The EDA tool space has been booming in this new “mobile era” of computing. As the world transitions to system-on-chip design methodologies, and as more teams are developing even more products for an ever-broadening set of end markets, the demand for ever more sophisticated design tools has only continued to skyrocket. After focusing on EDA’s largest player – Synopsys – in a prior article, I’d like to now shift my attention to the third largest (by revenue) player in this space: Mentor Graphics.
Some Quick Background
While I assume most long-time readers of SemiWiki are quite familiar with Mentor from a technical/product perspective, the company’s revenue base can be broadly classified into five different product/service segments: Scalable Verification, IC Design to Silicon, Integrated System Design, New and Emerging Products, and “Services and Other”.
Mentor’s Verification products essentially allow semiconductor design houses to determine whether a given chip functions as intended. As designs continue to balloon in complexity (for example, even the Apple A7 – which is a chip intended for a small smartphone – packs in over 1 billion transistors), the cost of finding out your design doesn’t work and that you need to go back and do another version (this means fixing the design, taping out, and then waiting weeks to get back the new samples from the fab) is non-trivial. Better verification tools mean lower development costs and faster time-to-market.
Mentor’s Calibre® tool family is a suite of tools that offers physical verification, transistor-level modeling and extraction, lithography, yield enhancement, and reliability measurement. In addition to the Calibre tools, Mentor offers its Olympus-SoC™ place-and-route tool. To augment the effectiveness of the Olympus-SoC tools, Mentor offers a platform known as InRoute™ which allows designers to use the wide variety of Calibre tools within the Olympus-SoC place-and-route tool.
Finally, Mentor offers a whole suite of products to facilitate with the design of PCBs, including its Expedition Series® aimed at larger enterprise customers, PADS® product line which is a lower cost product for Windows based systems, XtremePCB™ which allows multiple designers to edit a design simultaneously and XtremeAR which is a PCB routing product.
Digging into the Financials
Mentor Graphics’ share price, like Synopsys’, trades within a hair of its 52-week high (in the world of stocks, if your company is consistently trading near its 52-week highs, then you’re doing something right). The secular trends that drive the success of the EDA tool space are certainly clear: more complex chips designed to be built on increasingly complex manufacturing processes means that there’s an insatiable need for EDA tools. Further, the fact that – unless you’re doing your own in-house tools (and even companies like Intel that do their own tools in house don’t rely on them exclusively), you really only have three options: Mentor, Synopsys, and Cadence.
Indeed, the company’s most recent earnings report highlights a number of key positive trends. System and software revenue was up 7.3% on a year-over-year basis, gross margins (that is revenue less cost of goods sold) were up from 80.7% to 82.3% from the year-ago period, and operating margin was up from 8.3% to 10.5%. As far as the full year goes, the company reiterated its revenue outlook of $1.155B and bumped up its earnings-per-share forecast to $1.59, which is a solid $0.03 above Wall Street’s consensus. To top this all off, Mentor increased its share buyback authorization to $100M, up from $56M. Sales growth, margin growth, and what appears to be market share gains all point to a company that’s in great shape. In particular, there appears to be incredibly strong demand for Mentor’s emulation products as the increased complexity in IC design (thanks to much more advanced semiconductor processes) has moved more design teams to emulation for full-chip verification. This trend should only continue to play to Mentor’s strengths.
In addition, management had the following encouraging things to say on the call:
- The average annual run rate of the renewals in the firm’s 10 biggest contracts increased 90%
- 20 new companies in this quarter alone purchased the Calibre toolset (bringing the total number of purchases to over 1250)
- Among the top five emulation bookings during the quarter, four of the companies were first-time emulation customers, and three of those were top 20 semiconductor companies. In addition 3 of the top 10 semiconductor companies in the world either have evaluations for Mentor’s emulation tools in progress or are looking to expand current install bases
Now I would like to look at Mentor from two angles: a discounted cash flow basis (which allows me to use my estimate of Mentor’s future cash flows to determine the fair value for the stock today) and from a more chart-based perspective. As far as Mentor’s stock goes, it is in a very obvious uptrend:
As was the case with Synopsys, the stock is nicely above all of the key moving averages (and recently tested and successfully rebounded from the 50-day moving average – which many market technicians believe to be a key indicator of a stock’s “health”). Further, the shorter-term moving averages are very cleanly above the longer-term moving averages, which is a further sign that the stock is in pretty good shape. The chart here doesn’t lie: investors aren’t going to let this one dip too far before buying.
But what is the company actually worth? Assuming that the company can earn $1.59/share this year (as per management’s expectations), and assuming that the company can drive a few more points of operating leverage against a high single digit/low double digit long term growth rate, it’s not tough to justify a fair value range of $25-$28 today, which would represent anywhere from 12%-26% upside from current levels. Not a screaming buy, but the shares certainly don’t look particularly expensive. In fact, that’s probably the most frustrating thing about the EDA stocks: they’re great companies operating in a near-ideal environment (and Mentor is particularly interesting given the trend towards using its emulation tools), but it’s almost always priced in.
Also Read: A Brief History of Mentor Graphics
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