During the just finished quarter, Mentor acquired the assets of Ponte Solutions and also acquired Flomerics. The first acquisition is expected to further strengthen its presence in the DFM market segment, where it holds a leading position with its Calibre line. The acquisition of Flomerics, a provider of thermal simulation and analysis tools, will immediately aid in improving the company presence in the PCB market, and may in the not too distant future, play a role in the DFM market where heat dissipation is becoming an important issue for IC designers.
The professionals, not surprising, took another position. Jay Vleeschhouwer, of Merryll Lynch, who has covered EDA for years, issued a report the day before the Mentor announcement. I respect his judgment because he has shown a very good understanding of our industry and the leaders of its major companies. In the report Jay issued a buy recommendation for Mentor and an underperform for Cadence. Although the semiconductor industry is sluggish, Mentor is well positioned in key market segments, has kept control on its costs, and is investing in new products development. Nothing has changed negatively between May, when Cadence made its initial offer, and now. Thus Cadence's decision cannot be justified by a deteriorating fiscal condition of Mentor or even a negative change in its projected positions in the market in the next twelve months or so. The real reason is that the cost of the acquisition had increased as I wrote in my blog last week.
Cadence has announced that it has committed and additional $500 million to repurchase its own shares in the open market. This is in addition to the $412 million already committed to the same activity. So Cadence plans to spend almost one billion dollars to boost its shares price in the market. But, as Mr. Vleeshhouwer points out, this "would consume most of Cadence's available cash and the estimated 2008-2009 operating cash flow would replenish less than the new authorization."
It is time, once again, to wonder if Cadence is intent on going private by establishing an above average position in treasury stock, or if the move is intended as a defense against a take over offer from an unwanted source. I find it interesting that the amount of money now earmarked for stock re-acquisition is relatively equal to the amount of funds that had been projected to acquire Mentor, and also very similar to the company's projected revenue for FY08. But then again, life might just be a sequence of coincidences.
August 18, 2008
A different kind of day at Cadence
By
Gabe
Moretti
August 15th was not supposed to turn out the way it did, if you were a member of the Mentor Graphics executive team. Ever since Cadence public offer to acquire it for $16.00/share, Mentor had been busy doing due diligence and building a constructive response to the unsolicited offer. At the end of June it retained both Goldman Sachs and Merrill Lynch to advise them on financial matters. Then it did what any rational company would do: it made sure that its key employees would have financial security in case of a takeover and re-organization (read layoffs). And when it thought it was ready, it told Cadence it was ready for those face-to-face talks that Cadence executives desired.
The first direct discussion between Cadence and Mentor on the subject of the proposed acquisition was scheduled for August 15th.
Instead, Cadence issued a press release stating that it was abandoning the effort to acquire Mentor Graphics. So much for all the work. That Mentor was taken by surprise and that it was somewhat disappointed by the news can be seen in the following sentence taken directly from their press release "Mentor Graphics notes that this withdrawal is inconsistent with both Cadence's recent public statements and recent communications between Mentor Graphics and Cadence." But, should a new suitor materialize, Mentor is ready and the bottom offering price will have to be $16.00/share, so not all is lost.
What Cadence said and did
The public trip from "we want you because it makes sense," to "we are not interested," required very little time. In fact, things went very wrong for Cadence in the last sixty days.
On June 17th, the day after the public announcement, I wrote that there would be significant anti-trust issues raised about the proposed acquisition. During the ensuing weeks Cadence continued to say that it was working with the Federal Trade Commission (FTC) and that it expected a quick approval since it saw no "restrain of trade" issues in its plan.
Cadence also stated that it had lined up financing sources for the deal and that the deal itself was not dependent on obtaining said financing. I always found the two statements a bit puzzling. On the one hand you are working to obtain financing before you finalize the deal, but on the other hand you do not need such financing. What the second statement really meant was: we believe we can obtain financing for the deal on terms that are favorable to Cadence, and thus the deal makes sense from a financial point of view.
Finally, I have also learned that the acquisition was not, as I first assumed, Mike Fister's idea. I am thus offering my apologies to Mr. Fister for defining the proposed deal as his Napoleonic gamble. In fact the Board of Directors of Cadence instructed Mr. Fister to go make the deal happen. This is a problem because there is no single champion for the deal that is so passionate to perform miracles to see his or her idea come to a positive conclusion.
What happened
Reality did not collaborate. First of all Mentor did not think the deal was so sweet to rush into acceptance. This Cadence must have expected. You offer 16, they want 23, you offer financial security to key executives and raise the bid to 17, they come back with 20: you get my drift. It turns out that all this probably went on, and this part of the negotiations was progressing according to expectations, since they had agreed to meet and talk directly on Friday August 15th.
But on July 23rd Cadence reported Q2 revenue that showed a 92% plunge in second quarter profit from the previous year, forecast a significant third quarter loss, and halved its 2008 operating cash flow to $175 million. It also issued an outlook for fiscal 2008 revenue that was well below its 2007 results, by about $500 millions in fact. This was a very big problem with securing the financing of the acquisition. The company lost over a third of its equity value almost overnight, and its near term financial health outlook took a decisive turn for the worst. The result was that financing became much more expensive than had been planned. By the time the new numbers were used, the cost of the acquisition became a real challenge.
Just like any individual, companies looking to borrow money are assigned a credit rating, usually based on the exotic sounding "debt-to-EBIDA ratio". EBIDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization" and is a fairly accurate measure of the ability of a company to repay its debt on time. It works inversely of your credit score. The higher your score the easier to obtain a loan and the lower the interest you will have to pay. Companies want a low debt-to-EBIDA number. According to an article by Gerald E. McCormick of Reuters, a score of 2 or 3 is considered safe. But Cadence number is close to 4 and is likely to go higher.
To complicate matters another reality hit Cadence square in the face. The FTC, as most EDA analysts had predicted, decided that the transaction required a second look and an analysis that would stretch into many months. The outlook for the EDA industry and for Cadence for next few months is not positive, the general economic picture worldwide is sluggish, and that includes semiconductors sales.
In a couple of days, on August 20 to be precise, Mentor is due to report its financial condition. I suspect it will show to be in a better position than Cadence. Thus its contribution to the combined company would be more substantial than what Cadence had valued when it offered $16/share. This explains Mentor's eagerness to enter in direct negotiations after having been so reticent (before Cadence announced its fiscal results). Given the new conditions Cadence would have to raise its offer and negotiate from a much weaker position. And so Cadence gave up the quest before Mentor had the opportunity to humiliate it by arranging a merger on its terms.
See Also:
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August 05, 2008
Looking for opportunities
By
Gabe
Moretti
When looking at the near future of the semiconductor, and thus by implication the EDA industry, most people cite the International Technology Roadmap for Semiconductors (ITRS) report, but I think I found a more appropriate indicator: work on developing EDA standards.
For many years the ITRS has correctly predicted the adoption by the majority of design houses of semiconductor fabrication nodes. And with every step on the predicted, if not dictated, path, the EDA industry has found its challenges and its opportunities. But a funny thing is happening, now that we have entered the era of very deep sub-micron process. The majority of design houses are not moving to the most advanced fabrication node as swiftly as in the past.
It is true that there are still a couple of dozen companies that need to be at the leading edge of semiconductor capabilities in order to compete successfully, Intel, AMD, and Nvidia being the most representative. It is also clear that FPGA companies, like Xilinx and Altera, see the most advanced node as an opportunity to increase capacity, lower power requirements, and improve their competitive position against ASIC devices. But in spite of their considerable purchasing power, these companies alone will not keep the EDA industry viable.
Since tools that address the most advanced processing node are also the most profitable, EDA vendors are seeing the pool of providers of high margin revenue evaporating to a puddle. It is also true that the creation of new EDA companies has been centered around the need to provide evolutionary, and in some cases, revolutionary, solutions to the latest design and fabrication problems presented by a new process node. With fewer potential customers, the number of startups is bound to decline and their potential to reach a viable level of revenue is also going to be lower. This significantly impacts the probability of a new stock public offerings by EDA companies, and even significant acquisitions of startups by the four largest companies, who will find themselves strapped for cash.
The disappointing revenue news from Cadence is just the latest, and most visible, indicator that a new business model is urgently needed.
The opportunities
Historically most EDA standards have been developed by four organizations: the IEEE, Accellera, Si2, and OSCI. The IEEE has been the leader, both in terms of numbers and international visibility, followed by the other three, in the order I wrote them. Many of the standards developed by Accellera have gone on to become IEEE standards, and OSCI has adopted the same process, although its mission is much more restrictive than Accellera. Si2 has preferred to form industrial coalitions, from which it receives an income as members must pay yearly dues, to develop and support its work. As such the documents developed by such groups belong to a different class of "standards", since they are not a standard according to the international definition of such documents.
Most of the work going on the Design Automation Standard Committee (DASC) which is the arm of the IEEE that addresses EDA issues, deal with either mixed-signal design, verification, and system level design. The work in Accellera targets both mixed-signal and verification. OSCI major work at the present is the development of the TLM 2.0 document, an important contributor to solving system level design issues. Only Si2, which has a greater number of members from the semiconductor industry than the other three organizations, continues to focus on fabrication issues dealing with support and use of the most advanced fabrication node available.
System level design is a market sector that has yet to be clearly defined by EDA vendors. At the moment none of the traditional EDA companies can claim to fully understand or support system level design, although CoWare has consistently claimed to know, and both Springsoft and Mentor have shown that they have some understanding of the software/hardware co-design and co-development problem. Startups, like Carbon Design Systems for example, are making progress in this area and may find it quite rewarding in spite of some pundits observing that "there is no money in selling software tools". I guess Microsoft or Wind River, for example, did not get their memos.
Having had the luxury of dealing with reality using the digital approximation for many years, system houses are now being forced to use analog design in order to realistically duplicate natural phenomena. Mixed-signal design is becoming a requirement for competitive products that serve the most promising sector, end-user products, like games, phones, and personal electronic appliances. Automotive and medical applications, two other sectors that are expanding significantly, also require analog and mixed-signal design.
As long as design verification continues to be a post-facto approach, it will remain expensive, and in fact, true to its history, the cost of verification will increase with the complexity of design. In spite of various efforts, we still have not found a way to develop a method to produce "correct by construction" designs. We have tried, with both languages and tools, but failed for different reasons. VHDL, for example, is a much more rigorous language than Verilog, and many design errors can be avoided simply by its use, but designers found the language to be too difficult and verbose, and opted to take their chances with Verilog instead. The Rosetta language, a very promising academic exercise, is languishing and the IEEE is now working on Estorel, a system level design language that has been used in Europe for a few years. Higher-level synthesis, like Catapult-C from Mentor or C-to-Silicon Compiler from Cadence are worthy efforts, but they have very limited capabilities to proclaim the original design bug free.
Conclusion
Obviously there are technological problems still to be solved. But the business plan must be different this time. The customers are not companies for which price is not an issue, capability is. The customers of the next few years are just as price sensitive as they are needy of new solutions. They have not grown stingy: they are addressing markets that offer far less profit margins, thus they must keep their own costs as low as possible. The most profitable EDA company in the next few years is not the one that can provide a solution to 22-nm design implementations at any cost, but the one that can offer the cheapest and most reliable set of tools to develop designs that use proven processes with demonstrated high yield capabilities.
See also:
Cadence reports poor results
Carbon Design Systems acquires SoC Designer from ARM
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July 22, 2008
Cadence greener grass
By
Gabe
Moretti
Cadence's efforts to acquire Mentor Graphics are of course motivated by more than greed. Greed needs to be justified, explained, rationalized, or it does not make a good story. I have been thinking about this for a while and now I can write about it. When financial analysts, the group of people Mike Fister talks with frequently, describe an industry as "ripe for consolidation", they use the term with a very precise meaning. "Ripe for consolidation" means that the "Street" cannot expect returns from investments in the sector much better than the rate of inflation, or the WSJ Prime Rate, whichever is smaller. Therefore they issue either neutral or negative investment advice when covering the companies in the sector. This is not good news for Cadence, or any of the other publicly traded EDA companies.
The traditional model
In a traditional market sector, consolidation generates two positive effects: better price control, and lower costs. Combined they generate higher profits which translate in stronger stock, which generates additional investments. Consolidation means less competition, of course, since there are less producers and thus supply can be better regulated to stay a bit below demand, a sure way to raise prices.
Consolidation normally creates redundancies in the administrative and often in the production and support sectors of the resulting organization: thus it is possible to reduce staff positions and cut costs, especially overhead, or indirect, costs.
In the case of Cadence and Mentor administrative, marketing, sales, and support organizations can be significantly smaller than the sum of the present two, or at least this is the reasoning by the financial analysts.
The fact that there are product redundancies is also not seen as a waste, but as an opportunity for divesting, at a profit of course, those products, either through an outright sale or through a spinoff.
So when EDA editors write against the proposals, they are seen either as biased, ignorant, or idealists. And often a combination of some of the above.
Why it will not work
The EDA industry is not like any other industry. It is a service industry and the relatively small number of significant buyers have alternatives not present in traditional industries.
The number of customers dealing with leading edge problems, the ones that purchase licenses that generate the largest profits margins, is becoming smaller with each fabrication node, normally an indicator that supply consolidation is desirable. But in our industry the best customers are also the ones with the greater access to alternative solutions.
Assuming that Cadence is successful and that it can impose a new pricing model on the industry, and supposing that Synopsys falls in line, this would mean two things: Magma will increase its share of the markets in all sectors with the exception of digital simulation and verification where it does not have a presence, and smaller companies would also see greater opportunities to expand. The result would be that in order to be competitive, Cadence would have to match what the customers want to pay, not the other way around.
Cadence is locked in too many standards, and of course it would be very difficult to undo Open Access, a reasonably straight forward tool for startups to "augment" capabilities in the installed Cadence base. The jump from "augment" to "replace" is not very long when the financial stakes are high enough. Cadence does not have unique technology in any sectors of EDA: it competes directly with at least one among Synopsys, Mentor, and Magma, in every one.
Demand can also be mitigated by IDMs and by Foundries by developing internal tools. Consolidation in the supply sector would mean that there would be a higher supply of well qualified engineers willing to work on proprietary tools. By the time it would take Cadence to settle the ripples from the merger, say two years, its customers would be in a position to counter any of its pricing moves. They are not going to wait and see, they are going to react immediately on all three fronts: roll your own, switch to a direct competitor, and nurture one or more startups.
So, although I have heard from a few financial analysts who think the acquisition is good for Cadence and for the industry, I continue to believe it will not work even if classical investment theory says it should.
See also:
Cadence bids to buy Mentor Graphics
M&M Would Be Sweet
Cadence-Mentor deal makes sense, says analyst
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