Running a large hedge fund isn't only about grabbing stakes worth hundreds of millions of dollars in single companies. Some successful funds engage in numerous small trades that will do little to move the needle of immediate results. These investments are made for purposes of diversification or, in many cases, as tests to begin accumulating larger positions. This is a characteristic of the mammoth $12 billion fund run by Bridgewater Associates. It's also representative of the Tiger Global hedge fund, which is operated by Tiger Global Management and managed by a team headed up by Chase Coleman and Feroz Dewan.
Tiger Global's most recent "13F" disclosure filing with the SEC reveals a new position in Cadence Design Systems (NASDAQ: CDNS), a leader in the field of EDA, or electronic design automation services. The fund purchased roughly 1.1 million shares during the quarter ended March 31, at a total outlay of $17.3 million. To place the dollars in context, at the end of the first quarter of 2014, the fund's total value topped $7.3 billion, so the position in Cadence Design Systems accounted for about one-fifth of 1% of the total fund.
Cadence Design Systems is a bit more esoteric than the typical Tiger Global investment, which, as I've described previously, is often a consumer-facing technology company. CDNS provides services to the electronic devices industry, by assisting companies in the design and validation of complex integrated circuits, or ICs. As electronic devices and their components become ever smaller and more prevalent, semiconductor foundries need increasingly sophisticated design software to manufacture ICs. Cadence Design Systems fills this niche service.
How specialized is this niche? In the company's own words:
With migration to advanced process nodes, the industry must adapt to more complex physics and manufacturing challenges such as the need to draw features on silicon that are many times smaller than the wavelength of light used to draw the features via lithography.
That's pretty small. CDNS provides software, hardware, and support to companies that are designing in the semiconductor industry's current scale, which is measured in nanometers.
While we're on the topic of small, with a market capitalization of just under $5 billion and trailing-12-month revenues of $1.5 billion, CDNS is a relatively diminutive company. But revenues are growing appreciably -- the company has posted a 13.2% compounded annual growth rate, or CAGR, over the past three years. It also enjoys a fairly solid financial position: While current assets of $1.2 billion barely cover current liabilities of $1.15 billion, Cadence has no long-term debt, and only $124 million of long-term liabilities. The company is also shoring up profitability: After a loss year as recently as 2010, it's been profitable each year since and posted an 11% profit margin before income taxes in 2013.
Revenue growth has been supported by acquisitions, including the purchase of Jasper Design Automation, a leader in an area of design verification known as "formal analysis," in April of this year, for $170 million in cash. The company has tended to use its strong cash flow to acquire smaller companies, selectively adding to its portfolio of design products.
The market has applauded both the revenue growth and profit. Cadence's stock has risen appreciably over the past few years:
While priced at nearly 43 times trailing-12-month earnings, Tiger Global evidently believes that Cadence Systems has further to climb. Though it's enjoyed a healthy stock price increase of more than 21% year to date, CDNS lags both the S&P 500 and Nasdaq 100 over a trailing-12-month period, gaining just 14%, versus the S&P 500's 20% gain and the Nasdaq 100's 28% rise.
So why is Tiger Global hedge fund taking such a tiny bite out of a tiny company? While it's in some measure fruitless to guess the rationale behind large hedge funds' trades from quarter to quarter, and you certainly shouldn't base your own investment decisions solely off 13F filings, it's fun to try to read the tea leaves nonetheless.
The fund's entry into CDNS has the appearance of a first bite of what may grow into a more significant position over time. CDNS devotes a significant portion of its budget to research and development: Last year's R&D spend topped $534 million, versus revenue of $1.5 billion. Thus, nearly $0.36 of every dollar in sales is plowed back into R&D. Management appears to be executing on this spend, as new products are being rolled out at a fairly aggressive clip. This is true of both the company's core EDA focus, and the sale of verification and design intellectual property ("verification IP" and "design IP"), as CEO Lip-Bu Tan highlighted in the company's most recent earnings call with analysts.
Tiger Global may be waiting to gauge the success of new offerings on revenue, while snapping up more shares over the next few quarters. We'll sift through the fund's filings next quarter to see if it's expanded its initial foray into this intriguing electronics company.
