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Mentor Graphics: LBO Recommended

Posted on Friday, Dec 28th 2007

Our third company in the EDA review is Mentor Graphics (MENT). As I said in the Cadence piece, if any company in the EDA industry is perfect for an LBO, it is Mentor Graphics. It has at least two excellent franchises – DFM and PCB design – and other players in the industry would be happy to buy those at strong premiums, making the private equity investors’ investment thesis one of chopping the company into pieces, and selling off the parts.

Anyway, such prospects are currently not on the horizon. Mentor Graphics had previously announced on November 5, 2007 that its revenue was going to fall short for Q3, at $5.5 million lower than the estimate of $190.5 million. It was blamed on “revenue timing issues on certain key orders that impacted results for the quarter.” The loss was due to a customer who rescheduled a shipment until the following quarter, while another order qualified as a booking but not as revenue. In actual results, Mentor generated $186.3 million in revenue for Q3 ending October 31, 2007, and in line with its reduced guidance. Net loss totaled $9.2 million versus $2.5 million in Q3 2006.

Mentor’s full year guidance for 2008 projected revenue of $860 million, which would equate to Q4 revenue in the neighborhood of $277.5 million. For fiscal year 2009 Mentor expects a revenue of $920 million, but this comes across extremely optimistic given the last two cycles. However, analysts as well are expecting a revenue performance of $918.7 million. As a result, this combined guidance could be a classic example of over promise and under deliver, especially when downturns in domestic GDP are usually followed by a slowdown in the integrated circuit business. If this cycle breaks, it would be due to the booming international markets. In particular, Mentor’s PCB business should gain from the worldwide boom, as the whole world wakes up to designing electronics for various products – from cars to cameras to phones.

The real company guidance was probably better stated by company President Gregory Hickley when he stated after the early guidance concern, the company sees “mixed economic signals.”

MENT currently trades at $11.50/share with a market cap of $1 billion and 89.7 million shares outstanding. The 52 week range has gone from a high of $19/share to as low as $10.50/share, and has not promised any return for investors any time soon. All of these factors again continue to make Mentor a target for acquisition, even more so now on the cheap.

I would really like to see this deal happen, as it would be a huge blessing for the EDA industry, which is caught in a box. As EDA’s prince charming Joe Costello had once described, the industry is like four dogs trying to fight for food from the same bowl.

The proverbial pie will only grow if adjacencies are brought into the fold. Meanwhile, the smart thing to do would be to euthanize two of the four dogs, and return the pricing structure to a healthier state.

This segment is a part in the series : Mentor Graphics


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I’m curious to know what adjacencies you think should be brought into the EDA fold? Since there is very little growth in the mainstream segments of the business, where should EDA companies look outside of the industry for growth?

Scott Seiden Saturday, December 29, 2007 at 11:52 AM PT

Hi Scott,

The obvious adjacencies are IP (Arm, Virage Logic), Semiconductor Capital Equipment (KLA Tencor, Applied Materials, Novellus, etc.), Test Equipment (Credence, Teradyne, Advantest, etc.), and the Fabs (TSMC, UMC, SMIC, etc.). Two other options are Embedded Software (Windriver Systems) and Front-end design environments (Mathworks).

Sramana

Sramana Mitra Saturday, December 29, 2007 at 1:02 PM PT

“if any company in the EDA industry is perfect for an LBO, it is Mentor Graphics. It has at least two excellent franchises – DFM and PCB design – and other players in the industry would be happy to buy those at strong premiums, making the private equity investors’ investment thesis one of chopping the company into pieces, and selling off the parts.”

As someone who works for Mentor Graphics, let me just say that would be a disaster. From an employee standpoint, Mentor is an excellent place to work and thus has very low employee turnover. Breaking it up into little tiny pieces and selling them off sounds so much like “Wall St.” (the movie). The main value in companies like Mentor is the knowledge in the employee’s heads. Get rid of a good number of them and that knowledge is lost.

Skeptictank Saturday, January 5, 2008 at 2:11 PM PT

“I would really like to see this deal happen, as it would be a huge blessing for the EDA industry, which is caught in a box. As EDA’s prince charming Joe Costello had once described, the industry is like four dogs trying to fight for food from the same bowl.”

On this point, I can partially agree (the stuck in a box part), however gutting Mentor Graphics won’t change that. What we need are a lot of new innovative, small startups to enter the space. Problem is that right now all of the incentives are in the webspace, not EDA – it takes years to make a good EDA tool that will sell in the relatively small EDA market. Whereas a couple of guys with laptops in a coffee shop can come up with a webapp in six months that ends up making them tens of millions (100s of millions in some cases). Perhaps this mis-allocation of talent is just indicative of another internet bubble (Bubble2.0), hard to say.

In many ways EDA is a very stodgy industry – but it’s not entirely the fault of the EDA companies. The customers are also at fault – they don’t want to take risks. To some extent, you can’t blame them with $Millions on the line.

Perhaps what’s needed is for some or all of the big 4 players (Synopsys, Cadence, Mentor) to start some sort of startup incubators? These startups would get into new niche areas that the current EDA companies can’t even imagine and develop products outside of the current company, but the developed products could be sold through the current EDA company channels thus making customers more comfortable.

…that’s my 2cents anyway. I think your diagnosis is mostly correct, but your prescription (elimination of EDA players) will only lead to less competition and less innovation.

Skeptictank Saturday, January 5, 2008 at 2:32 PM PT

Skeptictank,

My response to your first comment is this, that Mentor’s employees are stable because they are in Oregon, and they work in EDA. The combination of Oregon and EDA leaves them with few or no options. I suspect, even if parts of Mentor were owned by other companies, they would still be a relatively stable and happy workforce.

I think, your Wall Street analogy is well-taken, but the problem is, a company is also accountable to shareholders, and shareholders hold shares to make money.

Thus, today, given Mentor’s and the EDA industry’s status, the shareholders have no incentive to stay around.

On your second point, the industry is moving in the exact opposite direction than what you suggest. Cadence had a small corporate venture fund, which perhaps could be called an incubator due to its charter of nurturing innovation within the EDA industry. However, one of the first things that Mike Fister did after taking the reins of Cadence was to get rid of it.

As a result, today, EDA has almost no venture capital flowing into it. You are absolutely right, that the onus of creating a sustainable venture capital and innovation ecosystem is on the large players, and yes, Cadence and Synopsys should have venture funds that invest in EDA innovation, along with, perhaps, Intel Capital, KLA-Tencor, and some other corporate venture arms.

In its absence, EDA will continue to stagnate.

Sramana Mitra Saturday, January 5, 2008 at 3:23 PM PT

“Mentor’s employees are stable because they are in Oregon, and they work in EDA. The combination of Oregon and EDA leaves them with few or no options.”

Quite true. This is why it would be a disaster for many of the employees if Mentor were to be broken up. Many of them have only worked at Mentor their entire careers. It would also be bad for the local economy. Mentor also sponsors lots of local cultural events.

“Thus, today, given Mentor’s and the EDA industry’s status, the shareholders have no incentive to stay around.”

Perhaps, but from the inside I get the impression that things are going OK. I’m sure it could be going better, but I don’t get the idea that there’s trouble afoot either.

As far as innovation goes: I have a lot of contacts in the web development world and there is constant innovation going on in that sector. I definitely get the idea that EDA is stuck at around 1995 meaning that there hasn’t been much change in the products nor has there been much change in the way those products are developed. There are exceptions: Bluespec, for example. They do most of their devlopment in Haskell which likely makes them more productive (that and their product is also somewhat innovative). But Bluespec is the exception that proves the rule: innovation comes from small companies.

Skeptictank Saturday, January 5, 2008 at 4:54 PM PT

” ‘Mentor’s employees are stable because they are in Oregon, and they work in EDA. The combination of Oregon and EDA leaves them with few or no options.’

‘Quite true.’ “

Actually not quite true. MGC’s HQ is in Oregon with a notable # of employees there. But MGC also has significant R&D sites in San Jose, Longmont CO, Huntsville and Mobile AL, Marlboro and Waltham MA, 2 sites in France, Egypt, 2 sites in India, Hungary, Pakistan, Poland, the UK, and other locations. About 1/2 of the members of the Executive team are in OR, the rest are distributed around the US and Europe. I don’t know the exact number, but I believe only roughly 25% of the employees are in Oregon.

Regrading innovation, MGC has developed more products internally in the past 10 years than CDN and SNPS combined.

You specifically mentioned adjacencies such as Embedded Software (MGC has it’s product line here – Nucleus I think) and IP (MGC also participates here ands has a leading position in Ethernet IP). And they have partnerships with the Test and Manufacturing equipment companies as well as the FABS.

And regarding innovation, how can you state that EDA is stuck in 1995? ESL based design, low power solutions, and many other areas of EDA didn’t exist 5 years ago, and were barely a dream in 1995. Yes, BlueSpec is an innovative company but they aren’t the only company delivering solutions in the ESL space. MGC has the Catapult products as well as newly developed TLM tools for timing and power. Other companies also play in this area.

Other players have tools in these various areas, but this thread was in regards to MGC so I am only commenting on them.

So Skeptictank, if you truly work at MGC you seem to need to do more research on your own company. I agree that gutting them would be a bad idea. Not only for the employees but also for EDA and the semi’s in general. MGC has some top of the line products and some interesting newly developed products (including the recently Sierra tools). some of these products will be needed for the new challenges that the Semi’s face and gutting and killing any of these would set the industry back.

JT Wednesday, January 9, 2008 at 2:07 PM PT

http://www.reuters.com/article/marketsNews/idINN1732535120080617?rpc=44

Arpan Tuesday, June 17, 2008 at 7:50 AM PT
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