These software vendors are unsung winners in the semiconductor industry

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Mention semiconductor and chip giants such as Intel Corp., Advanced Micro Devices Inc. and NVIDIA Corp.

The pandemic has kept semiconductors in the spotlight as a host of industries, from consumer tech to the automotive sector, grapple with chip shortages. Software Companies Synopsys Inc. SNPS,
+0.43%
and Cadence Design Systems Inc. CDNS,
-0.59%
may not be household names, but quietly play an extremely important role in the broader semiconductor industry.

Synopsys and Cadence create electronic design automation software, or EDA, a crucial tool for chip design engineers. In a recent note, JP Morgan analyst Harlan Sur described chip design software as an essential, but often overlooked, part of the semiconductor value chain. Companies like Synopsys and Cadence hold more than 70% of the chip design software market, he explained, noting that chip design is tied to semiconductor research and development budgets, which are not reduced in the event of a slowdown.

“These companies have historically grown revenue even during a mid-cycle downturn,” Sur wrote.

Sur pointed out that over the past 11 years, which spans three cycles of declining semiconductors and three years of declining semiconductor revenues, EDA revenues, and thus Synopsys revenues and Cadence, have increased each year.

See now: Two Ways the Semiconductor Shortage May Play Out

Last month, fueled by fiscal second-quarter revenue and profit that beat analysts’ expectations, Synopsys raised its full-year guidance. In April, Cadence also raised its financial guidance for the year, boosted by better-than-expected performance in its first fiscal quarter.

Chip design activity remains strong, driven by Intel Corp’s next-generation complex chips. INTC,
-0.33%,
Advanced Micro Devices Inc. AMD,
+0.87%,
NVIDIA Corp.NVDA,
-0.49%,
Broadcom Inc.AVGO,
-0.65%
and Marvell Technology Inc. MRVL,
-0.72%,
according to JP Morgan’s Sur.

The adoption of custom chip designs by cloud giants Alphabet Inc. GOOGL,
+1.08%

GOOG,
+1.06%,
Amazon.com Inc. AMZN,
+1.28%,
META from Meta Platforms Inc.,
+1.20%
Facebook and Microsoft Corp. MSFT,
+0.67%,
as well as the likes of Apple Inc. AAPL,
+0.28%,
Juniper Networks Inc.JNPR,
-0.90%,
Cisco Systems Inc. CSCO,
-0.63%
and General Motors Co. GM,
+1.16%,
also leads to an increase in the number of chip engineers, Sur wrote. These companies need software tools for EDA chips, he added.

Against this backdrop, JP Morgan continues to see a compound annual growth rate (CAGR) in revenue of 10% to 15% for Synopsys and Cadence, gross margins of 80% to 90%, as well as a recurring revenue profile of 80% to over 90%. “We believe EDA remains a very attractive part of the overall semiconductor value chain,” Sur wrote.

FactSet data shows that Synopsys and Cadence have returned 14.4% and 12.8% respectively over the past year, compared to the SPX of the S&P 500 index,
+0.46%
down 11.75% over the same period. Both companies posted record closes on Dec. 27, 2021, with shares of Synopsys closing that day at $375.59 and shares of Cadence closing at $191.65.

See now: Synopsys and Juniper Networks Form New Company to Provide Silicon Photonics Platform

In April, Synopsys also announced an agreement with Juniper to form a new, separate company focused on open silicon photonics, which will provide technology for telecommunications, healthcare, data communications, high-performance computing, artificial intelligence, optical networks, and light detection and ranging (LiDAR, or remote sensing).

Of 14 analysts polled by FactSet, 13 have a buy or overweight rating on Synopsys and one rates the company as underweight. Of 15 analysts polled by FactSet, nine have a buy or overweight rating on Cadence, five have a hold rating and one has an underweight rating.

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