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What has driven Cadence to buyout Mentor?

Posted: 25 Jul 2008 ?? ?Print Version ?Bookmark and Share

Keywords:consolidation? acquisition? investment?

Cadence Design Systems' efforts to acquire Mentor Graphics are motivated by more than greed. Greed needs to be justified, explained, rationalized, or it does not make a good story. I have been thinking about this for a while and now I can write about it. When financial analysts, the group of people Mike Fister talks with frequently, describe an industry as "ripe for consolidation", they use the term with a very precise meaning. "Ripe for consolidation" means that the "Street" cannot expect returns from investments in the sector much better than the rate of inflation, or the Wall Street Journal Prime Rate, whichever is smaller. Therefore, they issue either neutral or negative investment advice when covering the companies in the sector. This is not good news for Cadence, or any of the other publicly traded EDA companies.

The old model
In a traditional market sector, consolidation generates two positive effects such as better price control and lower costs. When combined, they generate higher profits which translate in stronger stock and generate additional investments. Consolidation means less competition because there are fewer producers and thus supply can be better regulated to stay a bit below demand, a sure way to raise prices.

Consolidation normally creates redundancies in the administrative and often in the production and support sectors of the resulting organization. Thus, it is possible to reduce staff positions and cut costs, especially overhead, or indirect costs.

In the case of Cadence and Mentor administrative, marketing, sales and support organizations can be significantly smaller than the sum of the present two, or at least this is the reasoning by the financial analysts.

The fact that there are product redundancies is also not seen as a waste, but as an opportunity for divesting, at a profit of those products, either through an outright sale or a spin-off.

So when EDA editors write against the proposals, they are seen either as biased, ignorant or idealists. It is often a combination of some of the above.

Prevailing setbacks
The EDA industry is not like any other industry. It is a service industry and the relatively small number of significant buyers has alternatives not present in traditional industries.

The number of customers dealing with leading-edge problems, the ones that purchase licenses that generate the largest profit margins, is becoming smaller with each fabrication node, normally an indicator that supply consolidation is desirable. However, in our industry, the best customers are also the ones with the greater access to alternative solutions.

Assuming that Cadence is successful and that it can impose a new pricing model on the industry, and supposing that Synopsys Inc. falls in line, this would mean two things: Magma will increase its share of the markets in all sectors with the exception of digital simulation and verification where it does not have a presence, and smaller companies would also see greater opportunities to expand. The result would be that in order to be competitive, Cadence would have to match what the customers want to pay, not the other way around.

Using many standards
Cadence is locked in too many standards, and it would be very difficult to undo Open Access, a reasonably straightforward tool for startups to "augment" capabilities in the installed Cadence base. The jump from "augment" to "replace" is not very long when the financial stakes are high enough. The company does not have unique technology in any sectors of EDA. It competes directly with at least one among Synopsys, Mentor, and Magma. Demand can also be mitigated by IDMs and by foundries through developing internal tools. Consolidation in the supply sector would mean that there would be a higher supply of well qualified engineers willing to work on proprietary tools. By the time, it would take Cadence to settle the ripples from the merger, say in two years' time, its customers would be in a position to counter any of its pricing moves. They are not going to wait-and-see; they are going to react immediately on all three fronts: roll your own, switch to a direct competitor and nurture one or more startups.

Although I have heard from a few financial analysts who think the acquisition is good for Cadence and for the industry, I continue to believe it will not work even if classical investment theory says it should.

- Gabe Moretti
EDA DesignLine





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