios and can only add that someeone (insider) places his/hers comments here. Without some positive note i'll be dumping big time because i don't want to sit on this non-reconized unit. Barron's I beleive threw us all a curve ball--please correct me if you think otherwise!

Jun 09 04:27 PM