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Will Magma Die on the Vine?

Posted on Monday, Dec 31st 2007

Magma Design Automation, Inc. (LAVA) provides electronic design automation software products and related services, and is our fourth and final company in the EDA review. In February 2007 I reviewed Magma and noted they were a potential acquisition target given their legal problems in a losing patent fight with Synopsys. I pondered on the possibility of Synopsys taking over Magma and how that might restructure the industry.

Since then Magma won a re-examination of the involved patents, much to Synopsys’ chagrin in March, and gained leverage for a settlement in which Magma paid out $12.5 million and all other terms are settled and final. “For us, this case has always been about the return of Synopsys technology and the protection of our IP, and we have achieved this,” said Aart de Geus, chairman and CEO of Synopsys. And in response, Rajeev Madhavan, chairman and CEO of Magma noted, “I am pleased we found common ground for a resolution that makes business sense for both of us.”

Having put this dirty affair behind them, Magma in Q2 2008 posted record revenue of $53.5 million, a 27.5% increase YoY to $42 million a year ago and slightly higher than Q1 guidance. 76% of revenue came from backlog transactions and 24% from new orders (Q1 had only 14% in new orders). However, under GAAP rules Magma posted a net loss of $6.4 million (non-GAAP of $7 million positive net income), but this was almost 50% less than YoY results of $12.4 million in losses in 2006. And it was a surprise given Q1 guidance suggested Q2 net income would post at $0.26-0.28 loss/share. Compared to the previous quarter, Q2 was a bit better than Q1’s revenue total of $50.2 million and far better than the Q1 GAAP net loss of $11.3 million. The company also makes a point to note much of the difference in the GAAP rules is attributed to amortization, stock-based compensation, R&D charges, acquisition costs of Mojave, and related taxes, which it doesn’t believe is critically relevant to its core operations. Nonetheless, Magma’s management believes it had a good quarter.

The “success” was attributed specifically to products FineSim Pro and FineSim SPICE which grew in sales faster than expected and allowed entry into new markets Magma previously had no presence in, such as memory design. However, the spike in new orders was also attributed to clients under budget pressures to spend operating allocations. Then again, some would ask why punch a gift horse in the mouth. In short, Magma notes Q2 sales were a bit of an anomaly.

Magma also leverages operations costs with overseas facilities in three locations in India. Magma opened a facility in Noida in 2006 and gained a site in Mumbai with its November 2006 acquisition of Knights Technology. It March it expanded to Bangalore.

Company guidance for Q3 expected revenues of $53-55 million with a higher GAAP net loss of $0.19-$0.21 cents/share. Q2 was a loss of $0.16/share. The company strategy does not see the EDA market changing; in fact, despite regional differences, Magma instead sees clients trying to control and reduce the number of EDA vendors utilized, with market share changing among the players who survive to win the contract renewals. The company’s stock is currently priced at $12.36/share with a 52-week range of $8.13-15.70 and a market cap $436 million.

At this price Magma could be gobbled up just as easily as Mentor Graphics, but the question is, why? It might be a lot less expensive for Cadence and Synopsys to just win over market share in the next round of client contract renewals. More importantly, Rajeev Madhavan’s ego is unlikely to permit such a transaction, perhaps, causing the company to eventually die on the vine. In the meantime, investors should stay away from the company and the industry.

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I appreciate your review of the big four EDA companies. While I like the financial point of view, which is not my specialty, it seems like you treat the question of each company’s technology competitiveness too lightly. For example, how can Cadence or Synopsys just “wave a magic wand” and win over business from Magma unless they have competitive products? I’m not saying they don’t have competitive products in areas, but it’s a battle. Cooley’s DeepChip.com is a good source for technical opinions of EDA vendors.

Happy New Year! I look forward to reading more of your articles about EDA and technology in general in 2008.

John B

John B Tuesday, January 1, 2008 at 10:05 AM PT

Hi John,

Good question. I don’t think business is won by magic wands, but by selling products. I think, Cadence and Synopsys are creating a practice in the industry of flexible “all-you-can-eat” deals with the largest customers that will continue to make it very difficult for smaller companies to sell their products.

My assessment is that this is going to be very difficult for Magma to compete with, as the style of deal-making becomes widely adopted throughout the industry, and permeates down to the smaller customers.

One of the EDA industry’s dysfunctions is a very expensive sales force. Thus, the economics of selling large deals work much better than small point products.

I am sure that Magma will continue to have some good innovation. They have always been reasonably good at coming up with new products internally, something that Cadence has limited track-record in. However, the battle is being fought on a different ground than technology, and the issues for a financial investor on whether or not to invest in a stock like LAVA, unfortunately, have almost nothing to do with technical differentiation.

In fact, part of the problem with the industry today is that (a) disruptive technology is not coming into play (venture funding for EDA has dried up and most of the large vendors don’t do a good job innovating) (b) for the few pockets of technical innovation there is, the business models have become screwed up.

I am quite familiar with Cooley’s deepchip, btw.

Sramana

Sramana Mitra Wednesday, January 2, 2008 at 10:43 AM PT

Sramana, thank you for elaborating on the business dynamics in EDA. It helps broaden my perspective of what’s happening in/to our industry.

I can see how the “all you can eat” business model can screw small companies with good point tools. But as a customer of a couple of the big vendors, I like it. :-) It’s convenient to remix into the tools you currently need without having to involve Finance. One could argue that this isn’t helping bring innovation to EDA products, however.

John B

John B Wednesday, January 2, 2008 at 12:22 PM PT

That’s right, John. It’s a good deal for the EDA customers, this flexible remix. But be careful for what you ask for …

Sramana

Sramana Mitra Wednesday, January 2, 2008 at 12:49 PM PT

I’d like to point out that Magma does not consider itself a “point tools” company. Their claim to fame was an RTL to GDS2 design flow operating under a single binary contrary to their contemporaries which had different product lines for synthesis, simulation, placement, routing, etc ….

Dave M Thursday, January 3, 2008 at 10:47 AM PT

Yes, that is true. Magma’s customers have to adopt the whole methodology.

My point is, innovation in EDA happens (mostly) at the point tools level. Even with Magma, today, disruptive innovation is not going to be in coming up with a new methodology and throwing away the existing one.

It would be by adding point innovations.

Sramana Mitra Thursday, January 3, 2008 at 11:01 AM PT
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