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It is possible, as a few financial analysts have said, that Mentor's stockholders would see the Cadence offer as a good way of making a profit and exiting the EDA industry. The transaction is in fact even more profitable if you can, at the same time, short Cadence's stock. As I write this article Cadence is trading at $10.76 per share.
CDNS Bad News
Following the acquisition, Cadence is looking at an additional debt of $1.1 billion which, unless I have a broken calculator, will result in a finance charge of $55 million at 5% interest the first year. This is more than the $35 million in net profits Mentor generated in fiscal 2008, and that gives us a net loss of $20 million in finance costs alone. During the analysts's webcast on Tuesday Cadence stated that they expected that revenue would increase approximately by $50 million the first year. Guess where that number came from!
To that cost one should add the restructuring costs, which are going to be very high. Let's assume that, for some miracle, Synopsys and Magma's lawyers are not successful in proving the monopolistic status of the Cadence/Mentor merger in the small EDA industry, and that the transaction closes as Cadence anticipates. It is then likely that Cadence will have to close its Chelmsford site, since it would represent a complete duplication of development effort of products Cadence really wants from Mentor: Logic Simulation (the Questa platform), and PCB Design (the Expedition family). Since it would be unwise to retire the Allegro product, maintenance can be performed in India at far less costs.
Although disgruntled Mentor employees may find it difficult to immediately jump ship due to the low demand for new employees in the industry, ace technologists are always in demand, and given my connections with Mentor rank and file, I can state without any reservation, that almost all of them will choose to leave as soon as possible. The cultures of the two companies could not be more dissimilar: I have yet to receive a private communication from a Mentor employee approving of the transaction. This means no short term additional development for any of the key Mentor segments: Calibre, Questa, and PCB Design. Key Questa employees will find a welcome hand at Synopsys, and Calibre people will find the red carpet at Magma, as well as at Synopsys. As for PCB Design, Altium may finally have a substantial development group in the US. The probable financial result is lower revenue as customers switch to competitors' products they believe to be more stable and better supported. Even a 10% reduction in revenue from the 2008 Mentor level will amount to $90 million in round figures.
Remaining Mentor employees will stay because they have no choice, but they will not be as productive while they try to adapt to the new company, spend all of their emotional energy in office politics, and try to find the boundary point between employment and unemployment. Efficiency will drop with resultant lower margins for the company. There are too many variables in this equation to come up with a hard number, but a 3% decline in productivity could result in a $30 million increase in cost of goods sold.
Of course, given the corporate mentality, Cadence will choose to layoff a significant portion of the combined staff, and will not spare any functional area. The company has already indicated that it plans layoffs in administrative, marketing, and sales as a result of the merger, and will have to layoff in development as well, not just in the US but overseas as well. These restructuring costs will be high, certainly in the tens of million of dollars.
The bottom line is that in the first year the acquisition may cost Cadence around $175 million or more, and the second year could still see a cost of $100 million or so as a result of the merger.
The MENT Gambit
When a company is faced with an unfriendly takeover attempt, it generally goes to the medicine cabinet and takes a poison pill. The desired effect is not to commit suicide, but to make it so expensive for the suitor to complete the acquisition to convince it to desist in its efforts. But this is much easier done by privately held companies, and Mentor would find it unpopular with its existing shareholders.
The other tactic, of course, involves a white knight. A more acceptable company that make a desirable competing offer and thus avoids the necessity to accept the initial offer just to satisfy the greed of stockholders looking for an immediate return. There are no suitable white knights in the EDA industry. To be sure it would be interesting to see if this is the opportunity a semiconductor company is looking for to cove customers from conception to manufacturing. If it were to happen it would revolutionize the semiconductor industry and start a chain of events that would rock the economic system worldwide, since economic growth is so dependent on semiconductors.
But there is a third possibility, that makes sense, it is not so revolutionary, and may be good for the EDA industry.
So Wally and Greg here is my unsolicited advice: call Rajeev and start merger talks between Mentor and Magma. The resulting company will result in a product portfolio as strong or stronger than Cadence, and will be a very effective competitor to Synopsys. The two companies have similar corporate cultures, at least a lot more similar than Cadence and Mentor, the overlap in staffing is small, and the product fit could not be better if it had been developed by one company. Magma's customers would not only not be concerned, but they will find that instead of having two suppliers, One for Questa and Calibre, the other for Talus, and Hydra they would be dealing with just one.
Magma's Rio Magic will find a good fit with Mentor's Expedition, and Mentor's Eldo might help in expanding the market for FineSim and Titan. The resulting company will certainly have sales above the $1 billion.
A final word for Cadence
Cadence can still strengthen its product offerings through acquisitions and spend less than $1.6 billion.
- To strengthen the logic simulation and ESL offerings purchase Imperas. It would get expertise in SystemVerilog and good opportunity in the embedded software and multi-core design market.
- Purchase EVE before Synopsys does. It will significantly improve Cadence position in emulation and take off the table a very good way for Synopsys to complete the strategy it has started with the acquisition of Synplicity.
- Purchase Apache for low power and chip packaging to strengthen the back end IC design and verification and also improve the Allegro platform.
All three companies are similar in size to those you already acquired and successfully integrated; stick with this size of fish and you will avoid a very expensive corporate indigestion.
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