H & Q Part 3
June 17, 1999 - 9:04pm
Hambrecht & Quist
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Date: 6/18/99
3 of 4 DAC '99 Preview; Tackling Tough Problems in the Big Easy
Next week, EDA and SIP vendors will meet in New Orleans for the 36th Annual Design Automation Conference (DAC). DAC serves as the most significant conference for chip design tool providers, and typically announcements at DAC highlight the key issues facing the design community. We believe that the critical issues involve the next-generation of design tools for 0.18-micron designs, the recovery of the semiconductor industry and signs of life in Japan.
Growth for the majors will come primarily from winning larger contracts from a well-defined set of key customers.
The EDA industry is characterized by a relatively well defined set of large customers, including integrated device manufacturers (IDMs), fabless semiconductor companies and electronic systems vendors. The addressable customer base grows somewhat; for instance, we have recently seen new communications semiconductor companies grow into large EDA purchasers. Despite modest growth in the customer base, EDA vendors rely primarily on increasing budgets at the large customers, such as Intel, Sun Microsystems and Motorola. These increasing multi-million dollar contracts are subject to intense scrutiny and professional, down-to-the-wire negotiation at the end of each
quarter. We view this as a challenge for the whole industry as it becomes increasingly difficult for large EDA players to grow faster than EDA budget growth. Given the concentration of the customer base, it is also relatively easy for new start-ups to identify and target leading EDA purchasers.
Customers appear willing to pay large licenses and royalties for only the highest value SIP. The semiconductor intellectual property industry has matured over the past two years, resulting in several notable winners. The SIP model has proven to be a viable one for many smaller companies seeking to capitalize on design expertise in given segments, but perhaps not surprisingly, few businesses have proven able to scale into publicly-tradable franchises. The embedded
microprocessor companies, MIPS and ARM, have been able to carve out large 50+ million unit opportunities where the license fees and royalties are compelling for the public market investor. Rambus has targeted a billion unit market, DRAM, with a proprietary licensable interface and should see tremendous growth over the next 2-3 years. Artisan Components has carved out a position selling broadly applicable fundamental physical libraries and memories tuned for the
leading foundries. We expect a few more leading SIP companies to reach the public market, most likely in the analog/mixed-signal area where the value proposition is high and SIP clearly differentiated. We continue to believe the challenge for SIP companies is to find a market where the business can scale to a compelling size and where differentiation is long-term and sustainable.
Efforts by the majors to grow beyond EDA are still in their infancy.
The large vendors, such as Cadence, have struggled to grow beyond EDA, a relatively well defined industry with somewhat limited headroom. Recently the EDA industry underwent a large push into design services which has turned out to be somewhat of a failure. Cadence was the most notable proponent of the design services strategy, and under-performance last year in services appear
to have been the key underlying reason that Cadence stumbled this year.
Though there are some compelling segments in design services, the original vision of being a general design outsourcer appears to be fundamentally flawed. Design services, unlike many forms of consulting, is about getting a product out the door in a set timeframe, and managing that process can be tricky and easily unprofitable. We believe that in some areas of services,
such as methodology consulting and select verticals, there can be profitable growth. We do not think services alone will propel an EDA company beyond the boundaries of the EDA industry, at least without sacrificing profitability. We do think that strategic moves into system-level tools (e.g., software - hardware co-design & co-verification), embedded software and software development tools seem like more logical extensions of an EDA franchise. We are beginning to see moves in that direction, particularly by Synopsys and Cadence, but these are still relatively small efforts. The largest opportunities for growth by the major EDA companies will likely come at the expense of the other leaders.
PUBLIC COMPANY PROFILES:
ARM Holdings (ARMHY/$32.75/BUY)
*We expect ARM Holdings to report a solid June quarter, with the potential for modest upside to our estimates of $22.1 million in revenue and earnings per ADR of $0.05.
*The company continues to show good momentum in the royalty side of thebusiness driven by solid growth in the digital cell phone business.
*In 1998, approximately 50 million ARM-based processors were shipped. Webelieve that in 1999, that number could jump to between 125-150 million. ARM's average per unit royalty into this market will decline over the year mitigating the royalty growth potential, and we might expect a $0.12 average royalty by the end of they year.
*Licensing remains solid, with several key renewals this quarter, including Lucent and LSI for the ARM9E processor launched in May, which has enhanced DSP
capabilities.
Artisan Components (ARTI/$9.75/MARKET PERFORM)
*We expect Artisan to report a solid quarter on both the licensing and royalty front, meeting or exceeding our estimates of $4.30 million in revenue and a loss per share of $0.04.
*The company received its first royalty check from TSMC this quarter according to plan, and we believe royalties have the potential to ramp faster than the current model reflects.
*We remain somewhat cautious on the overall revenue size of the addressable market for physical libraries and believe that the transition in the physical libraries business (driven by Artisan's introduction of the free library model) creates some risk for of all the players in the market.
*The company's CFO recently resigned for personal reasons, and the company is in the process of recruiting a new CFO.
Avant! Corporation (AVNT/$13.19/MARKET PERFORM)
*We do not expect the Xynetix and Chrysalis acquisition to close this quarter as previously expected, so we are going back to our prior estimates of $70.5 million in revenue and EPS of $0.42. We expect Avant! to report a solid quarter in-line with these estimates.
*Avant! has a compelling flow (called SinglePass) centered on their Apollo place-and-route tool and tied together by the company's unified MilkyWay database. Cadence is moving towards a single database approach with their Genesis database project, a testament to the success and leadership of Avant! with this flow for deep submicron design.
*Avant! is building a credible presence in the front-end of the design flow and has made several strategic acquisitions over the past year, including interHDL for RTL verification and analysis and Chrysalis for formal verification.
*Our MARKET PERFORM rating is a result of the ongoing civil and criminal litigation against the company which has heavily depressed the shares. The fundamentals argue for a BUY rating. We expect the criminal trial to begin in late September and the civil trial to begin in early October.
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