Very nice story in the Interactive Version of Barron's only at (for interactive WSJ subscribers only): interactive.wsj.com
Too bad that it's not in the print edition and would be seen by a much wider audience.
Ian.
++++++++++++
DECEMBER 21, 1999
Cadence Shares Start to Pick Up the Beat
By Carolyn Whelan
This holiday season, nifty, multi-function consumer electronics devices like
screen phones and DVD-equipped PCs will take center stage.
So, it's no surprise that the sale of software and
services for combining applications on one tiny chip
(called Electronic Design Automation) -- and the
tools that enable that process -- are going gangbusters.
So, why has the stock price of EDA market leader Cadence Design Systems
been treading water since April?
Cadence's stock was badly battered after Wall Street soured on its
aggressive pricing policies, optimistic revenue recognition and the flat revenue
it expected this year. From March 25 to April 20, the stock lost over 60% of
its value. It's been stuck in the mid-teens ever since.
Software companies traditionally earn revenues from licenses. Much like car
rental agencies, they collect money over time as customers take out a
long-term lease on their intellectual property.
Until recently, the norm for software
licensing was known as Perpetual
Licensing, under which companies paid
for, say, a 99-year lease to access the
technology, and revenue was
recognized up front.
But, to stimulate demand and keep
sales growing during a semiconductor
downturn, the company introduced a
new three-year model called
Flexible-based licensing. It also
recognized revenues from software immediately. But to bring in more
business, Cadence heavily discounted services and offered cut-rate financing,
which outraged the investment community.
"It's not so much that they missed numbers, but the generous terms they were
giving customers," explains Jennifer Smith, a senior software analyst at Dain
Rauscher Wessels who upgraded the stock on October 12 to Buy from
Neutral. "That hurt cash flow and increased debt."
But some think Cadence has cleaned up its act, books and house, and that its
share price should follow suit.
Indeed, the company now uses a subscription-based licensing model, which
lets it record revenue as it gets paid.
"While it penalized short-term earnings, it's a major positive," declares Bill
Wilby, portfolio manager of the Oppenheimer Global Fund. "It should smooth
the earnings stream." (According to Morningstar, Wilby bought 470,000
shares of Cadence at the end of August).
"The investment community likes [the] subscription model. [It's a] more
conservative model with better visibility," Cadence's Chief Financial Officer
Bill Porter tells Barron's Online. "30% of our software bookings will be under
these new licenses, and we were able to achieve a 45% target [of new
bookings in the third quarter]."
"The third quarter was going to be good, and their metrics [look] better in
subscription-based licensing," says Smith.
And the overall 2000 outlook looks brighter, too, helped by the appointment
of a new CEO in April -- Ray Bingham, Cadence's previous CFO.
And then there's the market's incredible momentum. As manufacturers strive
to make things smaller, smarter, faster and cheaper, EDA software sales are
expected to more than double to $6.1 billion in 2003, from the $2.9 billion
expected this year, according to Dataquest, a unit of the Gartner Group.
Cadence has the largest share, or 28%, of that market, though archrival
Synopsys is catching up (see Weekday Trader "Synopsys Shows that
Runner-Up Can Finish First," April 29). Since April, Synopsys' shares have
gained 21%, to close at 59 1/4 on Tuesday.
But it's not necessarily a zero-sum game "Cadence and Synopsys are
exceptionally positioned to capture a great share of what we see as a rapidly
growing market," says Wilby.
Moreover, says Tom Rath, portfolio manager of the Safeco Income Fund,
Cadence should benefit from new products and a continuing up cycle in
semiconductors.
"Semiconductor stocks are being valued pretty high, and so should design
automation [stocks]," says Smith.
Especially Cadence, some say. "The stock was exceptionally oversold,"
claims Wilby, who started buying Cadence shares in March and added to its
position as late as October.
Trading late Tuesday at 19 3/16, Cadence is still a whopping 42% off the high
of 33 1/2 it set in January. It does sell at 52x expected 2000 earnings of 37
cents, according to First Call -- a huge premium to its 15% long-term
earnings growth rate.
But its 2001 P/E of 23x the 85 cents it is expected to earn that year is only
about 1.5 times that long-term growth rate and is a nice discount to
Cadence's average P/E of 26x over the last five years.
"All [EDA] companies are beneficiaries of a reacceleration of revenue growth
in the EDA industry, and we felt that Cadence was the cheapest way to play
that," says Rath.
That may be why three firms boosted their ratings on Cadence in December:
SG Cowen to Buy and Morgan Stanley Dean Witter to Strong Buy -- both
from Neutral ratings -- and Credit Suisse First Boston upgraded the stock to
Buy from Hold.
Still, Cadence's earnings probably won't pick up before the second half of
2000, and the problems may have caused the company to lose at least some
of its edge.
"Though all this turmoil, they lost their innovative approach to technology,"
says Smith And the ability to prove that they have 0.18-micron technology [a
smaller chip size] is key to their success."
Others worry about a recent exodus of top-level managers, though Cadence
claims it wants a flatter organization. Finally, new competitors -- or
technologies -- could leapfrog Cadence: Synopsys, for example, is clearly
gaining ground.
Still, says Wilby, "[Cadence's] leaders have gotten pretty good at watching
technology developments like a hawk,".
And so have investors looking for a reasonably priced stock with good
growth prospects. |
