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In the fall of 2022, I wonder if Cadence Design Systems (NASDAQ: CDNS) was too strong, but it certainly preceded the AI craze that followed shortly, but most certainly more recently Second-rate.
Since that time, the stock price has essentially doubled as investors recognize its growing role in the semiconductor industry (as well as other markets).
While the business is great, the future prospects are very good, and the margins are growing, I’m concerned that the risk reward here doesn’t actually make it appropriate to invest here.
computing technology
Cadence provides computing technology for electronic system design. Founded by engineers for engineers, the company touts its strong focus and culture in developing cutting-edge computing software for such smart systems.companies do this With more than 10,000 employees spread across 26 global development centers, the vast majority are R&D and field engineers.
The business offers a comprehensive product portfolio including digital design, analog/custom design, debug and verification, printed circuit board design and multi-body field optimization.
The company plays an important role across the industry, benefiting from key megatrends such as data science, machine learning, autonomous vehicles, 5G, IoT, and artificial intelligence. Chip design and architecture are becoming increasingly important as the load and expected performance increase.
This is evident in the results, as the business’ sales of $2 billion in 2017 have grown steadily to $3.5 billion in 2022, while non-GAAP operating margins are an impressive 40% of sales. Additionally, approximately 85% of sales are recurring as the company has a backlog of more than $5 billion.
2023 – Adding more expertise
Cadence is known for its occasional M&A activity, including Buy Rambus SerDes and memory interface PHY IP business from RMBS last summer.This is Already following Through another small acquisition, in the form of Intrinsix Corp, which is something (something) Last September.
Earlier this year, Cadence announced the acquisition of Santa Clara-based Invecas.after this transaction release February fourth quarter results. Sales are reportedly up 15% to $4.09 billion in 2023, indicating the company’s sales have doubled since 2017.
The company reported strong GAAP operating profit of $1.25 billion, with GAAP earnings per share of $3.82 and adjusted earnings of $5.15 per share. A large part of the gap between the two earnings metrics comes from stock compensation expenses, so I’m only willing to put actual earnings around $4 per share. Guidance for 2024 is strong, with a backlog of $6 billion, of which $3.2 billion is expected to be recognized in 2024.
In 2024, revenue is expected to reach the mid-point of $4.58 billion, plus or minus $30 million, implying revenue growth of approximately 12%. Adjusted earnings are expected to grow at an even more impressive pace, at the midpoint of $5.92 per share. That makes actual earnings here likely closer to $5 per share, trading at $317 per share, which implies a very high P/E ratio, with a realistic forward P/E ratio of over 60x P/E.
The company’s 272 million shares currently have a float value equity value of $86.2 billion, and while that includes a modest net cash position of $350 million, that doesn’t really change the thesis. The valuation is high based on forward sales data, as an 18x sales multiple looks fair if it’s a P/E ratio, but of course, the company’s business is highly profitable and the company’s growth prospects are good.
Another bolt-on deal
In early March, Cadence Design announced its next bolt-on deal, although it was still a significant deal in dollar terms given current market values. Cadence has completed a $1.24 billion deal to acquire BETA CAE Systems International AG, a leading system analysis platform provider of multi-domain engineering simulation solutions.
About 60% of the deal, about three-quarters of a billion dollars, will be paid in cash, as net debt of $400 million is expected to be fairly manageable, while about 500 million shares will also be issued.
The deal is set to close in the second quarter, with BETA CAE Systems reporting annual revenue of approximately $90 million, showing it has paid a sales multiple of nearly 14x. Adjusted dilution is expected to be $0.12 per share in 2024, but the deal is not exclusive to that year and fiscal 2025 earnings results are expected to be non-quantitatively accretive to earnings per share.
Now?
Cadence’s stock has fully participated in the rise of the semiconductor market given its position in the industry; in fact, its stock price has performed better and been less volatile than many semiconductor companies themselves. Against this backdrop, companies like Cadence play a premium and more important role in an environment where higher performance is the name of the game.
The question is to what extent this good news is priced in, but it’s the combination of higher operating profits and higher sales multiples they’re getting that makes me a little cautious here.
While the share price is definitely worth a substantial premium compared to market multiples, the reality is that the risk-reward ratio is simply skewed after the share price essentially doubled from its early 2023 levels. This means that, while I like the business very much, I don’t feel the need to participate at current levels until the risk-reward increases significantly.
