Mention semiconductors and chip giants such as Intel Corp., Advanced Micro Devices Inc. and NVIDIA Corp. spring to mind, but there are other, less high-profile companies, operating in the space that deserve attention.
The pandemic has kept semiconductors firmly in the spotlight as a host of industries, from consumer technology to the automotive sector, wrestle with chip shortages. Software companies Synopsys Inc. SNPS, +2.20% and Cadence Design Systems Inc. CDNS, +3.81% may not be household names but are quietly playing an extremely important role in the broader semiconductor industry.
Synopsys and Cadence build Electronic Design Automation, or EDA, software, a crucial tool for chip design engineers. In a recent note, J.P. Morgan analyst Harlan Sur described chip design software as a critical, but often overlooked, part of the semiconductor value chain. Companies like Synopsys and Cadence own more than 70% of the chip design software market, he explained, noting that chip design is tied to semiconductor research and development budgets, which don’t get cut in downturns.
“These companies have historically grown their revenues even in times of semi cycle downturns,” Sur wrote.
Sur pointed out that over the past 11 years, which spans three semiconductor down cycles and three years of semiconductor revenue declines, EDA revenues, and therefore Synopsys and Cadence revenues, have grown every year.
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Last month, fueled by fiscal second quarter revenue and earnings that topped analysts’ expectations, Synopsys raised its full-year guidance. In April Cadence also raised its financial forecast for the year, boosted by better-than-expected performance in its fiscal first quarter.
Chip design activity remains strong, thanks to complex next-generation chips from the likes of Intel Corp. INTC, +2.19%, Advanced Micro Devices Inc. AMD, +3.21%, NVIDIA Corp. NVDA, +5.17%, Broadcom Inc. AVGO, +1.96% and Marvell Technology Inc. MRVL, +2.58%, according to J.P. Morgan’s Sur.
The adoption of custom chip designs by cloud giants Alphabet Inc. GOOGL, +4.67% GOOG, +4.16%, Amazon.com Inc. AMZN, +2.53%, Meta Platforms Inc.’s META, -3.93% Facebook and Microsoft Corp. MSFT, +2.57%, as well as the likes of Apple Inc. AAPL, +3.51%, Juniper Networks Inc. JNPR, +2.75%, Cisco Systems Inc. CSCO, +1.94% and General Motors Co. GM, +3.04%, is also driving an increase in the number of chip engineers, Sur wrote. These companies have a need for EDA chip software tools, he added.
Set against this backdrop, J.P. Morgan continues to see a 10% to 15% revenue compound annual growth rate (CAGR) for Synopsys and Cadence, 80% to 90% gross margins, as well as a recurring revenue profile of 80% to more than 90%. “We believe EDA remains a very attractive part of the overall semiconductor value chain,” Sur wrote.
FactSet data show Synopsys and Cadence have returned 14.4% and 12.8%, respectively, over the past year, compared with the S&P 500 index’s SPX, +2.73% decline of 11.75% over the same period. Both companies’ had record closes on Dec. 27, 2021, with Synopsys’ stock closing that day at $375.59 and Cadence shares closing at $191.65.
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In April Synopsys also announced a deal with Juniper to form a new, separate company focused on open silicon photonics, which will provide technology for the telecom, healthcare, data communications, high performance computing, artificial intelligence, optical networking and light detection and ranging (LiDAR, or remote sensing) industries.
Of 14 analysts surveyed by FactSet, 13 have a buy or overweight rating on Synopsys and one rates the company as underweight. Of 15 analysts surveyed by FactSet, nine have a buy or overweight rating on Cadence, five have a hold rating, and one has an underweight rating.