Cadence Design Systems, Inc.

Moat: 4/5

Understandability: 3/5

Balance Sheet Health: 4/5

Cadence is a leader in electronic system design, providing software, hardware, and intellectual property for the semiconductor and electronics industry. It has over 35 years of experience and is a critical part of the design process for most chip makers.

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The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Cadence Design Systems, Inc., or CDNS, is a leader in electronic system design, offering software, hardware, and IP solutions to semiconductor and electronics companies. Their products enable clients to design, simulate, and verify the complex chips used in various applications.

Business Overview

Revenue Distribution : Cadence’s revenues come from a mix of product and maintenance revenue, services, and IP. The System Design and Simulation segment accounted for 27% of revenue for the latest 3-months ended September 30, 2024. While this is the largest segment, they are growing the slowest. Functional Verification, Emulation and Prototyping revenue is growing the fastest at 26%. Finally, the system design and analysis sector accounted for 14% of the company’s revenue and has a slightly slower growth rate of 12%. Geographically, the Americas are the biggest contributors to revenue. While the Americas are their largest contributor, they are also the slowest-growing and most stable region. The company is focusing to grow business in other emerging markets such as China and India.
Industry Trends: The semiconductor industry is experiencing rapid innovation, particularly in AI and machine learning, which is requiring increasing levels of chip complexity. Semiconductor design tools are very capital intensive and are critical to chip manufacturers. New technologies, such as AI, are creating opportunities for new entrants to the industry, but it is tough for a new entrant to compete with established firms due to network effects and lock in. Demand for software design solutions is also increasing as more and more products become “smart” (cars, appliances, homes, etc) and chips are being implemented in almost everything. This industry is highly competitive, and the market leaders will continue to grow their share of the market.
Margins: In the last report, for the nine months ended September 30, 2024, Cadence’s gross margins were 83%, and operating margins were at 32%. They have consistently reported healthy margins. They are also trying to increase profit margins by cutting costs from sales and R&D through AI and better efficiencies.
Competitive Landscape: The semiconductor and electronics design market is dominated by a few major players like Cadence, Synopsys, and Mentor Graphics (now part of Siemens). These companies have high switching costs as their software becomes a part of the design process. This creates a “sticky” client-base and is hard to compete with, leading to an oligopoly in the market. Smaller competitors have also risen but have small market shares. There is also a tendency for integration between software vendors and foundries to further limit market participants.
What Makes Cadence Different? : Cadence’s software provides the bedrock of design and verification in the semiconductor and electronics industries. The fact that they provide all the steps of a complex design process, and they also continue to maintain their technological lead make it difficult for competitors to displace them. They have a well-diversified portfolio, which allows them to get contracts across various industries.

Cadence has had some recent changes. In February 2024, the board of directors appointed Anirudh Devgan as Chief Executive Officer. He has been with Cadence since 2017 and had a long background at IBM before that. He is also a member of the company’s board of directors.

Financials

Revenues:

Cadence has shown an impressive track record for growth and profitability. The company has shown strong revenue growth quarter-over-quarter for 2024. Cadence’s total revenue for the nine months ended September 30, 2024, was $3,062M, an increase from $2,617M for the corresponding period in 2023. The total revenue was about 54% in the Americas, 24% in Europe, and 22% in Asia. The company has shown solid revenue and margin growth in the last few years. A good part of the revenue growth came from an increase in product subscriptions and licenses.

Profitability: Cadence has consistently been profitable, with high margins which it is trying to improve, both on operating and net income. For the nine months ended September 30, 2024, they have reported net income of $571.8 million compared to $308.4 million for the corresponding period in 2023. This shows the company’s profitability has increased substantially YoY, despite any negative impacts from higher input costs.
Balance Sheet:
- The company has a total cash and cash equivalents position of $1,652M and short-term investments worth $383M for the quarter ended September 30, 2024. On the liability side, they have $346.5 million in short-term debt, and $2,462.3 million in long term debt. Overall, it has a healthy balance sheet with cash and investments greater than its short-term debt, but it has a high amount of long-term debt.
- It is to be noted that they have $287 million and $156 million in noncurrent and current lease obligations respectively which are also their liability.
- The company has a high goodwill amount ($1.04B), along with acquired intangibles ($1.64B). This implies that a large part of their valuation is tied to acquisitions, and they may face a need to write-down their value if it turns out that the companies they have purchased aren’t performing as expected, which can affect their financial health.
Cash Flow: Cadence has been generating more and more cash from operations, and also more free cash flow. For the nine months ended September 30, 2024, they have a free cash flow of $987.7 million, which is far more than $490 million for the same period in the last year. They are using their free cash flow to pay down debt, but also for share buybacks and acquisitions. They have a good amount of free cash flow to continue their operations and increase their business.
Risks: The biggest risk is related to competition. There is always the risk that the leading companies can lose out to a new entrant by a technological breakthrough or better pricing. However, these barriers to entry are usually high. Furthermore, as the industry consolidates, companies will get fewer opportunities. The high levels of acquisitions also carries a high risk if a company overpays for a company or fails to achieve synergies.

Another risk to their profitability is the volatility in the semiconductor sector due to economic trends. A contraction in global economy could lead to a decrease in sales for companies that provide software solutions for those industries. The company could also be hurt by rising interest rates, especially as it is highly leveraged. Finally, a portion of revenues are generated outside of the USA. Any major global instability can affect their growth and profits. As the company is present in many different countries, it may face some risk from regulations or geo political situations.

Understandability: 3 / 5

Cadence’s business is moderately complex to understand. The business of providing semiconductor design software requires some technical knowledge to understand, but their business model can be more easily understood using the above analysis. It is not simple, but it can be well understood by someone who studies the business deeply.

Balance Sheet Health: 4 / 5

Cadence’s balance sheet is healthy and in good shape. They have more assets than liabilities, but they also have a sizable amount of debt. They have consistently improved and increased their FCF. Their profitability and margins have remained impressive, and they have a solid track record. If they can reduce their debt burden, their financial health can be rated higher.