I have regularly commented on the EDA industry and discussed specific companies in the past, including Cadence (CDNS), Mentor Graphics, Magma (LAVA), and Synopsys (SNPS). Today I would like to take another look at Cadence, and examine what has changed since I last wrote about the company.
During the summer Cadence was rumored to be in buyout discussions with Blackstone (BX) and KKR (KFN), which I said were preposterous. The only company in the EDA industry that warrants a buyout is Mentor Graphics (MENT). Nonetheless, rumors seem to be persisting in the industry, telling of how clueless people are about how buyouts work, and what investors’ motivations are in such deals.
Cadence announced Q3 earnings on October 24, 2007 and the results posted were better than analysts had expected. Cadence Q3 revenue totaled $401 million with net income resulting in $97.4 million, versus $81.4 million YoY for the same quarter.
For guidance, Cadence predicted it would meet analysts’ expectations in Q4, and revenue would be in the range of $465 million to $475 million.
Regardless of beating analyst expectations, the market has not been kind to the stock. With a market cap of $4.9 billion and 268.8 million shares outstanding, CDNS closed at $21.69/share prior to announcing earnings on October 24, 2007. The following day the stock was downgraded, and closed at $19.32/share. The downgrading was due to a lack of faith in a new licensing model that will affect Cadence’s pipeline. In earnings discussions the company made a commitment to keep focused efforts on making sure that it would have strong technology offerings, and to keeping a management eye on the product pipeline, which in turn would keep the company successful. Analysts seem to (rightly) disagree with that conclusion.
Two acquisitions have provided Cadence with key ammunition in growth segments of the EDA business. Clear Shape and Invarium, both in the DFM segment, bring technologies that would have been difficult to develop internally. I am glad to see the infamous Mike Fister NIH (Not Invented Here) syndrome, a direct import from Intel (INTC), has not hindered Cadence in DFM, as it would have been absolutely fatal. [You can read more about DFM here.]
Cadence’s direction is to envelope the client and cover as many areas as possible under umbrella all-you-can-eat contracts. The company is placing a lot of bets on the introduction of a draw-down license, or EDA Card, in which Cadence found its customers buying more software through an umbrella license than through traditional product-specific ordering. This approach, which was started two years ago, has continued to grow revenues significantly, they claim.
The hope is to capitalize on what Cadence dubs “spontaneous demand,” and have the flexibility to meet the variety of needs at the moment they occur, and Cadence believes the company can generate more sales as a result.
The fallacy in the argument is that Cadence continues to sell its future short. These multi-year all-you-can-eat contracts, while introducing predictability into revenue streams, also take the punch out of technology breakthroughs, disruptive innovations, and associated upsides. The sales force, now incentivized with a commission structure to sell more of the very large all-you-can-eat deals, no longer pays any attention to point products. Yet, the irony of EDA is that any disruption, should it happen, would happen in the point products.
It is not an easy equation to balance - between umbrella deals and point products - since each have their pluses. However, the industry, as a whole, is still spinning in place, and nothing important has happened since I first wrote my article, "Future of EDA," which pointed out the dysfunctions.
Meanwhile, the rumor of a buyout is back, with a share price considerably cheaper at $17/share than the $23/share price of the summer. I still maintain, there is no upside in Cadence for a Private Equity firm, and not much for any investor, unless Cadence makes some very drastic steps to re-engineer the industry. That would mean mergers like ArvinMeritor Inc. (ARM) or KLA Tencor (KLAC), which would consolidate adjacencies of a significantly different scale. Should such deals be in the realm of possibilities, then a private equity buy-out may be a very interesting proposition.