Synopsys Inc. (SNPS, Financial) has capitalized on the incredible rise of the semiconductor industry by playing a critical role in how these crucial components are manufactured. Synopsys specializes in developing electronic design automation (EDA) software used for designing and testing integrated circuits. The past does not predict the future, but the signs all seem to point to semiconductors contnuing to play a big role in society and technological evolution, and Synopsys has an important role in that growth.
Why is EDA software important?
First, EDA tools are employed in the design and validation of semiconductor manufacturing processes, guaranteeing that they produce the necessary performance and density. Secondly, EDA tools are utilized to ensure that a design satisfies all the manufacturing process requirements. Deficiencies lead to a chip that either doesn't work or works at a lower capacity. Finally, after the chip is made, there is a need to track the performance of the device from testing after manufacturing to deployment in the field. The objective of this monitoring is to confirm that the device retains its expected level of performance throughout its lifespan and to prevent unauthorized tampering with the device.
The total addressable market for EDA tools is expected to reach $22 billion by 2030, according to Grand View Research. Synopsys gets roughly 65% of its revenue from EDA sales and has roughly a 30% market share according to TrendForce. This is why Synopsys has been able to crush it for more than a decade with top and bottom line growth.
Rock solid financials
Synopsys concluded its 2022 fiscal year (which ended on Oct. 31, 2022) with better than expected results and then started off this fiscal year with another earnings beat during the first quarter, despite a choppy microenvironment that saw reduced growth in the industry. For the full year of fiscal 2022, Synopsys saw revenue grow 18% to more than $5 billion, up from $3.1 billion in 2018 and $1.9 billion in 2013. The company now expects to earn between $10.50 and $10.60 per share in 2023. By 2030, I estimate earnings could reach $20 per share or higher, especially considering the company continues to buy back its stock.
More importantly, the company's minimal debt level and $1.1 billion in cash means that the elevated interest rates in the market will have a negligible impact on its expenses and the company can continue to make strategic acquisitions. These have been a stable of growth for the company, and while it has racked up nearly $4 billion in goodwill on the books, that hasn’t stopped Synopsys from also growing retained earnings at a healthy clip.
In the last 10 years, retained earnings have grown from $1.3 billion to $5.8 billion, which has produced nearly $50 billion in market appreciation. In other words, the company has generated $10 in market price for every $1 retained.
Huge advantage in AI
Synopsys' trademark product DSO.ai, the company's artificial intelligence design solution, has played a vital role in driving the current financial growth by substantially reducing turnaround time, compute resources and power consumption. Seven of the top 10 semiconductor companies have utilized DSO.ai for production design, saving R&D resources for the customers and helping Synopsys double its customer count in the last 12 months.
Synopsys is also in favorable position to withstand (perhaps even take advantage of) a possible economic downturn. In particular, technology spending tends to be resilient in the face of economic challenges with companies understandably cautious about cutting expenses that are crucial for future growth. Additionally, the CHIPS and Science Act signed into law in August should boost earnings by providing funding for its R&D initiatives. The act provides roughly $280 billion in new funding to boost domestic research and manufacturing of semiconductors in the United States, which Synopsys is sure to get a sizable chunk.
Mr. Market is fickle
Synopsys will likely not be the growth story it was in the last decade going forward. It doesn’t need to be. With this level of profitability and the need for products in the semiconductor market at stable high marks, it should continue to build retained earnings and book value at a similar rate going forward. Synopsys should continue to benefit from both the rising complexity of chip designs and the accelerated trends toward artificial intelligence, 5G communications, autonomous vehicles and cloud computing.
If the market continues to reward that growth with a 10 to 1 capitalization increase, by 2030 the market value could reach north of $160 billion. On the other hand, what’s more likely to happen is that despite the growth and profitability, the market will reduce its reward ratio to 5:1 or even 2:1, meaning even if Synopsys books an additional $11 billion in retained earnings by 2030, that will only be worth another $22 billion to $55 billion in market cap - still a signficant addition to the current market value of $55 billion.
