CSFB:BUY,PC is winning wrt PKS
Action: We are lowering our investment rating on Synopsys from strong buy to
buy based on the following reasons:
Technology Transition: Physical Compiler appears to be tracking well on soft
metrics, but the overall timing appears to be stretched and the relative
financial impact of the upgrade cycle is likely lower.
Recent Changes in Licensing Mix: Multi-year TBLs have constituted a more
meaningful percentage of license revenues in the past 3 quarters. Revenue
quality has therefore been more aggressive.
Business Model Transition: We estimate that a "transitioned" approach will be
multi-quarter and is likely to materially impact FY01.
Investment Outlook: . While Synopsys remains our top-pick in the EDA sector,
the stock is likely to trade in a range ($30-$40) over the next few months..
Price Target Mkt.Value 52-Week
06/28/001 (12mo.) Div. Yield (MM) Price Range
USD 35.88 $42.00 $0 None $2,550.7 $75.63-34.38
Annual Prev. Abs. Rel. EV/ EBITDA/
EPS EPS P/E P/E EBITDA Share
10/01E $3.20 11.2X 58% $
10/00E $2.60 13.8 54%09/99A $2.64 13.6 47%
Jan. April July Oct. FY End
FY2001E $0.70 $0.75 $0.82 $0.93 Oct.
FY2000E 0.68 0.53A 0.64 0.75 Oct.
FY1999A 0.58 0.62 0.68 0.76 Sept.
ROIC (09/99) NA
Total Debt (09/99) $29.4mm
Book Value/Share (09/99) $11.69WACC (09/99) NA
Debt/Total Capital (09/99) NACommon Shares 71.09M
EP Trend2Est. 5-Yr. EPS Growth 20%
Est. 5-Yr. Div. Growth NA
1On 06/28/00 DJIA closed at 10,527.8 and S&P 500 at 1454.8.
2Economic profit trend.
Synopsys has emerged as the second largest electronic design automation (EDA)
software and services provider, with TTM revenues of over $800mm. Synopsys has
established a franchise in the front-end segment of the market around the
triumvirate of DesignCompiler, VCS, and PrimeTime. Already a key force in
physical analysis with EPIC, Synopsys is selectively targeting growth
opportunities in physical design.Investment Summary
Update on Physical Compiler Upgrade Cycle: Physical Compiler is Synopsys'
front-end solution to the "physical synthesis" challenge. With more than 15,000
installed seats of Design Compiler (Synopsys' flagship logic synthesis product
line) along with a very competitive "physical synthesis" offering, we have
argued that Synopsys is very well positioned for the upcoming retooling cycle.
In April, we suggested that partly due to "incomplete" front-to-back single
vendor solutions and partly due to a lack of technology differentiation, users
were only buying the minimum new technology for their most aggressive design
starts. Thus, we argued in favor of a 2H00-biased retooling cycle ramp.
Competitive forces notwithstanding, Physical Compiler continues to gain traction
vis-à-vis Cadence's PKS (placement-knowledgeable synthesis) based on the
metrics (as of F2Q: 119 active customer engagements and 14 tapeouts, vs. 51
engagements and 6 tapeouts quarter-over-quarter; unofficially number of
tapeouts now exceeds 20).
There are three issues related to the technology upgrade cycle that should be
updated:
Impact on Design Compiler: With the ramp in Physical Compiler, it has become
evident that Synopsys' workhorse Design Compiler will now decline sequentially
. not off a cliff but not a soft landing either. Clearly, the combination of
PC and DC during FY00 will exceed product revenues for DC during FY99, but
customer transitional issues prevail.
Pricing Environment: Competitive cut-throat pricing has been scaled back,
however, 1Q EDA sector product revenue analysis suggests continued y/y pricing
declines. Additionally, Synopsys (like Cadence) is burdened by the relative
discounting expectations of larger customers who have multi-year time-based
deals coming up for renewal. This dynamic is likely to dampen near-term growth.
"Compelling Value" of Upgrade?: The incremental data on Synopsys' Physical
Compiler is generally positive as mentioned. However, during our discussions
with users at DAC (anecdotally, not statistically sampled), it appears that the
"compelling value" for upgrading from Design Compiler to Physical Compiler is
not perceived to be strong. Phrased differently: Given the "price of
admission" to Physical Compiler, customers are taking the opportunity to assess
alternative new technology offerings (spanning the gamut of Magma, Monterey,
Silicon Perspective, etc.) before making a material financial (and more
importantly, production design flow) commitment.
On the margin, we are more concerned about the two latter points, rather than
the expected impact on Design Compiler. Synopsys appears to be grappling with
the tough challenge of price elasticity of demand for Physical Compiler . how
quickly should adoption be driven vis-à-vis smaller competitors while garnering
sufficient value from a customer-base that appears to be exerting continued
pricing pressure?
While we continue to believe that Synopsys' market position should enable the
company to emerge as the key established-EDA-vendor through this technology
retooling cycle over the next 12-18 months, we incrementally believe that the
near-term transition is likely to be rocky.
Looming Business Model Transition: Over the course of the past three weeks,
Synopsys' management has caused some uncertainty in the market regarding the
company's licensing model. This has been further complicated by every sell-side
analyst injecting an opinion about which direction Synopsys should take, and
about what the impact on forward projections is likely to be. Indeed, as
recently as June 7th, we chimed in emphatically with "no accounting issue".
In the weeks that have followed, we have uncovered some issues that now concern
us. Before addressing these concerns, however, some background information is
warranted:Time-based Licenses: Over the course of the past 2-3 years, Synopsys
transitioned their licensing model to incorporate one-year time-based licenses
(1-yr TBLs). The company targeted about 25%-35% of license revenues to be
1-year TBLs. We have applauded the transition, despite the initial growth
impact, because of the relative visibility and predictability as compared to
traditional perpertual (PERP) licenses.
What's the accounting issue?: Specifically, a Technical Practice Aid (TPA)
appended to SOP 97-2 by an AICPA committee (TPA 5100.53). Basically, the "
clarification" suggests that time-based licenses of 12-months (or lesser)
duration should be ratably (equally per quarter) recognized for revenue
purposes. For the CPAs, the details can be found at: http:/www.aicpa.org/
members/div/acctstd/general/tpa3.htm
How does this impact Synopsys?: Based on our prior analysis, we had estimated
that about 25% of recent quarterly product revenues were of the 1-yr TBL ilk.
Based on this "exposure", we suggested that a) any small impact would simply be
a one-time change in revenue manadated by an arcane accounting ruling, and b)
to consider the very simple "innovation" of a 13- month or 367-day license.
What has changed?: Apparently, with all the licensing changes taking place in
the industry, we had not stayed on top of some recent dynamics at Synopsys.
Figure 1 summarizes the essence of what we were assuming for product revenues by
license type, and our current interpretation after spending additional time
with the company. A description of the various licensing models is provided as
an appendix to this desknote.
Rather than divert the focus from what matters, we will simply state that a) the
disparity is likely due to our mis-interpretation, and b) there is no
guarantee that the "now" analysis is 100% fool-proof (i.e., the EDA industry and
companies like Synopsys have not done a fantastic job of explaining the various
licensing models and related revenue recognition schemes. |
