Synopsys, Inc. (SNPS): Buy, Sell or Hold?

Earnings Analysis: Synopsys Inc. (NASDAQ:SNPS)Synopsys, Inc. (NASDAQ:SNPS), one of the leaders in electronic design automation (EDA) software, has performed extremely well for its shareholders over the past few years, and is currently sitting just below its 52-week high. With tech stocks being hit-or-miss this year, how should you play this one going into its earnings report on May 22? Does this one have more in the gas tank, or has Synopsys, Inc. (NASDAQ:SNPS) reached its limit, for now?

Synopsys, Inc. (SNPS): Finding The Cheapest EDA Software Company

About Synopsys

Synopsys, Inc. (NASDAQ:SNPS) designs the software that engineers use to design and test integrated circuits (semiconductor chips) for use in a variety of applications. Today’s integrated circuits are increasingly complex, and require the latest in software technology to build. The process of designing and building IC’s occurs in several steps, so Synopsys has broken its business down into four groups; Core EDA, Intellectual Property and System-level solutions, Manufacturing Solutions, and Professional Services.

The Core EDA group accounts for the bulk of the company’s revenue, generating 62% of the total last year. An interesting fact about Synopsys, Inc. (NASDAQ:SNPS) is that it is truly an international company, with over half of their sales (52%) coming from international markets.

Over the past decade or so, the company has shifted its strategy toward time-based software licenses, as opposed to one-time licenses. In effect, this works like a subscription, and benefits the company by a) making the software more difficult to pirate, and b) creating a more steady, consistent stream of income as opposed to one-time software purchases that allow users to decide whether or not to buy the latest version.

The Numbers

With 2012 revenues of about $1.75 billion, Synopsis had its best year ever, by far. It earned $2.10 per share, which is projected to rise to $2.40 this year. Pay particular attention to the company’s guidance, as there are remarkably few analysts covering the company (only 6, according to my broker), and this generally creates the most uncertainty, and also the biggest post-report price swings.

At 16.9 times TTM earnings, Synopsys, Inc. (NASDAQ:SNPS) may appear a bit expensive at first, especially considering that the consensus calls for 9% forward growth. One thing to note is the company’s $600 million in net cash (cash minus debt) which reduces the P/E to 15.1. Ok, I like that a little better! Still, let’s see if there is a better deal to be had in the sector.

What Else is Out There?

One similar-looking company is Cadence Design Systems, Inc. (NASDAQ:CDNS), which is a slightly smaller producer of EDA software. The company has a very similar business makeup, with a little more than half of its revenues coming from overseas and a similar product portfolio. Cadence earned $0.77 per share last year, for a P/E of 18.3 times earnings; however the consensus is for 11% forward growth. Cadence also has a better cash position, with $827 million in cash and absolutely no long-term debt. With a market cap of just $3.9 billion, this is very significant. Excluding cash, Cadence trades for just 14.3 times earnings, less than Synopsys, Inc. (NASDAQ:SNPS) with better growth.

The other major player in the EDA software space is Mentor Graphics Corp (NASDAQ:MENT), which is significantly smaller than both of the others mentioned here. Mentor trades at the lowest P/E of the three, at just 12.8 times last year’s earnings, however the fact that it doesn’t have as great of a balance sheet (a little more debt than cash) makes me a bigger fan of the other two. Also, Mentor has a much more inconsistent earnings history than the others, and that is a red flag for me when it comes to long-term investing.

Buy, Sell, or Hold?

As far as the EDA software industry goes, the biggest is not necessarily the best. For those investors who have Synopsys, Inc. (NASDAQ:SNPS) on their radar, maybe you should consider Cadence instead. I don’t know about you, but 14.3 times earnings with 11% forward earnings growth sounds pretty good to me. For those who are set on Synopsys, Inc. (NASDAQ:SNPS), do nothing now, but wait until the earnings release. Who knows, maybe the market will realize that it’s a bit expensive and we’ll get a nice pullback.

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