STOCK: SNPS | 9/14/20 FIRST FOCUS

SYNOPSYS, INC. (Ticker: SNPS) LBIRLBIRLBIR Recommendation RecommendationRecommendation

Stock Price: $203.3 (9/11/20) Company Size: $30.85B Author: Madhu Chaudhary

Company Rank: 282 Sector: Technology Industry: Semiconductors

Synopsys, Inc. is a technology company that provides designing and verification as well as intellectual property solutions primarily to semiconductors and electronics manufacturers.

IN THIS FIRST FOCUS WE’LL COVER:  Summary of the Business Synopsys provides silicon design and verification, intellectual property, and application security Grab-and-Go solutions.

THESIS  Recent Developments Synopsys continued to see stable growth trend in Q3 An investment in Synopsys is a play FY20. Top-line growth slightly outperformed on increasing use of electronic chips in consensus as some of the revenue shifted out of Q4 everyday objects as the world becomes into Q3. Profitability margins showed steady more interconnected. The company is improvement as company continues to enjoy one of the leading EDA software and benefits of economies of scale. IP solutions providers in the world. The company’s success depends upon  Competitive Environment its ability to onboard large and Synopsys operates in a competitive industry in technologically advanced electronic which it holds a strong market leading position as manufacturers as long-term clients a result of continuous innovation and expansion of while continuously expanding its its solutions and IP portfolio. solutions portfolio through consistent  Conclusions/Recommendations innovation and inorganic Although the company operates a strong cash flow acquisitions. generating business, current valuation leaves only

marginal upside given its moderate growth profile. We assign a “YELLOW LIGHT” rating to Synopsys.

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0.94 STOCK: SNPS | 9/14/20 FIRST FOCUS

Data as of 9/11/20 unless specified

Revenue Fwd $3,971M Enterprise Value: $30.79B Market Cap: $30.85B (TTM): ($3,511M) Fwd (TTM) 7.7x YTD Return: 42.3% RSI: 45.85 Price/Sales: (8.8x) Gross Margin Revenue Growth 78.6% 6.24% ROIC (TTM): 27% (TTM): (TTM, YoY): 200-day Moving 52-Week High: $230.2 52-Week Low $104.9 $171.49 Avg.

EBITDA $1152M CFO $1010M FCF $768M

Insider Transactions: In 2020, Chi-Foon Chan (co-CEO) has sold 416,767 shares, Aart de Geus (co-CEO) has sold 168,924 shares, Joseph Logan (CMO) has sold 137,099 shares, Trac Pham (CFO) has sold 47,645 shares, and John Runkel (General Counsel) has sold 49,629 shares.

contributes 90% of the total top line of the SUMMARY OF BUSINESS  company, out of which, 58% comes from EDA Synopsys provides Electronic Design and 32% from IP & system integrations. This is a Automation (EDA) software solutions that are mature business and generates an operating used by engineers to design and test integrated margin of 29%. circuits or chips used in electronic devices. The Software integrity segment: Through this company was founded in 1986 by Aart de Geus segment, Synopsys provides software tools who still serves as its Co-CEO and Chairman. which are used in application testing for Listed in 1992, Synopsys has grown into a global detecting security and integrity loopholes in company with offices in 120 countries and application coding. The company entered the headquarters in California. application security business through acquisition Synopsys’ business operations are divided into of Coverity in 2014 for $350 million. Since then, two primary segments: - this segment has grown to contribute 10% of the Semiconductor and system design segment: This overall business of the company. Operating is Synopsys’ core segment and comprises of tools margin of software integrity products has and softwares which the company provides for significantly improved from 9% in 2018 to 13% in designing and verification i.e. testing of silicon 2019. Synopsys was named as a leader in Gartner chips. The segment also includes Synopsys’ magic quadrant for application security testing proprietary IP solutions which it licenses to chip by a significant margin in 2020. developers and earns royalties. This IP is used as EDA input to construct a larger silicon chip, thus 10% helping speed up the whole semiconductor IP & System 32% building process. As of 2019, it was the second 58% Integration Software largest semiconductor IP revenue generating Integrity entity in the world, behind ARM Ltd which has been just acquired by NVIDIA. The segment Source: Synopsys, Inc. 10-K

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0.94 STOCK: SNPS | 9/14/20 FIRST FOCUS

Semiconductors and system design customers primarily include semiconductor and electronic US system manufacturers such as Intel Corporation, IBM Foundry, MagnaChip, Dongbu HiTek, 23% Europe SilTerra, TSMC, etc., while customers of software 47% 9% integrity segment include companies from a Korea 11% variety of sectors such as electronics, financial 10% Japan services, media, automotive, healthcare, energy, etc. Intel is the largest customer of the company and accounts for 13% of the total business of Synopsys. Source: Synopsys, Inc. 10-K Synopsys has three streams of revenue generation. Revenue from licensing of various ◼ Total Addressable Market (TAM) software to customers is recognized in a time- As per Grandview research, electronic design based manner over the period of contract which automation software market stood at $8.7 billion typically approximates three years. IP product in 2019 and is expected to reach $14.54 billion by sales and hardware sales are recognized upfront 2025, growing at a CAGR of almost 9%. Synopsys in the period when transaction is made. is the global leader in EDA solutions and is well Maintenance and service revenue is recognized placed to take advantage of this growing trend. over the maintenance contract term. Investors must note that 90% of company’s revenue is As per recent report released by IP nest, Synopsys recurring in nature and is comprised of time- holds 18.2% of the global IP revenues, which based products, multi-period IP contracts, and totaled to almost $4 billion in 2019. With the semi- maintenance and services. As of Q3 FY 20, conductor markets expected to grow at a CAGR unrecognized revenue stood at $4.6 billion, out of of 6% between 2019 and 2022 as per statista, we which over $600 million were part of non- expect IP licensing market to expand at the same cancellable commitments. rate. As per Grandview research, Application security market size stood at $4.9 billion in 2020 and is Time-based expected to reach $10.7 billion by 2025, growing 15% products at a CAGR of 17%. This brings Synopsys’ 19% Upfront combined total addressable market at $18.6 products 66% billion. Maintenanc e & Service ◼ Special/Unique Characteristics of the Company Source: Synopsys, Inc. 10-K Synopsys holds a broad portfolio of well accepted Although United States is the largest market for intellectual property rights which it licenses to its Synopsys, the company’s sales are well customers for streamlining and improving their diversified across geographies. IC manufacturing process. As of FY 19, it had

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more than 3,200 US and foreign registered Synopsys has been a major beneficiary of the patents. technological advancements experienced in the last decade. In recent years, there has been a Synopsys typically enters into long term tremendous increase in the adoption of mobile contractual relationships with its customers devices and other electronic products which in which stabilizes revenue across business cycles turn have led to more demand for integrated and also leads to predictable cash flows. As of last circuits with higher performance, smaller size as quarter, 90% of the top-line of the company is well as reduced power consumption. This comprised of recurring revenue. Remaining continued innovation in chip technology has performance obligation stood at $4.6 billion. fueled Synopsys’ top-line growth in recent years The company consistently invests in research and which has grown at a CAGR of 11% between 2015 development to introduce new products and and 2019. solutions and also looks for attractive acquisition opportunities to expand its portfolio Revenue trend inorganically. 4.00 3.36 3.51 20% 3.12 3.00 2.72 15% 2.24 2.42 LB•LOGIC We like Synopsys’ long- 2.00 10% term contractual revenue focused business model as it leads to sticky billions in 1.00 5% revenue and cash flows. 0.00 0% 2015 2016 2017 2018 2019 2020 TTM Revenue YoY increase  RECENT DEVELOPMENTS Source: Synopsys, Inc. 10-K, 10-Q Synopsys was virtually immune from the impact While over the last few years, growth has been a of coronavirus pandemic because of a robust function of expansion of smartphone business, recurring revenue-based business model and the source of future growth is likely to be substantial backlog of unrecognized performance increased adoption of high-speed cloud obligations. In Q3 FY 20, Synopsys reported its computing, data centers, 5G networking, artificial highest ever total revenue of $964 million, which learning, electric and autonomous vehicles, represents a YoY growth of 13%. This increase Internet of things consumer products, etc. was primarily driven by growth in customer Synopsys being the largest US based EDA and IP adoption of solutions offered by the company. solutions provider is well placed to benefit from Another reason for the outperformance in top- these robust trends. line growth was advancement of some revenue On the profitability front, Synopsys has been scheduled for Q4 to Q3. While its core reporting expansion of operating margins semiconductor and system design segment consistently for the last few years as it enjoys expanded by 13% YoY, Software integrity benefits of operating leverage and economies of segment reported a YoY increase of 12%. scale. Adjusted operating margin improved from 25.4% in Q3 FY 19 to 33.6% in Q3 FY 20. This significant improvement was primarily

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attributed to strong growth in top-line as well as uncertainties because of the coronavirus lower operating expenditure because of limited pandemic. Synopsys ended the recent quarter employee travel due to pandemic related with a strong cash position of over $1 billion. restrictions. Another reason for this sharp Given total debt of just $107 million and no major improvement in profits was advancements of near-term obligations, the available liquidity will some of the revenue which was originally provide the company with access to enough planned for Q4 into Q3. growth capital in the foreseeable future.

Operating profits 943.4  COMPANY MANAGEMENT 1000 838.8 30% 689.8 Aart de Geus co-founded Synopsys in 1986 and 750 648.5 25% 524.7 569.3 has been serving as its CEO since 1994. In 1998, he 500 20% also took over the position of Chairman of the

in millions in 250 15% board. During his career, he has been recognized 0 10% with multiple awards including Electronic 2015 2016 2017 2018 2019 2020 Business Magazine’s “CEO of the year” award in TTM 2002, Silicon Valley Engineering Council Hall of Operating profit Operating margin Fame award and SVLG Lifetime Achievement Source: Synopsys, Inc. 10-K, 10-Q award. He also serves on the board of directors of Applied Materials, Inc., corporation that supplies For full financial year, Synopsys has a target of equipment and software used in the manufacture 10% revenue growth and an operating margin of of semiconductor chips, flat panel displays, and 28%, while for the long term it targets high single solar products. Here is a video of Mr. Geus digit revenue growth and operating margins of speaking at the Global Foundries Technology just over 30%. Conference in 2019. Synopsys is a mature cash flow generating Chi-Foon Chan has served as the co-CEO of company with significant recurring cash flows. In Synopsys since 2012. Mr. Chan joined Synopsys the first 9 months of FY 20, it reported a cash flow in 1990 and served as company’s chief operating from operations of $789 million, which represents officer from 1996 to 2012. In 2014, he led a YoY increase of over 36%. Apart from steady Synopsys’ entry into the application security revenue growth, this sharp increase was because business segment through the acquisition of of higher deferred revenue during the period due Coverity and Codenomicon. Prior to Synopsys, to timing of contracts and invoicing. For the full he served as the general manager of year, Synopsys expects CFO to increase by 13% microprocessor group at NEC Corporation. He on a YoY basis. has also served as engineering manager at Intel Although the company does not pay any Corporation. He holds an MS and Ph.D. in dividend, it has been consistent in returning computer engineering from Case Western profits to shareholders in the form of buybacks. It Reserve University and a BS in electrical has repurchased $2 billion of stock since 2015 and engineering from Rutgers University. has made several strategic acquisitions over the Trac Pham has served as the CFO of the company years to broaden its IP portfolio and expand its since 2014. He joined Synopsys in 2006 as Vice software and design businesses. In Q3 FY 20, it President of financial planning and strategy did not buy back any stock given the economic

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0.94 STOCK: SNPS | 9/14/20 FIRST FOCUS

division and became Vice President, Corporate Synopsys’ software integrity solutions compete Finance in 2012. Prior to Synopsys, he held with several other application integrity tools leadership positions at Juniper Networks. He providers such as Checkmarx, Veracode, Micro holds a BA in Economics from UC Berkeley and Focus, HCL Software, etc. however, these players MPIA from UC San Diego. He also holds a CPA are significantly smaller in size and focus on qualification. specific areas of application quality analysis, whereas Synopsys has expanded its security Directors and executive officers together held solutions portfolio to cover end to end application 1.87% stake in the company as of February 10, protection. It was recently named as a leader in 2020. Gartner magic quadrant for application security  COMPETITIVE ENVIRONMENT testing. Synopsys operates in the highly competitive technology sector. It is the global market leader in EDA software solutions and competes with other EDA vendors such as Cadence Design Systems, Inc, and Mentor Graphics Corporation, as well as IC manufacturers’ own designing tools and capabilities. In IP licensing segment, Synopsys competes with Arm Ltd. which holds a dominant market position in processors for mobile phones, TVs, and Smart TVs. It also competes with Cadence Design Systems. As per the recent report released by IPnest, ARM maintained its industry leading position in global total IP revenues with a market Source: Synopsys, Inc. Investor presentation share of 41%, however, its position weakened as compared to 2018 when it held 43% share. Synopsys’ IP license revenue grew by 14% to $717 million and its market share expanded from LB•LOGIC We like the fact that 16.8% in 2018 to 18.2% in 2019. Cadence remained Synopsys is cementing its market third with 5.9% share. leading position in application security industry, however, this segment only contributes 10% of company’s total business and it will take a considerable period of time until it becomes a major driver of Synopsys’ overall growth.

Source: IPnest, March 2020

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 TREND ANALYSIS: $40 billion. Assuming Arm’s revenue grew by VALUATION around 8% annually between 2016 and 2020, its Synopsys’ valuation has expanded recently as the Price to Sales ratio at current valuation works out street expects the company to be a major to around 19x, which is significantly higher than beneficiary of the ‘work from home’ economy as Synopsys. Investors must note that, Arm Ltd. demand for cloud computing and faster enjoys higher valuations because its IP comprises electronic devices grows post-pandemic. The of highly efficient core microprocessor stock is currently trading at a price to sales ratio technology designs which forms an integral part of 8.8x which is significantly higher than its 5-year of the chipset functioning. Arm’s chip designs average of 5.1x. Although the company is a were used in more than 50% of smart devices in market leader in EDA solutions market and the world including Apple and Samsung devices. boasts stable recurring cashflows, we believe the As mentioned earlier, it still generates over 40% current valuations are more than full given its of the global IP licensing revenue. Having said high single digit top-line growth rate target and that, we believe Arm Ltd.’s acquisition by Nvidia limited operating margin improvement expected at such high multiples may also provide near in the long term. Nvidia recently announced the term lift to Synopsys’ stock prices. acquisition of Arm Ltd. form Softbank Group for

Revenue Growth Fwd Revenue Operating Price to Sales

TTM (%) Growth (%) Margin (%) ratio Synopsys, Inc. 6.24% 8.43% 17.18% 8.81x Cadence Design Systems, Inc. 7.73% 9.18% 21.83% 11.7x Keysight Technologies, Inc. -2.58% 5.40% 17.84% 4.22x ANSYS, Inc. 9.36% 11.07% 29.09% 17.93x Source: Seeking alpha

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learning, electric and autonomous vehicles, CONCLUSION /  Internet of things consumer products, etc. Having RECOMMENDATION said that, given its single digit revenue growth Synopsys has enjoyed strong growth in recent and limited improvement in operating margins years primarily fueled by increased adoption and expected in the long run, we believe that the technological advancements in handheld devices. current valuation of Synopsys is at a premium It is the industry leader in EDA solutions and is and investment at these prices is likely to yield well placed to benefit in the long term from mediocre returns for investors. For now, we growth in spaces such as high-speed cloud assign a “YELLOW LIGHT” to Synopsys. computing, data centers, 5G networking, artificial ◼ Stock Chart for Synopsys, Inc. (SNPS)

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◼ Performance Data 2014 2015 2016 2017 2018 2019 RETURN ON INVESTED CAPITAL (%) 21.5% 19.8% 22.2% 16.9% 23.5% 23.6% GROSS MARGIN (%) 77.8% 76.9% 77.6% 76.0% 76.4% 77.6% EARNINGS (MILLIONS USD) 473.8 524.7 569.3 648.5 689.8 838.8 YoY Earnings Growth (%) 0.5% 10.7% 8.5% 13.9% 6.4% 21.6% REVENUE (MILLIONS USD) 2057.5 2242.2 2422.5 2724.9 3121.1 3360.7 YoY Revenue Growth (%) 4.9% 9.0% 8.0% 12.5% 14.5% 7.7%

◼ Valuation Data 2014 2015 2016 2017 2018 2019 SHARE PRICE (USD) 36.5 50.1 59.3 87.1 89.6 136.4 SHARES OUTSTANDING (MILLIONS) 155.9 155.2 151.5 150.4 149.3 150.3 MARKET CAP (MILLIONS USD) 5699 7772 8974 13099 13367 20505 PRICE/SALES RATIO 2.77 3.47 3.70 4.81 4.28 6.10

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