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Cadence Comes Tumbling After

Posted on Thursday, Jul 24th 2008

Cadence announced rather unimpressive Q2 results yesterday. Revenues of $329 million were higher than the market’s expectations and grew 15% sequentially but recorded a 16% year-on-year decrease.

Product revenue was $195 million, maintenance revenue $100 million, and services the balance of $34 million.

In the quarter, 49% of revenues came from the Americas, compared with 40% the previous quarter. Asia followed with a 30% contribution; Japan brought in 18% of overall revenue. Europe’s share was 21% of overall revenue.

For Q3, Cadence projected revenues of $235-$245 million with a non-GAAP loss of $0.09-$0.11 per share. Revenue projections for the year are $1.12-$1.14 billion, compared with the company’s earlier guidance of $1.6 billion. Projected EPS for the year is $0.01-$0.05. The market was looking for EPS of $1.16.

I have often talked about consolidation within the EDA industry as the first step to improving its future and the possible buy-out of Mentor Graphics. With the recent announcement of Cadence’s hostile takeover bid for Mentor Graphics, the dice are finally rolling.

Cadence has already purchased 4.3 million shares of Mentor amounting to 4.7% of Mentor’s common stock through open market transactions. I said that this takeover bid of $1.6 billion, or $16 per share, might be slightly high, but the deal would be worth the money if Cadence is able to leverage the alliance to compete with Synopsys and get the industry out of the current price wars.

The deal means Cadence would have additional debt of $1.1 billion on aggressive credit terms. Given the market conditions, it might be a difficult debt to repay, but management seemed confident of the company’s ability to pay it back in four years – with or without synergies from Mentor.

Management, however, is worried about the current market conditions. With the sales cycle lengthening and budgets tightening, customers are willing to stay at older nodes. Customers across the globe are willing to take risks in delivery or efficiency instead of investing in superior technology.

On pricing, Cadence is going back to a 90% ratable license mix, which will enable them to keep the value of their technology. This is a step back from the 50% ratable/50% upfront model that they had earlier migrated to. It is unclear what impact this change would have on the company’s financials.

The company’s shares slipped in after-hours trading before recovering marginally to $10.27. This morning, however, the shares have tumbled down to a new 52-week low of $6.9. That puts its market cap at $1.7 Billion, compared to Mentor’s $1.2 Billion. It would be interesting to see what Mentor’s earnings have in store.

Mentor, so far, is not talking to Cadence. They have hired bankers (Goldman and Merrill) to “fend-off” Cadence’s acquisition bid, which, with the current share price situation, may have to go away anyway. If Mentor’s stock also drops dramatically, then paying $16/share may not be a great idea. On the other hand, if Mentor holds up, this puts Cadence in an awkward position. Mentor will point to the Cadence stock and ask shareholders, “You want us to merge with THEM?”

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Hi Ms Mitra,
Few questions and some comments. Comments first — what kind of financial analysts miss revenue analysis by 10000% and still get retained?? I hope the $0.01 vs $1.16 was not a typo. 😀 Now the questions:
a) Mentor stock too has tumbled. Where do you see this acquisition thing going? I am hoping you’d say nuts though. 😀
b) Is Cadence revenue drop a function of the economic turmoil or Fister’s inability to see beyond Wall street and the next 2 quarters at a single glance? Missing EPS targets by such a margin suggests more fundamental problems than what meets the eye (I think).

Regards

Arpan Friday, July 25, 2008 at 9:20 AM PT

I have been wondering also how come there is such a dramatic fiasco … Asked the question of Cadence’s marketing, but no answer.

Mentor stock has not tumbled enough, but we need to see an earnings call to gauge where things stand with their business.

Is it a Cadence micro issue or an industry macro issue? I would like to see the other sector earnings to assess. Cadence, of course, is trying to frame the results as a macro issue.

Your questions on Fister – wait to see the rest of the industry results, and then we can talk.

If the whole industry is soft, and it is indeed a macro situation, then the acquisition discussions will continue, but at a lower price.

If it is a Cadence mismanagement issue, then Fister will get fired.

I don’t have any information one way or the other beyond what I have written above.

Sramana Mitra Friday, July 25, 2008 at 10:19 AM PT

Hi Sramana,

Do you see signs of the start of a Contraction in the works ?

EDADude Friday, August 1, 2008 at 5:24 PM PT

Cadence’s poor results have killed any possibility of a buyout. The credit-crunch continues and DB (Cadence’s lender on the buyout deal) will likely not want to back the deal now given still deteriorating conditions in the credit markets and Cadence’s deteriorating business conditions.

The fact that the deal is dead is, for now, a good thing for EDA and the electronics industry: chaining Cadence & Mentor together and throwing in about $1.2B in debt (likely at 9% or more) would have sunk the resulting company going into a deep & long recession. Now at least one of them can survive.

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