Investors fret over Synopsys licensing practices
By Michael Santarini
EE Times
(07/13/00, 2:31 p.m. EST)
SAN MATEO, Calif. — Uncertainties over Synopsys Inc.'s software licensing practices have contributed to the downward slide of the company's share price, which fell to $32.5625 on NASDAQ on Tuesday (July 11).
Synopsys' stock topped $75 in December but has fallen since, most drastically in recent weeks, after Jessica Kourakos, a financial analyst with Goldman Sachs, and then Erach Desai, an analyst with Credit Suisse First Boston, issued reports that questioned licensing strategy of the EDA industry's revenue leader.
In a desknote report, Kourakos — who currently lists the stock as an "outperformer" — predicted that Synopsys would lower its guidance for fiscal '01 to account for the conversion of its Time Based Licenses (TBLs) to more predictable subscription-based licenses. Kourakos said that a move to a more conservative subscription model could benefit Synopsys, and advised investors to take advantage of Synopsys' low stock price.
Then two weeks later, Desai downgraded Synopsys from a "strong buy" to a "buy," based largely on Synopsys' rapid adoption of the multi-year TBL.
In a desknote report sent to clients, Desai noted that 48 percent of Synopsys' revenues for the second quarter of fiscal 2000 were derived from multi-year TBLs. Desai had expected 30 percent of revenues to come from TBLs.
Desai said he fears Synopsys' heavy use of TBLs is inflating revenue in the short term, and that subsequent quarters may be weaker than expected.
Desai and some analysts frown upon multi-year TBLs because they closely resemble the flexible-access model (FAM) licensing once used by Cadence Design Systems Inc., and seen as a leading factor in Cadence's stock drop in the first quarter of 1999.
Under FAM and multi-year TBL models, companies recognize 100 percent of the revenue from a multi-year product license up front, rather than over the 12 quarters during which customers make payments on the license.
"Customers are thinking that cash and budget are coming from future years, while these EDA companies are recognizing them now," said Desai. "Whereas if you had people buy perpetual licenses, you couldn't discount them at levels you can with FAMs and then the customers would have to come back repeatedly. Maybe they wouldn't come back with the same volume, but over three years, they would buy more copies and give EDA companies a renewing revenue stream. With FAMs and long-term TBLs you have stuffed the pipeline."
Desai said he does not want to see Synopsys' multi-year TBLs go over 25 percent of revenues. "It is merely a personal metric and doesn't have to do with any detailed analysis," he said. "We don't want a repeat of what happened to Cadence."
Desai said he prefers to see EDA companies use subscription, perpetual or one-year TVL licenses, because discounts are less prevalent and they allow for a more reliable tracking of revenues.
Brad Henske, chief financial officer at Synopsys (Mountain View, Calif.), said Synopsys will not repeat Cadence's FAM incident from the first quarter of 1999. Henske and financial analysts said that when Cadence made its transition from FAM licensing, FAM had accounted for over 90 percent of the company's quarterly revenues, which adversely affected the long-term outlook.
Synopsys has been moving its licensing mix from a heavy use of perpetual licenses to a greater number of time-based licenses in order to realize greater returns, Henske said. The company is currently looking for the right mix of licensing options, he said.
"The logic behind doing it [moving to a greater mix of time-based licenses] is pretty simple," said Henske. "If I sell you a perpetual license for piece of software, you are sort of done forever. We have Design Compiler customers that paid us whatever price ten years ago, and they are getting these considerable upgrades with magnitudes better performance on maintenance. We have been getting a small maintenance stream from that. If you sell them a three-year license, in three years they will be back."
In the second quarter ended April 29, Synopsys gathered 25 percent of revenue from perpetual licenses and the rest from "time-based licenses of various terms," Henske said.
Jay Vleeschhouwer, an analyst with Merrill Lynch, said that he and other analysts have been anticipating a move by Synopsys since last month's Design Automation Conference to a heavier use of short-term, time-based licensing models.
"The shares have been under pressure due to the expectation that this shift would be set in place at least starting with fiscal year '01," said Vleeschhouwer. "The interim result of which would be to lower reported revenue growth expectations from current estimates. That direction and uncertainty over the precise change have been pressuring the stock."
This transition, along with a deceleration in new Design Compiler licenses, has led Merrill Lynch to maintain an intermediate neutral rating on Synopsys shares, Vleeschhouwer said.
Synopsys is expected to announce results for its third quarter ending late this month in mid August.
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