In Part-I of this series of EDA articles, we discussed how the EDA market is a Triopoly between CDNS, SNPS & Siemens EDA (Mentor Graphics). In Part-II of this series, we discussed the TAM and growth opportunities for the EDA segment. In this article, we will discuss near-term risks with respect to what could affect their revenues as well as stock performance.
Risks: EDA segment growth over the long term is quite attractive. The sector is also one of the lowest volatility segments within the semiconductor value chain. However, here are a few near-term risks that may impact the segment:
1) China Export restrictions: All EDA vendors have anywhere from 15-30% of revenues from China. NVDA (not an EDA vendor) recently filed an 8K stating about 7% of their next quarter revenues will be impacted by US high-tech export licensing. US BIS, on Aug 12, 2022, announced a new ban on exporting semiconductor tech to China, including specific EDA software for making 3-nanometre and more advanced chips. China already has the capability and the technology to produce 7-nanometre chips. So theoretically only technology to develop smaller than 7-nanometre chips should be restricted but tools could be used across the entire spectrum and politics may not always follow logic. The bans announced so far are not material for existing revenues but will impact growth as China will be forced to use local vendors, henceforth. So, this is a material risk to the industry.
2) VC Funded Start-ups developing chips for AI & ML: Let me explain this point with a comparison to the Automobile industry. In the Chip industry, CPUs, GPUs & Specialized Chips are roughly equivalent to your Sedans, SUVs, and Formula 1 race cars respectively. A CPU is equivalent to a Sedan, very general purpose, and can be used by the entire family. A GPU is like a slightly specialized car, SUV may be used for off-roading but is still general enough for many purposes. Finally, the specialized chips (AI & ML) are equivalent to a Formula 1 race car, designed, optimized, and built exclusively with one purpose in mind. Over the last few years, hundreds of VC-funded start-ups have mushroomed all over Silicon Valley working on these specialized chips designed specifically for AI & ML in Cloud infrastructure, Automotive & Industrial applications. They are all funded for the next 2-3 quarters but in the next round of funding, could see some shutdowns if VC funding dries up due to macroeconomic reasons. They all use EDA tools to design chips. However, EDA vendors generally charge for licenses based on the revenues of the customer (semiconductor industry). Hence, EDA revenues have been around 2% of the semiconductor revenues, historically. Start-ups don’t generate much revenue, consequently, the EDA licensing revenues from these start-ups are also minuscule even though the number of (per seat) licenses used by them could be quite material.
3) Semiconductor cyclicality: Semiconductors is a cyclical industry and hence EDA vendors also face a certain amount of cyclicality. Crypto mining, Gaming, PCs & Cloud infrastructure are the four major end-users of semiconductor chips. Three of those four are expected to see revenue declines over the next four quarters. NVDA, INTC, AMD & most recently AAPL are all warning of a slowdown in demand. Hence there’s some risk to EDA tool demand in the near term.
Conclusion: The risks are very real and likely to manifest in the near term. However, EDA revenues are dependent on the R&D spend of Chip designers/Manufacturers and less so on their topline. Since semiconductor companies focus on R&D during a downturn, EDA revenues are shielded from the extreme volatility of semiconductor industry revenues. Having said that, EDA is not immune from the investor perception of semiconductor cyclicality; so even though their revenues and profits may not be affected much in a downturn, their stock prices could still see volatility in-line with semiconductor companies, albeit of a much lower magnitude compared to the semiconductor companies. We take advantage of such opportunities and believe are pretty close to one, now. It’s a reminder of Warren Buffet’s words of wisdom: “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble”. Our highly concentrated, BayFort Capital’s Global Leaders Portfolio is designed exactly to take advantage of such opportunities.
We will continue our discussion about the next frontier in this space, Artificial Intelligence tools in Chip Design, and how it’s changing the industry fundamentally (happens once in a decade or so in this space) in Part IV of this series.
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Links to all articles in this EDA series:
1) Part I : EDA Triopoly – https://www.linkedin.com/posts/ketuls_nvidia-synopsys-cadence-activity-6975015392578555905-qYc-?utm_source=share&utm_medium=member_desktop
2) Part II: EDA TAM – https://www.linkedin.com/posts/ketuls_synopsys-cadence-mentorgraphics-activity-6977506349010038784-ir2R?utm_source=share&utm_medium=member_desktop