2023-08-24 11:34:19 ET
Summary
- Synopsys is a leading provider of technological infrastructure for the development of semiconductor chips, making it a real enabler of generative AI.
- The company has shown consistent top and bottom line growth, management has guided for strong profitability and double-digit revenue growth in the long term.
- Synopsys is a true generative AI play, but is it a buy here?
Synopsys ( SNPS ) might not be a household name for even tech investors but it should be with generative AI on the rise. SNPS provides the technological infrastructure to enable the development of semiconductor chips. In other words, unlike many companies which may pretend to be AI stocks, SNPS is a real enabler of generative AI. The stock has been a powerful performer over the near and long term, but that strong price performance has coincided with consistent top and bottom line growth. SNPS is highly profitable with management committing to healthy double-digit revenue growth and 100 bps of annual margin expansion over the long term. Those looking to buy or short the stock need to carefully consider the wide fair value range due to the high quality of this business.
SNPS Stock Price
We are in a generative AI bubble, or at least that’s what it feels like with stocks from many industries seemingly rising solely based on how many times they say “AI” on their conference calls.
Amidst the hype, however, there are the real companies that are set to benefit from generative AI, like Nvidia ( NVDA ). SNPS provides the software infrastructure used by NVDA to design its chips, making it also deserving of a generative AI premium, though its upside exposure may be limited as I explain later.
SNPS Stock Key Metrics
In its most recent quarter, SNPS delivered 19% YOY revenue growth to $1.487 billion, a fabulous result given that most tech companies are seeing slowing growth following the pandemic. SNPS delivered $336 million GAAP net income and $445.9 million non-GAAP net income - representing very healthy profit margins. I note that unit-level margins stood at 79% as of this past quarter, as most of the company’s business comes from high-margin recurring revenue streams.
SNPS has historically used stock repurchases to return cash to shareholders and this year is no different with the company already repurchasing just over $900 million in stock.
FY23 Q3 Presentation
SNPS has a long history of showing durable revenue and even faster earnings growth - during a year in which many companies are seeing vicious slowdowns, SNPS expects to deliver more of the same.
FY23 Q3 Presentation
SNPS ended the quarter with $1.8 billion of cash versus almost no debt - this is the kind of business that I can see levering up when they choose to.
Looking ahead, management has raised guidance and now expects revenues to grow by 15% for the full year. For reference, revenue growth stood at just 8% through the first two quarters of the year (prior to this past quarter).
FY23 Q3 Presentation
On the conference call , management spent considerable time framing its positioning amidst the growth of generative AI. Unlike some other tech companies in which their claim to association are suspicious at best, SNPS deserves every bit of it.
In this new era of Smart Everything, these chips in turn, drive growth in surrounding semiconductors for storage, connectivity, sensing, AtoD and DtoA converters, power management, et cetera. Growth predictions for the entire semi market to pass $1 trillion by 2030 are thus quite credible.
Synopsys is the leading EDA provider to AI chip designers. Designers requiring unmatched capabilities in design tools, particularly at the most advanced process nodes. They also need our leading interface IP portfolio as AI chips are banking on enormous amounts of data, driving new, faster and lower power interconnect protocol.
Management noted that revenues related to the development of AI chips already account for over $500 million in revenues on a trailing 12-month basis, nearly 10% of the business.
How might generative AI boost the company’s financials? SNPS products will be used to develop generative AI chips but the company itself may benefit as well. Management noted that recent renewals came in at a 20% boost due to companies adding additional products to their renewals. Moreover, management expects the integration of generative AI into their own products to help further separate itself from the competition.
That said, investors may be getting ahead of themselves here, as this is a mature business which does not have the same upward torque exposure as someone like NVDA. To make an analogy with the energy sector, if NVDA is like Chevron ( CVX ) with full exposure to rising oil prices, then SNPS is like the pipeline company Enterprise Products Partners ( EPD ) in that it is supporting the rise of generative AI but will not experience the same extreme fluctuations in revenues. It is notable that in spite of the strong trends seen by generative AI beneficiaries such as NVDA, management declined to indicate how much generative AI will boost their business, if at all, only stating that they will give more guidance in the next quarter.
Is SNPS Stock A Buy, Sell, or Hold?
SNPS operates under three industries in design automation, design IP, and software integrity, though it is mostly well known for the first one.
FY23 Q3 Presentation
SNPS is the clear market leader in Electronic Design Automation - in layman’s terms, SNPS gives semiconductor companies like NVDA the tools to design their chips that they eventually sell to their customers.
FY23 Q3 Presentation
You can find more information on EDA here from the company’s website.
SNPS’ main customers in EDA are all the semiconductor companies (including NVDA) as well as major companies from a variety of industries for its software integrity products.
FY23 Q3 Presentation
At recent prices, SNPS was trading richly, but not quite at nosebleed bubble prices. The stock changed hands for just under 40x this year’s earnings estimates.
Seeking Alpha
During a time in which tech stocks have undergone a dramatic recovery, that kind of valuation might not seem crazy, but it is evidently rich when compared against consensus estimates for a low double-digit revenue growth rate moving forward.
Seeking Alpha
Management has given long-term guidance for double-digit revenue growth and 100 bps of non-GAAP operating margin expansion annually.
FY23 Q3 Presentation
Assuming 50% long term net margins, 15% growth, and a 1.5x price to earnings growth ratio (‘PEG ratio’), I could see SNPS trading at around 11.3x sales, just right around where the stock is trading at. That suggests shareholders can earn forward returns in-line with their revenue growth rate, assuming no multiple compression. But just how reasonable is that assumption? It is possible that hype for generative AI fades, and with it this premium valuation. I also note that my assumptions - 15% growth and 50% long term net margins - may prove too aggressive, especially after one year’s time, assuming the company does reap some near term generative AI boost. On the other hand, it is still possible for the stock to get more expensive - not just because NVDA itself is trading at 26x sales but simply due to mature, dominant businesses often earning PEG ratios in the 2x to 2.5x range outside of the tech sector. Based on a 2.5x PEG ratio, I could see SNPS trading up to 19x sales, implying a stock price of $745 per share or 66% potential upside. This illustrates the danger in trying to short this stock, as it is not quite at nosebleed valuations just yet.
Valuation is still a risk, but mostly due to the greater potential for excess volatility - I don’t see a bubble here. Instead, I point out that the company recently derived 20% of its revenues from China - if political tensions escalate, then that revenue may eventually be at risk.
FY23 Q3 Press Release
I also note that SNPS does have great customer concentration, having one top 10 customer making up 10% of revenues last year. That said, management cites having customer retention rates ranging from 92.5% to 97.5% and it makes sense for the most dominant design software to retain business, not too dissimilar with the dominance of products like Microsoft Word ( MSFT ) or AutoCAD from Autodesk ( ADSK ). It is possible that Nvidia or other key customers get big enough that developing their own EDA software becomes feasible, though I find such an event to be unlikely given that SNPS has been able to improve their software through decades of improvements. Perhaps the greatest risk is simply that of volatility - I expect the generative AI bubble to eventually pop, and SNPS may see some volatility at that time. The valuation is a bit too rich for my taste, as the stock is not offering multiple expansion upside to my fair value in the 1.5x PEG ratio scenario, nor is it offering fast enough revenue growth to make up for that. I rate the stock neutral due to valuation, but the stock is of utmost quality and this is one worth keeping on your watchlists.
For further details see:
Synopsys: The Software Company Powering Generative AI Chips