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Synopsys: Some Growth Costs Too Much

Judging from the companies' relative ratings on Motley Fool CAPS, where both stocks rate just a single star, this won't go down in history as one of the most highly watched mergers ever. Still, at $227 million, I think Synopsys' (Nasdaq: SNPS  ) purchase of Synplicity (Nasdaq: SYNP  ) merits a mention.

So what are the upsides to this deal? According to Thursday's press release, Synplicity brings with it expertise in programmable chips (called "field programmable gate arrays") that Synopsys lacks. Synplicity focuses on "hardware-based" products, which should complement Synopsys' software-based focus. Furthermore, Synplicity is a competitor to Synopsys, and taking out a competitor is almost always good for margins. When that competitor brings with it an expanded client base, it's even better -- and in this regard, I note from their respective filings that Synplicity brings a handful of customers that Synopsys does not appear to serve in its own right: Xilinx (Nasdaq: XLNX  ) , LSI Corp. (NYSE: LSI  ) , Avnet (NYSE: AVT  ) , Lattice Semi, and Arrow Electronics.

Buy the numbers
So from a high-level business perspective, the deal appears to make sense. But do the numbers work? Because Synplicity carries $43 million in cash and no long-term debt on its balance sheet, Synopsys is getting the company for an enterprise value of $184 million. That works out to about 2.6 times sales -- a significant premium to Synopsys' own enterprise value-to-sales ratio of 1.8.

So, at first glance, Synopsys is paying a rich premium. That might be justified if Synplicity was earning better profits on its sales than Synopsys, but the opposite is true. Over the past 12 months, Synplicity's operating margin hovered around 4% -- Synopsys pulled down something closer to 12.5%. Little wonder, then, that Synopsys predicts its earnings will take a hit from this deal in fiscal 2008 (but recover in 2009).

It seems to me that Synopsys' plan is to "buy growth." Growth in the form of a larger customer base. Growth, too, in the form of sales that are outpacing Synopsys. Last quarter, Synplicity's revenue was up 22% year over year -- several times as fast as Synopsys managed. Whether that growth is worth owning, though, will depend on whether Synopsys succeeds in squeezing as much profit out of its new revenue stream as its existing revenues produce.

Is that doable? Go to CAPS now and tell us what you think. If investors on balance think Synopsys' purchase is a good one, we should see the stock gain at least a second star in short order.

Find our synopses of Synopsys' past few quarters:

Read/Post Comments (1) | Recommend This Article (3)

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  • Report this Comment On March 24, 2008, at 10:22 PM, BayAreaBMWFan wrote:

    Your analysis is too shallow for an industry as specialized as EDA. EDA is different from most other software segments since a bulk of the revenue comes from company-wide all you can eat deals and not on a per-license basis. A must-have product and a complete tool-set enhances your pricing power signficantly.

    SYNP sells to customers who get free software from FPGA vendors but need SYNP for their high-end stuff. It is very hard to compete against free and SYNP's financials reflect the flat-lining. For SNPS it is a strategic buy since their own FPGA design offerings are limited. Further it allows them entry into a new design domain with scope for expansion as software and hardware design merge.

    A merger with SNPS cuts a lot of SYNP's expenses (salesforce, marketing, administration) which you have completely ignored in your analysis


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