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What Is Electronic Design Automation (EDA) Software?

Chips contained thousands of transistors in the 1970s but they contain more than a hundred billion today so it's impossible to create these designs manually like it was done back then. That’s where electronic design automation (EDA) software comes in - a category of tools that help electrical engineers design and develop ever more complex chips using specialized software.

What Are the Market Shares of the Major EDA Companies?

The category is concentrated primarily in the hands of three vendors, Cadence Design Systems (CDNS) with 40% market share, Synopsys (SNPS) with 30% and Siemens EDA with approximately 20% with Ansys (ANSS) having about 6% and another 10 companies making up the remaining 4%.

Why Aren't More Companies Involved in the EDA Space?

Ketul Sakhpara, CFA and Founder of BayFort Capital, points out in a 2-part article, how difficult it is to break into the EDA space because of its high entry barriers, namely:

1.  The Chip Sign-off Process:
   • Once a chip is designed it needs to be manufactured but before it is manufactured it requires the checking of every single function (thousands if not more) of the chip, its enormous computing power and finally its documentation, each of which has to be signed-off by lawyers for both the designer and the potential manufacturer since a mistake here is irreversible and the cost of a mistake is too high compared to the cost of the tool.
2. Intellectual Property:
   • It’s a lot cheaper and faster for chip designers to buy off-the-shelf IP components but they need to pay for these third-party IP building blocks in their chips to IP owners, a lot of which are owned by the top 3 EDA vendors. This annual IP base of revenues provides these vendors the capacity to keep funding R&D for new tools as well as buying out any new niche (subset) tool provider in the sector to fill a hole or improve their suite of EDA tools and this process has led to consolidation in the industry that we see today.
3.  Human Resources:
   • The EDA infrastructure hasn’t changed much for many years. Most engineers are in their forty’s now having started in the sector back in the 1990s so developing new EDA tools is difficult as the industry is limited in terms of experienced professionals and many of the current group of specialized chip design engineers prefer not to change their development tools to achieve small incremental features as it affects their productivity.
4. IP Protection:
   • Attempts to develop EDA tools to compete with the top 3 vendors by other fledging EDA companies is likely to infringe on existing patents in one way or the other due to the lack of professionals who have not worked at the three vendors.

Questions & Answers About the EDA Industry

Given the above stated difficulties in breaking into the EDA industry it raises the following questions as to whether, or not, it is worth trying to do so:

1. How big is the Total Addressable Market?
   • The market size increased to $13B in 2023 and, according to research by Deloitte, is anticipated to reach $21.6B by 2028.
2. What is its rate of growth?
   • The compound annual growth rate (CAGR) based on the above anticipated market size in 2028 is expected to be almost 11% between now and 2028.
3. What are the major factors contributing to this growth?
   • Realizing the dangers of relying on a single region (Taiwan) companies are setting up chip manufacturing units in different geographies and as these plants come online over the next few years they will have to apply their own EDA processes and chip designers will have to rely on EDA tools to integrate with new chip manufacturing facilities.
   • Electric Vehicle (EV) sales are expected to increase by 12 times by 2030 according to Deloitte, and EVs use 2-5x more chips compared to combustion engine automobiles.
4. Is it worthwhile investing in the EDA space?
   • Given the expected CAGR between now and 2028, the building of new chip manufacturing plants, the rapid growth in sales of EVs and the number of chips in automobiles growing with the advent of autonomous vehicles the EDA space is set to take off.
   •  In addition, the demand for EDA software is less susceptible to the fluctuations of economic cycles compared to semiconductor demand. Chip design is a constant need, regardless of economic conditions, making the EDA software market a strategic investment avenue for those looking to capitalize on the AI chip industry’s expansion.
5. What are the biggest variables related to total industry results?
   • Siemens EDA, formerly Mentor Graphics, operates on a mostly upfront license model and its variability is tied to the timing and magnitude of contract renewals for its physical verification and printed circuit board design (PCB) businesses.

The Custom Design Chips Company Portfolio

Below are the performances of 3 of the 4 major companies in the EDA space in 2023, in descending order, with their respective market capitalizations and expected Price-to-Earnings Growth (PEG) Ratio over the next 12-month period:

1. Cadence Design Systems (CDNS): UP 69.6% in 2023
   • Market Capitalization: $69.5B
   • PEG Ratio: 2.91 (46.6% above the sector mean)
2. Synopsys (SNPS): UP 61.3% in 2023
   • Market Capitalization: $74.5B
   • PEG Ratio: 2.06 (only 3.8% above the sector mean)
3. Ansys (ANSS): UP 50.2% in 2023
   • Market Capitalization: $29.9B
   • PEG Ratio: 5.09 (156.6% above the sector mean

Siemens EDA is included in Digital Industries, one of 6 segments of the Siemens Aktiengesellschaft conglomerate, and no separate information is available on the 6 segments.

Why the PEG Ratio Is Included?

Since growth is a key component of a stock's expected return, the inclusion of the PEG ratio provides a fuller picture of a company's relative value in the market. The lower the PEG ratio - lower than 1.0 is best - the more the stock may be undervalued given its future earnings expectations while a ratio greater than 1.0 generally suggests a stock is overvalued.

The PEG ratio should be used along with other tools such as the balance sheet, debt burden, and cash flow, or other valuation metrics that use the income statement. It's also important to understand things like a company's competitive advantage, its addressable market, and its long-term growth prospects.

Conclusion

The demand for EDA software is anticipated to maintain robust growth, with double-digit increases expected to continue throughout the decade as the major semiconductor companies (see list here) begin to require, and acquire, custom-designed chips for their new products. This growth trajectory is likely to be stable, as the demand for EDA software is less susceptible to the fluctuations of economic cycles compared to semiconductor demand while chip design is a constant need, regardless of economic conditions, making the EDA software market a strategic investment avenue for those looking to capitalize on the AI chip industry’s expansion.

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