Photo by Mohamed Nohassi on Unsplash
 

Introduction

Electronic design automation (EDA) software stocks are a category of tools that help electrical engineers design and develop ever more complex custom chips using specialized software. The category is concentrated in the hands of Cadence Design Systems (CDNS) with 40% market share, Synopsys (SNPS) with 30% and Siemens EDA with 20%. Ansys (ANSS) - soon to be acquired by Synopsys (see here) - has about 6% and another 10 companies make up the remaining 4%.
 

Why the EDA Space is Set to Take Off

The compound annual growth rate (CAGR) of the category is expected to grow by 11% between now and 2028 and reach $21.6B by that date according to research by Deloitte. Given the expected CAGR, 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.
 

Deep Moat Preventing Category Entry

In a 2-part article, BayFort Capital points out that it is extremely difficult 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 Financial Requirements:
   • 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 the consolidation in the industry that we see today.
3.  Lack of Human Resources:
   • The EDA infrastructure hasn’t changed much for many years 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. Potential Intellectual Property Infringement:
   • 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.
      

The Custom Design Chips Company Portfolio

Below are the performances of 3 of the 4 major companies in the EDA space in February, in descending order, along with YTD and in 2023, with their respective market capitalizations and expected Price-to-Earnings Growth (PEG) Ratio over the next 12-month period and their latest news, commentary and/or analysis.

1. Synopsys (SNPS): UP 7.6% in February; UP 11.4% YTD; UP 61.3% in 2023
   • Market Capitalization: $90.2B
   • PEG Ratio: 2.4 (15% above the sector mean)
   • Latest News, Commentary and/or Analysis:
     • Synopsys Stock Soars To a Record High as AI Boom Drives Bullish Outlook, Earnings Beat
2. Cadence Design Systems (CDNS): UP 5.5% in February; UP 11.8% YTD; UP 69.6% in 2023
   • Market Capitalization: $858B
   • PEG Ratio: 3.4 (64% above the sector mean)
   • Latest News, Commentary and/or Analysis:
     • Cadence Expands Tensilica Vision Family with Radar Accelerator and New DSPs Optimized for Automotive Applications
3. Ansys (ANSS): UP 1.9% in February; DOWN 7.9% YTD; UP 50.2% in 2023
   • Market Capitalization: $29.6B
   • PEG Ratio: 4.0 (93% above the sector mean
   • Latest News, Commentary and/or Analysis:
     • Ansys Announces Q4 and FY 2023 Financial Results

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.
 

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.
 

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.

More By This Author:

9 Largest Quantum Computing Stocks Up 3% In February; Now Up 4.5% YTD
AI-Powered Drug Discovery Stocks Index Up 9% In February; Remains Down 8% YTD
Cloud Computing Stocks Category Up 5.6% In February; Now Up 9.3% YTD