Leading semiconductor design software company Synopsys (NASDAQ: SNPS) is having a moment. Over the last three years, the company has shot out of relative obscurity and into the limelight -- and for good reason.
As per new CEO Sassine Ghazi, Synopsys has "delivered a 17% revenue CAGR [compound average growth rate], non-GAAP [generally accepted accounting principles] operating margin improvement of 7 points, and non-GAAP EPS [earnings per share] growth at a 26% CAGR." For a large software company, it's been a stellar run higher, especially considering that includes a bear market.
But is that financial performance good enough to justify an 80% run since the start of 2023? Perhaps.
A more important question, though, is what will happen going forward -- because while Nvidia gets most of the attention for the current AI hype, Synopsys plays a huge role as well. Can Synopsys go parabolic like Nvidia stock has?
Is Synopsys ready to pull off an epic move?
Synopsys' most recent quarterly earnings were very good. Revenue increased 21% year over year to $1.65 billion, and adjusted EPS increased 36% year over year. Management increased its full-year expectation for adjusted EPS, now anticipated to increase 21% from 2023.
The item that has captivated everyone's attention, though, is the pending merger between Synopsys and design simulation software provider Ansys (NASDAQ: ANSS). Officially announced in late January, this deal isn't likely to be finalized until sometime in 2025, pending regulatory approval.
Nevertheless, there are big moves happening in this market. Synopsys is trying to acquire Ansys as ridiculously complex AI systems are ratcheting up challenges for customers -- from data center operators to auto manufacturers to smartphone developers. Synopsys' peer Cadence Design Systems recently announced its own AI-powered supercomputing platform to boost customers' simulation capabilities in the design workflow. And Keysight Technologies also quietly made a small acquisition to increase its own capabilities in the same department.
What's the big deal with simulation software anyway? Ghazi commented on the earnings call:
There is no one more capable of helping companies innovate for this era of pervasive intelligence. Semiconductor companies are now designing with a system approach in mind, while system companies are unlocking additional value through purpose-built chips and software-defined systems. At the same time, customers see the fusion of electronics design and physics simulation as critical to delivering high-performing and high-yielding solutions for their business.
Synopsys-plus-Ansys unlocks new market opportunities for the merged business, especially as the growing pervasiveness of AI makes design work more complex. Ansys already makes the bulk of its revenue from non-tech customers in industrial markets, so Synopsys could get its own design software into the hands of companies that need help with AI the most. If successful, this could help blur the lines between computing intelligence of today and the (currently) very different world of mechanical engineering.
But why compare Synopsys-plus-Ansys to Nvidia, though? Back in 2019, I wrote extensively about an underrated pending acquisition the AI titan was trying to make: network chip design company Mellanox. When Nvidia finally closed the deal in early 2020, the pandemic had struck, and few investors were paying attention to the new AI training potential Nvidia was sitting on.
However, Mellanox ended up being an absolutely critical piece of Nvidia's current AI dominance, as it helped the company solve some problems with quickly moving massive amounts of data during the AI training process.
Could Synopsys be trying to solve for a similar AI pain point (making AI usable in everyday applications for the masses) by purchasing Ansys? Maybe it is, and big profitable gains lay ahead in the coming years.
A premium-priced stock, but for good reason?
All of this may sound good, but there's the problem of valuation. Synopsys stock fetches a high premium of 63 times trailing-12-month EPS, and 67 times trailing-12-month free cash flow (which more closely aligns with adjusted EPS). On a forward-looking basis, Synopsys trades for about 42 times expected EPS -- still a high price tag to be sure.
Nvidia also trades for a similarly hefty valuation, and has for many years. It would seem that top AI stocks are destined to be "expensive." New AI is still in the early stages of development, after all, and have the potential to unlock massive new efficiencies in business operations.
Mind this premium, but don't ignore Synopsys stock either. With or without Ansys, it sits at a critical point in the semiconductor industry, and in AI development at large. Acquiring Ansys could go down in history as a huge deal. Consider utilizing a dollar-cost averaging plan to build a position in Synopsys over time to smooth out the inevitable volatility in stock price.
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Nick Rossolillo and his clients has positions in Cadence Design Systems, Nvidia, and Synopsys. The Motley Fool has positions in and recommends Cadence Design Systems, Nvidia, and Synopsys. The Motley Fool recommends Ansys. The Motley Fool has a disclosure policy.
