Intelligent Design
In this edition of the Smart Investor newsletter, we examine the stock of a global leader in electronic design automation. We are not selling any stocks this week but have placed three companies under review for possible deletion from the Portfolio. But first, let’s delve into the latest Portfolio news and updates.
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Portfolio Updates
❖ Howmet Aerospace (HWM) has been one of the best performers in the past year in both the Smart Investor Portfolio and the S&P 500. The shares of the aerospace and defense engineered solutions provider rose by over 120% in the past 12 months. HWM is the only triple-digit gainer in the S&P 500 whose rally hasn’t been led by AI trade but rather by its outstanding delivery and consistent high double- or triple-digit YoY EPS growth over the past 12 quarters.
❖ Year-to-date, the Portfolio’s best performer is EMCOR Group (EME) which rose by almost 100%. The company is a mechanical and electrical construction leader and has established significant expertise in complex facilities and infrastructure projects, including data centers and semiconductor facilities. As such, EMCOR has benefited greatly from the increased demand for AI data center construction. Moreover, EME’s expertise in energy efficiency and sustainability projects has become all the more valuable given the increasing power demands of AI data centers.
❖ The Portfolio’s performance leader in Q3 2024 was PayPal (PYPL) with a gain of nearly 35%, its best quarterly gain since 2020. The company changed CEOs last year, finding one who clearly succeeded in implementing a strategic turnaround at PayPal, focusing on streamlining operations and enhancing profit margins. In July, PayPal raised its full-year profit forecast for the second time and announced increased share buybacks. The improved financial outlook and renewed investor confidence under new leadership have led to stock outperformance.
❖ The Portfolio’s best performer in September was Oracle (ORCL), which gained almost 20%. The company’s stock was lifted by multiple factors, including ORCL’s impressive financial results, including cost management and profitability metrics, as well as cloud infrastructure and applications business expansion, strategic partnerships and AI initiatives, strong position in the database market and enterprise software, and more.
❖ Amazon (AMZN) won a partial dismissal of a lawsuit filed by the U.S. Federal Trade Commission (FTC), which accused the company of maintaining an illegal monopoly. Further details of the development are still unknown. The U.S. antitrust regulators at the FTC and DoJ are increasingly targeting Big Tech, with Meta Platforms, Apple, and Alphabet (GOOGL) facing lawsuits. The tech leaders are also under increased scrutiny in Europe. In September, Alphabet was slapped with a hefty fine for anti-competitive practices, although it did win a separate legal challenge against the European Commission, which annulled a previously imposed fine. Meanwhile, Google’s parent filed a formal complaint with the EU antitrust regulator, accusing Microsoft (MSFT) of abusing its market power in enterprise software. The world’s largest tech company was investigated by FTC earlier this year as part of a broader examination of key players in the AI sector, including OpenAI and Nvidia. In addition, the Big Cloud trio – Amazon, Microsoft, and Alphabet – are facing an FTC inquiry over the concentration in the cloud market.
❖ Check Point (CHKP) has announced that it completed the acquisition of Cyberint Technologies. According to the cybersecurity pioneer, Cyberint integration will expand CHKP’s external risk management solution capabilities.
❖ According to reports in the press, Arista Networks (ANET) was chosen by Meta Platforms to provide the networking infrastructure for a massive AI model training cluster. The Facebook parent’s Llama 4 large language model will be trained on the massive cluster of over 100,000 of Nvidia’s H100 GPUs. According to Evercore ISI analysts, if and when the deal is finalized, it could represent a $250 million revenue opportunity for Arista.
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Portfolio Stocks Under Review
❖ Super Micro Computer (SMCI) remains under review for a possible sale. In fact, we had our finger on the “Sell” button following an additional setback for the company in the past week but decided to wait until the next Newsletter for the final decision. The rationale for holding the stock is to observe the market’s reaction to the 10-for-1 stock split performed on October 1st – which was a strong down day for the semi sector, with a sea of red obscuring our view.
Last week, Supermicro saw its shares plunge on news that the U.S. Department of Justice is reportedly investigating the company’s accounting practices. While the stock strongly rebounded afterward ahead of this week’s split, it still clocked in a sizable weekly loss.
As a reminder, SMCI underwent a turbulent period, which included strong hits to investor sentiment stemming from a short-seller’s report and an SEC filing delay. Although Supermicro confirmed that there would be no changes to its financial results or forward guidance, many analysts – including JPMorgan, Bank of America, and Barclays – have cut their price targets citing the heightened uncertainty.
On the other hand, the stock was strongly lifted by GlassHouse Research’s report, dismissing Hindenburg’s allegations and saying that the filing delay is “a precautionary measure.” The forensic accounting firm announced a long position in SMCI “for the foreseeable future,” stating a highly favorable risk-reward ratio and valuation.
In addition, Supermicro was recently cheered by Needham analysts, who dubbed it “the coolest kid in AI town” and a major beneficiary of the rapidly accelerating investments in AI infrastructure due to its first-mover advantage in liquid-cooled rack-level solutions. Notably, the average SMCI price target at leading Wall Street houses implies a surge of over 67% in the next 12 months.
The Smart Investor’s long-term thesis regarding SMCI’s immense long-term potential remains intact; we believe the current difficulties to be temporary. However, we are focusing on the company’s provision of clear communication about compliance questions, which we see as key to its ability to overcome negative sentiment weighing down the stock. Moving forward, the company’s tremendous potential as a leading AI server maker can come back into the limelight if the legal issues are cleared.
❖ (VRTX) remains under review following its underwhelming Q2 results, which included an EPS miss. The company reported a wider earnings-per-share loss than was expected. Notably, the negative EPS was a one-time event brought on by expenses associated with an acquisition of Alpine Immune Sciences, as well as increased investments to support launches of new therapies. Vertex raised its full-year product revenue guidance, citing growth in sales of its cystic fibrosis (CF) treatment and the soon-to-launch gene therapy Casgevy. The stock of the biopharma giant fell from its all-time high following Q2 underperformance, though not by a large percentage. Vertex’s stellar finances and cash-producing capabilities, along with its strong portfolio of existing and prospective treatments, provide a strong argument in favor of the company. The main negative factor was VRTX’s high valuation, which could limit its near-term upside. However, top Wall Street analysts are mostly positive on the stock, and it even received a price-target upgrade from Morgan Stanley. In addition, investor sentiment has been very positive lately, and the stock has considerably outperformed the S&P 500 over the past week. Still, while VRTX also outperformed the index over the past 12 months, its future path is unclear. We are waiting for news regarding the company’s trials on portfolio candidates, as well as other possible catalysts, before taking further action.
❖ We are placing Lam Research (LRCX) under review for a possible sale following several analyst price-target reductions. Mizuho Securities, Citi, and UBS have cut their price targets on the chip processing equipment maker. Citi lowered its estimate for wafer fab equipment spending, basing its outlook on weak consumer demand for PCs, smartphones, and autos, weighing on producers of chips for those industries. Mizuho also cut its projection for semiconductor equipment spending for the rest of 2024 and 2025, citing headwinds in China and concerns about Intel’s recent spending cuts. Of these factors, China stands as the main selling reason for LRCX due to the company’s high exposure to the Chinese market. While this has driven growth, it also presents risks due to potential market fluctuations and geopolitical factors. Although the average analyst price target for Lam’s stock still envisions an upside of almost 32% in the next 12 months, the slew of downgrades has materially harmed investor sentiment. We are waiting for the possible positive sentiment infusion around LRCX’s 10-for-1 stock split, effective on October 3rd. In addition, in two weeks the company will report its FQ1 2025 earnings; investors will focus on the details pertaining to the pending investment cycle in semiconductor capex, China orders, and benefits from growing demand for AI chips.
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Portfolio Earnings and Dividend Calendar
❖ The Q2 2024 earnings season has passed while the Q3 season hasn’t yet begun. Thus, no Portfolio companies are scheduled to release their results until mid-October.
❖ There are no ex-dividend dates for Portfolio companies until the next Newsletter.
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New Buy: Synopsys (SNPS)
Synopsys, Inc. is the world’s leading provider of electronic design automation (EDA) solutions and services. The company is also a leading global player in intellectual property (IP) integration solutions, as well as system verification and validation. The company operates globally, serving a diverse customer base in the U.S., Europe, and other geographies.
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From Startup to Industry Leader
Founded in 1986, Synopsys rapidly grew from a small startup to a global leader in its field. The company’s explosive growth was supported by its early relationships with leading chipmakers, strategic partnerships with foundries, and heavy investment in research and development, as well as strategic acquisitions.
Today, with a market cap of almost $80 billion and annual revenues of $5.5 billion, it is ranked #584 on the Fortune 500 list. It is the world’s 15th-largest software company by market cap and the 13th-largest by earnings. It ranks #1 in the world among EDA solution providers and in IP licensing.
Synopsys has a very broad customer base, serving a wide range of customers across various industries, including semiconductors, systems companies, software developers, and enterprises in sectors like financial services, medical devices, automotive, and industrial. The company’s clientele among leading enterprises spans many industries. Thus, SNPS serves virtually all semiconductor companies in the world, including all of the top 20. It lists eight out of 10 top software companies in the world among its clients, along with seven of the top 10 automotive OEMs and 16 of the top 20 commercial banks in the world.
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Integrated Business Model
Synopsys operates in two segments: Design Automation and Design IP. Its third and smallest segment, Software Integrity, was sold in May 2024.
The Design Automation segment – which oversees the firm’s EDA solutions, a critical and highly value-adding piece of the chip design process – is responsible for nearly 65% of the company’s 2023 revenues. Synopsys is the global leader in electronic design automation solutions, holding the largest market share globally (about 33%). The company heads the “big three” EDA leaders, and along with Cadence Design Systems and Siemens holds about 85% of the global market. Thanks to its market position, SNPS continues to be a key beneficiary of increasing chip complexity and the AI capex cycle boom, both of which support the projected continued fast growth of the EDA market.
Synopsys’ Design IP segment is responsible for over 26% of annual revenue. Although smaller in size than its EDA business, the segment has enjoyed very fast growth in recent years and has much wider profit margins. SNPS’s semiconductor IP business provides chip designers with various types of ready-made building blocks, saving them time and effort in developing complex components from scratch. This helps accelerate chip development and reduces risks for their customers. Thanks to its ability to continually develop IP for the latest technologies and ship them faster than competitors, SNPS has reached a #1 global position in IP license revenues with a 32% market share in 2023.
The IP business allows Synopsys to diversify its revenue and capture a larger share of the semiconductor design market. This is done through integrated offerings, allowing customers to accelerate their design process by using Synopsys’ tools and incorporating ready-made IP components. The IP business is seen as a natural extension of the EDA products offered.
A significant portion of Synopsys’ EDA business is subscription-based, while the IP licensing business includes both subscription and one-time licensing fees. Thus, the company’s business model includes a high percentage of recurring revenue, which comes from subscriptions and ongoing support and maintenance contracts.
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Innovation and Collaborations
Synopsys invests over 30% of annual revenues in R&D, which demonstrates its commitment to innovation and maintaining its competitive edge in its industry. This has helped the company stay at the forefront of advanced tech development, such as autonomous vehicles, artificial intelligence (AI), cloud, 5G, and more.
Synopsys is persistently increasing its product offerings to capitalize on the AI market growth, projected to expand at a CAGR of nearly 30% in the next five years. Thus, SNPS launched a cloud-based AI software tool for chip design in early 2020. Synopsys is heavily investing in developing AI-powered tools for chip design and verification, which include internal initiatives and offerings launched in partnership with industry leaders. It launched Synopsys.ai Copilot in collaboration with Microsoft, the world’s first generative AI (GenAI) tool developed specifically for chip design.
Besides Microsoft, Synopsys maintains a broad ecosystem of AI collaborations across the semiconductor and software industries. It collaborates with ARM and Qualcomm and works closely with companies like TSMC and Samsung Foundry to develop AI-driven design flows. Its AI-driven chip design optimization systems are used by multiple customers, including STMicroelectronics and SK Hynix. Today, AI-related products and services comprise almost 90% of the company’s revenue.
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Acquisitions Support Expansion
Throughout its 37-year history, Synopsys has made over 100 acquisitions that helped it expand its offerings, grow internationally, and become the leader in its market. While it counts numerous successful buyouts that helped Synopsys expand beyond its core EDA business into areas such as software security, IP, and broader system design solutions, contributing to its growth and market leadership, the most important one is still in the process of completion.
In January 2024, Synopsys announced its intention to acquire Ansys for approximately $35 billion. Synopsys has stated that it expects the acquisition to close in the first half of next year. The acquisition is set to be Synopsys’ largest to date, expanding its prominence in simulation software and systems design for chip designers, automobiles, and airplanes. Ansys, a global leader in the CAE (Computer Aided Engineering) and engineering simulation market, has had a research and development partnership with SNPS since 2017. The deal is expected to create an EDA/CAE software behemoth worth over $100 billion in market cap and has the potential to reshape the entire industry landscape.
To address potential regulatory concerns, Synopsys has agreed to divest its software integrity business unit, selling it to private equity firms for $2.1 billion, which created a newly independent, privately held company Black Duck. In addition, in an effort to address regulatory concerns, in September 2024, Synopsys announced it would sell its optical systems division to Keysight Technologies.
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Exceptional Financials and Robust Growth Rates
Despite multiple acquisitions, Synopsys boasts outstanding financial health. Its total debt-to-equity ratio is a meager 0.2%, with cash and short-term investments on its balance sheet amounting to $2 billion and earning SNPS notable interest. Over the last three years, Synopsys produced more free cash flow than EBIT, indicating strong cash generation capabilities.
In addition, the company’s fundamental strength is displayed in its high ROE, ROA, and ROIC, placing it in the top 25% of its industry. Its gross and FCF margins also come in the top 25%, while its operating and net profit margins make the top 10%.
In the past decade, Synopsys’ revenues have grown at a CAGR of 12.5%, while its earnings-per-share have increased at a CAGR of 19.5%. However, growth has significantly accelerated in the past three years, with revenues growing at a CAGR of 17% and EPS – at a CAGR of 26.5%.
Synopsys’ recent earnings growth acceleration can be attributed to several key factors, which are expected to stretch into the next several years. These include the advance of AI and silicon proliferation, which have significantly increased the complexity of semiconductor designs, driving demand for the company’s offerings. In addition, some company-specific positives support a strong outlook, including significant customer wins, expansion into new adjacent growth opportunities, and SNPS’s innovation and technology leadership.
The company reported its fiscal Q3 2024 results on August 21st, exceeding analysts’ revenue and earnings expectations. In fact, Synopsys has never registered a single miss in its quarterly EPS reporting history. In FQ3, SNPS registered record quarterly revenue, while its EPS surged by 27% year-on-year. These figures are all the more impressive since the company’s EPS has increased by high double digits since FQ3 2023. Synopsys said it expects record annual revenues in fiscal year 2024, with growth of approximately 15% driven by continued, strong execution and business momentum.
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Total Return in Focus
Synopsys’s stock has risen by just ~7% in the past 12 months, with most of its advance in the first half of the calendar 2024 wiped out by a strong decline over the past two-and-a-half months. The company’s competitors have seen a similar “fall from grace”, following the path of the semiconductor industry’s stocks.
The company’s exposure to China (responsible for about 15% of revenues) added to uncertainties weighing on the stock. This is despite the company’s FQ3 report reflecting Chinese sales growing by 60% year-over-year, notwithstanding the increasingly harsh restrictions on trade related to chip design and production. In the possible event of further restrictions coming along, this could adversely affect SNPS’s revenues. However, the impact should be limited given the surging demand for the company’s offerings elsewhere, which can compensate for the loss of revenue from China.
Moreover, thanks to Synopsys’s robust financial performance and strategic positioning, most leading Wall Street houses revised their EPS outlooks for the current and next fiscal years. Based on these optimistic earnings-growth forecasts, top analysts foresee an average upside of over 31% for SNPS stock in the next 12 months.
This combination of high-quality fundamentals with robust long-term growth prospects, of course, is reflected in the company’s valuation. However, while SNPS carries a significant premium over the Technology sector’s and Software industry’s average PEs, it has declined below its long-term historical average. In addition, Synopsys’s PE comes at the middle of the valuation range of its U.S. peers and significantly below that of its main competitor, Cadence Design Systems. In addition, based on its future cash flows, Synopsys appears about 10% undervalued.
It should be noted that if the Ansys acquisition is completed as planned, it is expected to create a leader in silicon-to-systems design solutions, considerably strengthening Synopsys’ market position and expanding its total addressable market by about 50%. The deal would also generate significant revenue and cost synergies, thus leading to a sizable increase in EPS. As a result, Synopsys’s valuation would be much higher than it is now.
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Investing Takeaway
Synopsys, Inc. is one of the highest-quality companies in the Technology sector, holding a dominant position in its industry and benefiting from a time-based, recurring revenue model and a diverse set of customers. Its leadership in AI-driven EDA solutions and strategic expansion into the fast-growing IP segment and the adjacent spheres have driven consistent revenue growth and margin expansion. The company’s pending acquisition of Ansys will significantly expand its total addressable market and create a leader in silicon-to-systems design solutions. With strong cash flow generation, ongoing innovation in cloud and AI technologies, and exposure to secular growth trends in artificial intelligence, high-performance computing, and automotive applications, Synopsys offers a compelling combination of stability and growth potential. Its relatively high valuation is justified by its stellar finances and the long future runway of earnings growth. Therefore, we view SNPS as a compelling opportunity for long-term investors and a valuable addition to the Smart Investor Portfolio.
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Smart Investor’s Winners Club
The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
Despite all the ups and downs in the markets, our list of Winners still holds 17 stocks: GE, AVGO, ANET, EME, ORCL, TSM, SMCI, PH, TPL, HWM, GD, ITT, CHKP, AMAT, APH, VRTX, and PNR.
The next in line to enter the lucrative club is still PYPL with a 22.13% gain since its purchase date. Will it close the gap, or will someone else outrun it to the finish line?
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Disclaimer
The information contained in this article represents the views and opinions of the writer only, and not the views or opinions of TipRanks or its affiliates and should be considered for informational purposes only. TipRanks makes no warranties about the completeness, accuracy, or reliability of such information. Nothing in this article should be taken as a recommendation or solicitation to purchase or sell securities. Nothing in the article constitutes legal, professional, investment and/or financial advice and/or takes into account the specific needs and/or requirements of an individual, nor does any information in the article constitute a comprehensive or complete statement of the matters or subject discussed therein. TipRanks and its affiliates disclaim all liability or responsibility with respect to the content of the article, and any action taken upon the information in the article is at your own and sole risk. The link to this article does not constitute an endorsement or recommendation by TipRanks or its affiliates. Past performance is not indicative of future results, prices, or performance.
