2024-01-17 06:30:00 ET
Summary
- ANSYS shareholders received a takeover offer from Synopsys, adding a premium to their already high-valued shares.
- Synopsys is paying a steep price for the acquisition, justifying the purchase with ambitious synergy targets.
- The combined company expects significant cost and revenue synergies, but the ambitious projections and historical difficulties with revenue synergies raise doubts.
ANSYS (ANSS) shareholders seem to have gotten really lucky, as shares of the company were already trading at a very high valuation, and now they have received a takeover offer from Synopsys (SNPS) which adds a nice premium. Seeing things from Synopsys' perspective, they are getting a wonderful business, but are paying a steep price. Even considering that part of the acquisition is being paid with their own shares, that look overvalued as well. There are significant cost and revenue synergies expected from the combination, but even accounting for these, it is difficult to justify the high price Synopsys is paying.
We'll get into the details, but our first impression is that ANSYS shareholders are the main beneficiaries from the transaction, and Synopsys will have to work really hard to achieve any accretion from the acquisition. We had covered both companies before, and we found both to have strong competitive moats and highly attractive characteristics. Still, as we pointed out about Synopsys, a big part of the returns shareholders have enjoyed have resulted from multiple expansion. Despite the stretched valuation, Synopsys, is higher compared to when we published that article. We were more accurate with ANSYS, rating it a 'Sell' at ~$371, where we emphasized that the main reason to avoid the shares was the excessive valuation. We upgraded the company at ~$254 based on a more reasonable valuation and solid guidance. Since then shares have outperformed the S&P 500 Index ( SPY ) by a wide margin.
Transaction Details
ANSYS shareholders are expected to receive $197 in cash and 0.3450 shares of Synopsys, currently trading at ~$511, for each ANSYS share. That would currently represent about $374 per ANSYS share, which means they are trading at a discount of about 13% to the offer price.
Given the regulatory hurdles the deal has to overcome, and the risk that Synopsys shares could trade lower, we think this is a reasonable discount. Especially considering that it could take a long time to complete and that interest rates are currently relatively high, meaning the opportunity cost of waiting for the deal to complete is also high.
Synopsys is justifying the acquisition explaining that it expands its target addressable market by 1.5 times to roughly $28 billion, and this TAM is expected to grow with a ~11% CAGR. This acquisitions combines leaders in semiconductor design and simulation and analysis. In their press release , they justify the acquisition as vertical integration that will allow them to offer more holistic and seamless solutions to customers. The fact that they emphasize the AI mega-trend, is not exactly comforting, as it reflects a high level of enthusiasm behind the deal that could have led them to overpay.
"The megatrends of AI, silicon proliferation and software-defined systems are requiring more compute performance and efficiency in the face of growing, systemic complexity. Bringing together Synopsys' industry-leading EDA solutions with ANSYS' world-class simulation and analysis capabilities will enable us to deliver a holistic, powerful and seamlessly integrated silicon to systems approach to innovation to help maximize the capabilities of technology R&D teams across a broad range of industries," said Sassine Ghazi, President and CEO of Synopsys.
One big thing Synopsys hope to gain from this deal is access to the customer relations ANSYS has in the automotive, aerospace, and industrial segments, with the company explicitly complimenting their go-to-market strategy and experience. At least Synopsys has good knowledge of ANSYS operations thanks to their partnership they forged in 2017. By working together, they probably understand their strengths and weaknesses better than other acquirers.
Financials
Looking at profit margins, ANSYS has better gross profit margins, but lower operating margins. This is probably the result that it is simply a smaller business, and therefore less able to apply operating leverage to fixed costs.
Given the excellent gross profit margins from ANSYS, we are not surprised that Synopsys expects operating margins and free cash flow margins to improve, as soon as the first full year post-closing.
Growth
Remarkably, despite being much larger in terms of sales than ANSYS, Synopsys has been growing revenues at a faster pace. Over the last ten years the average quarterly year-over-year revenue growth rate has been 11.69% for Synopsys, compared to 10.07% for ANSYS. Its growth has been more stable too, with ANSYS' growth clearly more volatile.
Cost and Revenue Synergies
The combined company expects to achieve roughly $400 million of run-rate cost synergies by year three post-closing and about $400 million of run-rate revenue synergies by year four post-closing, growing to more than $1 billion annually in the longer-term.
While this appears achievable, it is a significant number. As we can see from the graph above, the combined company will probably have annual revenue of ~$8 billion. So they are saying that they can reduce costs equal to about 5% of revenue, and add 5% to revenue from cross-selling and other revenue synergy strategies, like new products or services developed together. From what we have seen from previous mergers and acquisitions, cost synergies tend to be easier to realize, revenue synergies are much more difficult and can sometimes even results in dis-synergies. It remains to be seen if they deliver on these projections, but we do find them highly ambitious.
In any case, Synopsys expects the acquisition to be accretive to Non-GAAP EPS within the second full year post-close, and substantially accretive thereafter. Something in their favor is that ANSYS did not seem to be paying that much attention to efficiency, with their SG&A expense increasing as a percentage of revenue. At the same time, Synopsys was clearly gaining operating leverage and finding efficiencies, as its SG&A as a percentage of revenue has been declining for several years.
YCharts
Another area where they can easily reduce costs is stock-based compensation, as both companies had been ramping SBC significantly in recent years. Even as a percentage of revenues, the trend has clearly been to increased SBC compensation, with ANSYS in particular reaching levels that we believe are excessive.
YCharts
Balance Sheet
We believe Synopsys is being smart in using its own highly-valued shares for part of the transaction. This avoids over-stressing the balance sheet, and partially neutralizes buying expensive ANSYS shares by paying with Synopsys shares that are also expensive.
The expectation is that the merged company will generate substantial free cash flow, which allows them to rapidly de-leverage. They are aiming for less than 2x debt to adjusted EBITDA within two years post-closing. Looking further into the future, they target leverage of less than 1x, and expect to maintain investment grade credit ratings. Synopsys plans to fund the $19 billion of cash consideration through a combination of its cash on hand and debt financing.
Valuations
As we've previously mentioned, much of the gains the shares of these companies have experienced in the past ten years has been thanks to multiple expansion. Interestingly, they both are currently trading with a very similar price/sales ratio of ~13.5x.
Other valuation metrics tell a similar story, for instance, the EV/EBITDA multiple has been trending higher for both companies, and currently about 50% above their ten year averages.
Price to cash from operations per share is similarly elevated, and considerably above their ten year averages. The excitement around AI, technology, digitization, augmented reality, digital twins, and other mega-trends has clearly had an effect on their valuations.
While we consider both companies to be high-quality businesses, with very attractive margins, growth opportunities, and healthy incremental returns on investment, it is very difficult to justify their price/earnings ratio above 50x.
Their revenue growth is certainly not high enough to make a case that they deserve to trade at such a premium. The forward price/earnings ratios look a little more reasonable, but it is important to remember that analysts usually project non-GAAP earnings, and given the heavy use of SBC by both companies, that makes a significant difference.
Risks
The current difference between where ANSYS is trading, and the price Synopsys is offering (based on its current share price), means there is an arbitrage opportunity of ~13% if the deal effectively closes. However, this would mean shorting some Synopsys shares, for which there will likely be a borrowing cost, and there is uncertainty as to whether the deal will be approved and the timing.
The transaction is expected to close in the first half of 2025, subject to approval by ANSYS shareholders, regulatory approvals and other customary closing conditions. However, it could easily extend further into the future if regulators decide to take a closer look, or conditions for approval have to be negotiated.
Conclusion
We believe Synopsys is getting an attractive business, but it is paying an elevated price for it. This is somewhat mitigated by the fact that part of the payment will take the form of Synopsys shares, which appear to be overvalued as well. The cost and revenue synergies cited by the companies appear ambitious, and we have doubts whether they will be able to deliver on their projections. In particular, revenue synergies have historically been difficult to achieve and also difficult to measure.
We think ANSYS shareholders are fortunate to be getting this offer at a time when their shares already looked more than fully priced. Given the elevated valuations, regulatory risks, and the risk that the synergies might not be achieved, we are giving both a 'Sell' rating.
For further details see:
Synopsys Is Buying A Great Business, But It Is Paying A Steep Price For ANSYS