A TOOLSET FOR TECHNOLOGY
We are reinstating coverage of the electronic design automation (EDA) industry.
EDA software is a toolset used by integrated circuit (IC) designers in designing
and testing semiconductor chips. The EDA industry faced a challenging 2009 as
semi customers hunkered down on opex, and we expect a modest 2010 recovery.
Attention is turning more than ever to integrated EDA solutions, as shrinking IC
architectures have yielded scaling challenges with respect to both physical and
power limitations. Other key trends include: 1) increased focus on design for
manufacturing, power, and verification; 2) further adoption of electronic system
level design in select applications; 3) ramping use of standard-based IP; and 4)
exploration for growth avenues beyond IC design.

SYNOPSYS IS OUR TOP PICK IN EDA
Synopsys (Buy, PO $27) is our top pick based on its integrated product offering,
cash flow generation capabilities, and strong balance sheet. We’ve taken a more
cautious position on Cadence Design Systems (Underperform, PO $5.7) given
limited upside potential to 2010 and near-term disruption due to ongoing
corporate transitions. We are modestly positive on Mentor Graphics, as we see a
viable best-in-breed IC strategy coupled with green field market expansion, but
competitive headwinds in the IC design market could pressure long-term growth.

SEMI R&D TO GROW IN 2010; EDA INDUSTRY SHOULD FOLLOW
The $5b EDA industry tends to lag the cyclical behavior of the $250b
semiconductor market that it supports, and more closely tracks semiconductor
R&D spending. Our bottom-up semiconductor R&D analysis indicates
approximately 9% Y/Y growth in 2010 following 7% Y/Y decline in 2009. We are
initiating our 2010 EDA market forecast at +4% and 2009 at -10%. Note that the
subscription model transition underway at Cadence could cause a sharper 2009
decline and/or more muted 2010 recovery than the historical relationship would
normally suggest – Q1 and Q2 have declined 11% and 16% y/y, respectively. We
think low-single-digit growth remains a reasonable 2010 target, nonetheless.

VALUED IN A VACUUM; LONG-TERM UPSIDE TO EDA MULTIPLES
We’re fascinated to see a sharp disparity between EDA valuations when stacked
up against similar recurring revenue growth stories in our software universe.
Company specific growth stories vary, but long-term growth for EDA is likely in the
mid-single digit range. Comparable software stocks such as RightNow, Sybase,
and Symantec trade at 2.3x 2010 EV/Revenue vs. EDA at 1.4x. Moreover, EDA is
arguably a stronger industry than the software counterparts given the underlying
$250b semiconductor industry it supports and the considerably high barriers to
entry. We’re not calling for an immediate elimination of the valuation gap as we
see no clear catalyst on the horizon, but we certainly believe there is an upward
bias to EDA multiples over time.