How Cadence Designs the Future

Jon Markman

Cadence Design Systems ((CDNS) -Get Report) reported financial results Monday night that blew past expectations and led execs to lift their outlook for 2020 sales and profits.

There is a lesson in the numbers for investors: Bigger trends matter.

The San Jose, Calif.-based business is rare. Cadence makes electronic design automation software and hardware. It may seem a bit complicated but what you need to know is the company helps other businesses design integrated circuits, printed circuit boards and Systems on Chips.

These little circuits, boards and SoCs are behind every interaction in our connected lives. Every time we swipe on an iPhone screen, turn on our flat screen TV or washing machine, or stomp the gas pedal in a car, some set of instructions is routed across a maze of circuits, boards and processors. Without these systems, often designed using Cadence gear, there would be no digital revolution.

For the past five years, Cadence has been a consistent 6% to 9% annual revenue growth business. The company logged $2.3 billion in sales during 2019. Then, several longer term bets began to pay off. Fifth generation wireless technology began to be deployed. Networked computing moved to new architectures, too.

When Lip-Bu Tan, chief executive officer, guided analysts’ sales estimates higher at the end of 2019, he pointed to growth across all segments of the business. Data center and 5G units reported solid gains. However, Lip-Bu was most enthusiastic about AI and machine learning, a part of the business he felt might eclipse the core business over time.

Big data and AI are prompting demand from what he called new domain specific accelerators. These tasks demand custom silicon. Increasingly, new smarter SoCs and printed boards are being developed for healthcare, transportation and manufacturing applications.

This is a big trend. It’s happening regardless of near term macroeconomics and pandemic. The future is custom-made chips designed for specific needs. And Cadence is one of the few companies positioned to win this business.

This development echoes what is happening at Adobe ((ADBE) -Get Report). The company makes no hardware. In a modular new world of public clouds and software as a service, Adobe works in a narrow niche. Still, managers are considering building custom SoCs. Their partner of choice is Cadence.

These new chip business punctuated spectacular second quarter financial results. In a corporate press release, the company announced revenue reached $638 million, up from $580 million a year ago. Operating margins swelled to 24% even as the company continued to invest in collaborations and its Cadence Cloud, a system that lets partners design and verify next generation chips and circuit boards in a secure, cloud environment.

The infrastructure shift was opportune. Before the pandemic Cadence operated from 50 cites across the globe. The company now functions as a distributed network, operating out of 8,000 sites. Many of these are highly skilled Cadence employees working from home.

Despite the splintered nature of its post-covid-19 workforce, business is booming.

The firm now expects 2020 revenue in the range of $2.59 to $2.62 billion, an 11% increase over 2019. Operating margins should be 22%. Given the state of the world, these numbers are shockingly good, leading investors to send the stock up 4% in after-hours trade.

Cadence is a rare business because it operates in a niche where it has huge competitive advantages and the business is mostly untouched by near term macroeconomic events. Its customers operate on longer cycles.

For example, Cadence announced in July 2018 that it was awarded a contract by the Defense Advanced Research Projects Agency. The company will help the Pentagon research group automate the design of the next generation of specialized processors and printed circuit boards. That project is moving full steam ahead despite the pandemic.

Cadence trades at 38.2x forward earnings. Its market capitalization is still only $28.5 billion. The stock can be bought into pullbacks.