Cadence Stock vs Synopsys Stock: The Winner Is?

Diversification sometimes makes decisions more difficult. If you have two companies that are of the same size, and doing roughly the same thing, deciding which one to hold can be tough. Until one is firmly established as a leader, your choice will change as information changes. The easy way out is to purchase both stocks, but what if there’s a limit to how many stocks you can hold?

Around three years ago, we wrote about how to Invest in Many Types of AI Chips With One Stock. That company was Synopsys (SNPS), and they’re one of two publicly traded leaders in the area of electronic design automation (EDA) – basically computer aided design (CAD) software for chipmakers. More recently, we wrote about how Synopsys is using AI to take their platform to the next level. It’s a case of AI using itself to make itself better – a loop of increased learning that eventually leads to artificial general intelligence (AGI). If AI were to evaluate what it needed for global domination, it might well conclude that Western software eats the world.

EDA software is a small but mighty part of the semiconductor supply chain, and it’s mostly controlled by three Western companies. 

MIT

Cadence vs Synopsys vs Siemens (Mentor Graphics)

Putting AI excitement aside for a moment, the core technology behind EDA isn’t anything new. Commercial EDA first came about in the 80s which is also when our EDA leaders were founded – Synopsys (1988), Mentor Graphics (1981), and Cadence (1986). To gauge market saturation, we might start with total addressable market (TAM) which everyone seems to agree sits at around $10 billion today with growth expecting to mimic semiconductor R&D investment. Let’s assume no chipmakers are using pen and paper to design chips, and that everyone designing chips is utilizing one of the existing EDA solutions. That means all the market share has been captured, with “the big three” said to command 70% market share. We can check that number using back of the napkin math:

• Synopsys – 65% of revenues come from EDA, so .65 X 2022 revenues of 5.08 billion = $3.3 billion
• Cadence – 12% of revenues come from intellectual property (IP), so we back this out and get 2022 revenues of $2.63 billion
• Siemens – Doesn’t break down software segment so let’s assume 50% comes from EDA – last quarter saw $1.28 billion in revenues so let’s annualize that – $2.56 billion

These numbers reflect $8.5 billion of collective EDA revenues or an 85% market share by the big three based on a TAM of $10 billion. Perhaps our Siemens estimate is out whack, or maybe there really is only 15% market share left for “the big three” to steal from smaller EDA competitors. At any rate, EDA software is a well penetrated market. Consequently, growth can only be realized by:

• Stealing market share from competitors – adding features and functionality that can’t be copied by others – AI and big data might be a competitive moat here which both Cadence and Synopsys are utilizing.
• Selling to new entrants across multiple industries – requires there to be an influx of new chip designers – generative AI might drive demand here temporarily
• Industry consolidation – bear markets often lead to industry consolidation as we see happening in 3D printing and vehicle autonomy.
• Expanding into adjacent verticals – Cadence appears to be doing this as they acquired a digital twin firm, Future Facilities, and a biosimulation firm called OpenEye.
• TAM expansion – perhaps there will be an AI hardware boom where companies – both new and old, and across all industries – will look to design their own proprietary chips optimized for their own unique use cases.

Indeed, we see Synopsys selling across multiple industries already. Back in 2017, the Synopsys CEO told TechTime that, “eight of the top 10 software companies in the world are now Synopsys customers” along with seven of the top 10 automotive OEMs and 16 of the top 20 commercial banks in the world.

Synopsys vs Cadence

Synopsys seems to be leading based on revenues attributable to EDA and total revenues – 2022 revenues of $5.08 billion vs $3.56 billion from Cadence. Both companies expect about 14% revenue growth this year, and both will tell you that AI is their competitive advantage. And both have grown revenues at a compound annual growth rate (CAGR) of around 10.5% over the past five years.

Synopsys had impressive gross margins of 79% for 2022, but Cadence took the cake for hitting nearly 90% gross margins. As expected, both companies are profitable, so we don’t have to worry about survivability. That said, here’s what debt, cash, and goodwill look like for each firm.

Nothing in the above table would sway us either way in deciding between these two stocks, but there’s one big unknown we haven’t discussed yet – valuation – which we can assess using our simple valuation ratio.

• Cadence: 62 / (4 * 1.022) = 15
• Synopsys: 68 / (4 * 1.395) = 12

Cadence is more richly valued, but both are at twice our catalog average of six. While we might be keen on paying more for SaaS companies selling into blue oceans, the thought of an segment that’s constrained by a saturated TAM with questionable future growth doesn’t seem to merit a premium. These are also mature companies, so profitability (aside from simple gross margins) needs to be considered.

We previously said these firms were good ways to play the growth of AI because regardless of who dominates, EDA software providers stand to win. That’s true, but there appears to be no correlation between success and upside for EDA providers. For example, some analysts say Intel is the anonymous customer Synopsys mentions in their deck that accounts for more than 10% of revenues. And Intel isn’t exactly the shining beacon of AI success in the chipmaking industry.

NVIDIA is giving us plenty of semiconductor exposure at the moment and we don’t see the need to consider either of these names. That said, if we had to choose between Synopsys and Cadence today, we’d choose the former. That’s because Synopsys has the edge on market share (using EDA revenues as a proxy), they’re number two in their second-largest segment (intellectual property), and they’re a tiny bit more fairly valued, though too rich at the moment. We’re also led to believe they were doing the AI stuff well before it became trendy to splash all over your investor deck.

Considering AI Hype

Maybe there’s a thesis where every large company in every industry has a proprietary generative AI department that represents a competitive advantage. At some point, such specialized work might only be improved further by adopting personalized chips for every task. So, suddenly all large companies will be subscribing to EDA software in the same way everyone purchases an accounting solution or a CRM platform. We already see Synopsys selling across a broad swath of industries, so perhaps that’s already the case. Counting on generative AI to make the TAM expand seems like a big what-if, and we’re left wondering if AI hype might be taking its icy grip. Many firms have been using AI for a while, but suddenly everyone notices it when the AI hype train leaves the station. Take a shot every time you see “AI” or “ML” on the Cadence investor deck and see if you can make it halfway through the deck before passing out.

Conclusion

Once it works, nobody call it AI anymore – that is unless AI starts getting hyped by just about everyone as the panacea to mankind’s problems or its worst enemy. NVIDIA showed the world that AI isn’t just show, but they’re also profiting handsomely from the hype. From AI drug discovery to enterprise AI firms to synthetic biology platforms, everything is being peddled as an AI stock now. When do we arrive at a point in time where AI adoption is an assumption, not an exception? We’re probably there now, that is until generative AI decided to show up. It’s EDA’s time to shine as the software behind designing the world’s AI chips, but we’re left wanting for more potential than just having to steal market share or increase subscription prices.

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