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Synopsys (NASDAQ:SNPS) is a long-term growth story in the chip designing space. Its technology is used in designing modern chips which is continuing to drive its long-term revenue growth at a CAGR of around high single-digits. Its Internet of Things (IoT) and big data products enjoy significant competitive edge over products developed by other chip-designing software makers. Long-term investors can buy the company’s shares around the current price for making significant profit. I published an article on Synopsys earlier in January 2020. Since then, the stock rose significantly. I believe now we should take a fresh look on the stock, and therefore I am writing the current article.
Synopsys is a global leader in supplying the electronic design automation (EDA) software. Chip designers use the software to design and test integrated circuits (ICs). The company also provides semiconductor intellectual property (IP) products, which are pre-designed circuits used in the chip designing process. The company’s customers use its technologies in the chip designing process for low power as well as reliability, mobility, and security incorporated in modern complicated chips.
Growth Drivers
IoT-Related EDA Products
Synopsys’ primary growth driver is the growing IoT market. The company’s EDA products are developed keeping in view the IoT-related semiconductor chips. Chip designers use the company’s EDA products to automate the chip design process, and to reduce errors, which leads to more powerful and strong designs. The advent of AI (artificial intelligence) and ML (machine learning) is also boosting the demand for the company’s IoT-related EDA products. With the expansion of cloud-based data storage, the demand for EDA products on the cloud is increasing. Synopsys’ cloud-based EDA products for IoT offer customers scalability and flexibility, as a result of which the company’s EDA products beat competitor products. I believe the company’s IoT-related EDA products could continue to drive its long-term revenue growth in a sustainable manner.
Big Data and Analytics Market
Synopsys’ another growth driver is the big data and analytics market. After collection, big data is transmitted over wireline or wireless data networks, which are then processed in data centers, and analyzed using analytics in data centers. For processing and analysis of big data, GPUs and FPGAs are required, which have huge processing power for their massive parallel processing capabilities. EDA and IP products developed by Synopsys can be used for designing and testing of GPUs and FPGAs, also known as data center accelerators. According to a report:
The global data center accelerator market size is projected to grow from USD 13.7 billion in 2021 to USD 65.3 billion by 2026; it is expected to grow at a CAGR of 36.7% from 2021 to 2026.
The expected growth of the data center accelerator market at a significant rate could meaningfully boost Synopsys’ long-term revenue growth.
Competition
The field where Synopsys operates is highly competitive. The company’s competitors include Cadence Design Systems (CDNS), Siemens EDA (formerly Mentor Graphics Corporation) (OTCPK:SIEGY), Keysight Technologies (KEYS), Checkmarx Ltd., Veracode (now part of Thoma Bravo) and Micro Focus International (MFGP). Synopsys competes with these companies on the basis of product quality, product ease of use, and customer support.
Synopsys’ primary competitive advantage is that its Silicon to Software technology leads to increase designer productivity and efficiency by automating tasks. The technology also helps designers by adding intelligence to the design process, and by reducing errors. The company’s another competitive advantage is that it has remarkable digital and custom IC design capabilities. Its Fusion Design Platform for this purpose comes with innovative technologies, a common foundation, and flexibility. The platform helps customers reduce design times and risks and decrease uncertainties in design steps. As a result, the product enjoys strong demand and beats competitor products. Both the competitive advantages help Synopsys strengthen long-term revenue generation process.
Third Quarter Fiscal Year 2022 Results
The company’s third quarter fiscal year 2022 revenue came in at $1.248 billion, compared to $1.057 billion in the year-ago period, a year-over-year increase of 18%. The company’s non-GAAP net income for the quarter came in at $327.4 million, or $2.10 per diluted share, compared to $284.5 million, or $1.81 per diluted share in the year-ago period. Non-GAAP EPS increased 16% year-over-year.
The company delivered impressive results for the third quarter of fiscal year 2022. Top-line increased driven by the company’s customers’ increasing investments in more complex chips, more sophisticated systems, and more software. Bottom-line increased driven by the company’s stringent cost-control measures and broad-based strength in the company’s different technological portfolios. Many systems companies in the world from large hyper-scalers to AI startups have decided to design their own chips and systems to accelerate their differentiation, and Synopsys is successfully helping these companies in their journey to chip and systems design. As a result, Synopsys is being greatly benefitted in terms of strong revenue generation.
The company’s DSO.ai artificial intelligence design solution is a game changer design in AI-related chip design. The solution delivers outstanding productivity improvements in designers, and results in significant reduction in turnaround time and compute resources. I expect DSO.ai would significantly boost the company’s revenue growth in the coming months and years.
Valuation
Synopsys’ peer group companies include Cadence Design Systems, Keysight Technologies, Dassault Systèmes (OTCPK:DASTY), Atlassian Corporation (TEAM), and Roper Technologies (ROP).
|
SNPS |
CDNS |
KEYS |
DASTY |
TEAM |
ROP |
|
|
P/E Non-GAAP (FY1) |
33.29 |
35.80 |
23.25 |
– |
130.78 |
27.38 |
|
Price/Sales (TTM) |
9.11 |
11.98 |
6.00 |
8.63 |
18.62 |
6.63 |
|
Price/Cash Flow (TTM) |
26.26 |
34.71 |
27.88 |
28.17 |
59.45 |
27.87 |
(Data Source: Seeking Alpha)
Synopsys is fairly valued compared to its peers. The company has a balance sheet consisting of cash and equivalents of $1,383.6 million, and total debt of $669.1 million. The company’s revenue has grown at a CAGR of 12.68% in the last five years, and I believe revenue would continue to grow at a CAGR of high single-digits in the next five years. The company’s IoT and big data products could drive revenue growth in the next five years and support premium valuation in the same timeframe. By premium valuation I want to mean 20-30% higher valuation multipliers from the current level. In addition, long-term revenue growth could result in significant upside for the company’s stock. Long-term investors can buy the stock around the current price.
Assuming Synopsys’ revenue will grow at a CAGR of 9% in the next five years, I will find out the company’s long-term (five-year) share price. The company’s trailing 12-month revenue is $4,949.70 million, and at a CAGR of 9% the company’s end-2027 revenue will be $7,617.00 million, or $49.81 per share. In the last three years, the company’s shares have traded between the price to sales multiples of 5x and 15x. I expect in the next five years the company’s price to sales multiple will touch a high of around 12x driven by long-term demand (beyond five years) for the company’s chip designing products. Applying a price to sales multiple of 12x on Synopsys’ end-2027 revenue per share, I get $597.72 as the company’s end-2027 share price.
If the company’s revenue fails to grow at a CAGR of 9% and grows at a substantially lower rate driven by increasing competition in the EDA and IP market, its shares could perform badly in the long term. This is a key risk related to the valuation of the stock. In that case the valuation multipliers could shrink as well. However, given the company’s bright track record to bring innovative products to the market, I expect it will beat competitor products by a wide margin.
Risks
A large part of the company’s revenue comes from the commencement of new design projects by semiconductor manufacturers, systems companies and their customers. The increasing complexity of designs of ICs could lead to a decrease in design starts and design activities in future. As a result, the company’s revenue growth and profitability could be negatively impacted.
The industry in which Synopsys operates is characterized by rapid technological changes. In order to stay relevant, the company has made substantial investments for new product development, and for enhancing existing products as well. However, if the company fails to stay relevant in future, its revenue growth and profitability could be negatively impacted.
Conclusion
The company has made tremendous revenue growth in the past from its EDA and IP products. I expect the company will continue to generate significant revenue growth in the long term, albeit at a slightly lower growth rate due to increasing competition in the EDA and IP market. As I said above, I expect the company’s long-term revenue would grow at a CAGR of around 9% in the next five years, which coupled with valuation multiplier expansion, would lead to significant appreciation for the company’s long-term share price. Long-term investors can buy the company’s shares around the current price.
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