EDA vendors get squeezed on two fronts Bolaji Ojo (06/13/2008 12:36 H EDT) Precision is what the electronic design automation market is all about. And generally, customers believe EDA companies have, over the decades, invented tools that have fostered design accuracy in the semiconductor engineering community. Yet, at the very moment that accolades and financial recognition should be pouring in for the industry-s contributions to the rapid expansion of the high-tech market, EDA vendors are feeling more like orphans. Buffeted by the negative effects of poor and often erratic sales growth, weak leverage with customers, muddled pricing strategies and bloated operating costs, the EDA market is reeling as stockholders and private-equity investors shy away from even the better-managed companies. What's more, in a sector where innovation comes more from garages than corporate labs, an appalling dearth of startups, coupled with the growing dominance of three or so big companies, is creating concern about the industry's ability to renew product offerings fast enough to support customers. "It's an understatement to say that the EDA market is staring at a bleak future," said Sramana Mitra, an entrepreneur and industry consultant. "There is not enough growth in the industry, because there is not enough design expansion going on for the market to benefit from volume growth. I am not at all optimistic about the market. It's got all kinds of structural problems." EDA executives agree there is an urgent need for a comprehensive reevaluation of the industry's role in the semiconductor food chain. Among issues that companies such as Synopsys, Cadence, Mentor Graphics and Magma Design are dealing with internally--but that executives acknowledge are industrywide concerns--are how to expand the range of products offered to jump-start sluggish revenue growth, a constant criticism leveled against the sector by analysts. Additionally, all the leading players are introducing new pricing mechanisms to reinforce their positions with customers. A longer-term goal is for the industry to align its sales much more closely with those of its semiconductor customers, said Mitra. "EDA is a must-have product, but nobody wants to pay enough for it," Mitra said. "The size of the EDA market is minuscule compared with the value it brings. They need to get royalty from the volume and not just the design." Many of these issues won't be resolved for some time. In fact, getting chip customers to pay royalties based on IC unit shipments may be a nonstarter, especially since the three top EDA vendors appear to have adopted a different strategy of per-use licensing. The absence of clarity on the future of the EDA market has left the publicly traded vendors without a clear growth story for investors. The companies' huge gross-profit margins, in the range of 70 percent to 80 percent, don't trickle down to the net-income line, whittled down by outsized selling, general and administrative costs, and high R&D expenses. While EDA companies grapple with these problems, investors are already delivering their verdicts on their ability to resolve them quickly. The leading EDA vendors are getting clobbered on the equity market, their market values trailing by huge margins those of comparable companies in the semiconductor industry. Cadence Design Systems Inc. has been hit especially hard in the past six months. Although president and CEO Michael Fister has tried to energize the company through acquisitions, cost-cutting and boosting R&D to penetrate new markets, a recent slide in sales has many wondering if Cadence's previous single-digit to double-digit growth pace over the past four years is sustainable. Late in January, Cadence's share price sank to $9.89, its lowest level in almost a decade, giving the $1.6 billion revenue company a sharply reduced market value of $2.5 billion, vs. the 52-week-high capitalization of $6.1 billion. As of the middle of last week, Cadence shares were trading at around $11.25, for a $2.9 billion market value. By comparison, analog chip vendor Intersil Inc., with annual revenue far below Cadence's at just $757 million, had a market capitalization of $3.2 billion on the same day. The market value of mixed-signal IC supplier National Semiconductor Corp., which has slightly higher sales than Cadence, was $5.51 billion. Investors winced when Cadence announced late in April that 2008 revenue would be in the range of $1.49 billion to $1.54 billion, forecasting a slight decline from the prior year on what Bill Porter, then newly appointed chief administrative officer, described during a conference call with analysts as "a more difficult environment." Sales-timing issues are not the only problem facing EDA vendors. A look at their financials shows why they are compensated with such tepid valuations by investors. Their gross-profit margins are lofty enough to rank among the highest in the industry. For their last fiscal year, for instance, Cadence, Synopsys and Mentor Graphics recorded respective gross-profit margins of 87 percent, 81 percent and 85 percent. That compares with 52 percent for Intel Corp., 64 percent for National and 57 percent for Intersil. The positive comparison falls off rapidly from here. Operating expenses as a percentage of sales for the three EDA companies are vastly higher than for their IC counterparts. For Synopsys Inc., operating income as a percentage of sales in the past six years has been either negative or not higher than 10 percent, compared with 14 percent for Intel and 17 percent for both National and Intersil. This is a familiar refrain for other EDA companies, mainly because of the high sales, general and administrative (SG&A) and R&D funds the industry needs in order to sustain sales and renew its product base. While most semiconductor companies devote about 10 percent to 20 percent of sales to research and development, for instance, the numbers can be as high as 30 percent or 35 percent for EDA companies. "This is a tough business," said a spokesman for Cadence. "You have to invest in R&D to innovate and survive." The risk is that investors will see these numbers and tune out. In an already tough financing market, many private-equity firms shun the EDA market because startup activity is limited. That's due not only to rising vendor consolidation programs at chip makers, but also to pricing strategies adopted by companies such as Cadence, Synopsys and Mentor to squeeze out newcomers. "The large companies have invented this all-you-can-eat business model that will keep everyone else out," said industry consultant Mitra. "There is no incentive for equity firms to invest in the market, because not enough small companies are being formed." The irony is that Cadence's new pricing strategy was supposed to give it a competitive edge over rivals. But the company appears to be taking flack from investors over the erratic sales pattern resulting from that move, as customers push out orders and payments. For instance, second-quarter sales at Cadence are forecast to be in the range of $310 million to $320 million, or about 20 percent lower than the $391 million the company reported in the comparable quarter of 2007. CEO Fister attributed the decline to timing. "I think, realistically, that in this environment customers will take more time [to close deals]," Fister said in the April conference call. "So, we factored that into our outlook for the year. If we close business and some of it is going to move out beyond this year, that-s what is really driving the decrease." Cadence is not the only one caught in this revenue-recognition time warp, however. Virtually all the leading EDA companies are facing the same problem, although vendors like Synopsys have found some ways to reduce the impact of the timing problem. In the three months ended April 30, for instance, Synopsys- revenue rose to $325 million, up 11 percent from $292.93 million in the year-ago quarter. Chairman and CEO Aart J. de Geus attributed the improvement to the company-s strong market position and its efforts to penetrate new businesses through its acquisition of Synplicity. "Based on our business currently running ahead of plan, the closure of the Synplicity acquisition, what we see out of a healthy pipeline of opportunities and steady organic growth, our objective for 2009 is to reach double-digit revenue growth again," de Geus said. While the equity market has rewarded Synopsys for meeting and even exceeding its numbers, the company isn't really valued at the same rate as comparable companies outside of EDA. That's because Synopsys, like Cadence, still faces problems that are industrywide rather than company- specific. Cadence's equity decline, while more virulent than that of other EDA suppliers, was no aberration. It's symptomatic of an industry still struggling to find its rightful position and get the financial respect top executives believe it deserves, but which they can't seem to secure. http://www.eetimes.com/news/design/showArticle.jhtml?articleID=208403911 --

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