3 Takeaways From Our Cadence Scorecard

Cadence Design Systems (CDNS) – Motley Fool Scoreboard Analysis

Key Concepts:

• EDA Software: Electronic Design Automation – software tools used to design and verify chips and related hardware.
• Synopsis: Cadence’s primary competitor in the EDA software market.
• SaaS (Software as a Service): A software distribution model where applications are hosted by a provider and made available to customers over the internet.
• Operating Margin: A measure of a company’s profitability, calculated as operating income divided by revenue.
• Return on Equity (ROE): A measure of a company’s profitability relative to shareholder equity.
• Return on Assets (ROA): A measure of a company’s profitability relative to its total assets.
• Switching Costs: The costs a customer incurs when changing vendors or products.

Business Strength

Both Rick Munarriz and Jason Hall rated Cadence Design Systems’ business strength a 7 out of 10. While acknowledging Cadence’s strong position with approximately 30% market share in the EDA software industry, concerns were raised regarding its competitive standing against Synopsis. Jason Hall noted that while it’s not a “winner takes all” market, Synopsis’ recent deal with Nvidia suggests a potential widening gap between the two companies. Cadence’s “stickiness” – the high customer retention due to high switching costs – was recognized as a positive factor. The company has consistently grown revenue annually since 2009. Cadence provides tools to improve chip design and verification processes.

Management

The management team received ratings of 8 from Rick Munarriz and 7 from Jason Hall. Lip-Bu Tan, who previously led a significant turnaround at Intel, is credited with transforming Cadence into its current successful state, though he departed in 2021. The current CEO, Devan, has 30 years of experience in EDA software, including a period as President under Tan. Since Devan became President in 2017, the stock has increased nearly 8x. The current board chair, ML Crackour, is also relatively new to the role but possesses extensive experience. Employee surveys on Glassdoor show a high approval rating (85%) and a strong willingness to recommend Cadence as an employer (86%). Revenue growth has been positive every year since Devan joined Cadence in 2012.

Financials

Financials were rated 6 by Rick Munarriz and 7.5 by Jason Hall. Cadence operates as a Software as a Service (SaaS) business with a dominant market share, achieving 30% cash flow margins and 32% operating margins. This translates to high returns on equity and assets. The balance sheet is described as relatively neutral, with a balanced amount of cash and debt. While revenue growth has been consistent for 13 years, it hasn’t exceeded 20% annually, described as “slow and steady.” Analysts project revenue growth of 14% this year and 12% next year.

Valuation

Valuation received the lowest ratings: 0 to 5% projected 5-year returns and a safety score of 6 from Rick Munarriz, and a 5-10% return range with a risk assessment higher than average from Jason Hall. Both analysts agree the stock is currently overvalued, trading at approximately 60 times forward earnings. Rick Munarriz compared the valuation to that of a second-tier home improvement store (Lowe’s), suggesting it doesn’t justify the current price. Jason Hall acknowledged the stretched valuation but believes sustained revenue growth in the low to mid-teens could support earnings growth. Nvidia’s recent $2 billion investment in Synopsis was cited as a factor influencing the negative valuation outlook.

Notable Quotes:

• Rick Munarriz: “There’s a big difference between an artificial intelligence stock and an artificial intelligence stock.” (Highlighting that Cadence uses AI to improve its business, but isn’t fundamentally an AI company.)
• Jason Hall: “It’s not exactly rising dough all the time… It’s like driving around in a school speed zone with your boyfriend or girlfriend. It’s slow and you’re steady.” (Describing the consistent, but moderate, revenue growth.)

Logical Connections & Data:

The analysis progresses logically from assessing the business’s fundamental strength to evaluating its management, financial performance, and ultimately, its valuation. The discussion of management’s history and performance directly supports the business strength rating. Financial data (margins, ROE, ROA, revenue growth) provides evidence for the financial rating. The valuation assessment is informed by the previous sections, acknowledging the company’s strengths but ultimately concluding that the current stock price is too high. Specific data points include:

• 30%: Cadence’s market share in EDA software.
• 2009: The last year Cadence failed to grow year-over-year revenue.
• 299%: The stock increase since Devan became President in 2017.
• 85%: Employee approval rating of the CEO on Glassdoor.
• 86%: Percentage of employees who would recommend working at Cadence.
• 13 years: Consecutive years of revenue growth.
• 14%/12%: Projected revenue growth for the current and next year, respectively.
• 60x: Current price-to-forward earnings ratio.
• $2 billion: Nvidia’s investment in Synopsis.

Conclusion:

The Motley Fool Scoreboard analysis of Cadence Design Systems results in an overall score of 6.3 out of 10. While the company demonstrates a strong business foundation, effective management, and solid financials, its current valuation is considered significantly overstretched. Both analysts favor Synopsis as a more attractive investment option, citing its recent Nvidia partnership and potentially stronger competitive position. The analysis suggests limited upside potential for Cadence’s stock over the next five years, despite its consistent performance and industry position.