Thursday, December 1, 2011

LAVA flows to Synopsys in $507M fire sale

On November 30, Electronic Design Automation (EDA) vendor Magma Design Automation (Nasdaq: LAVA) announced that they had entered into a definitive agreement to be acquired by Synopsys (Nasdaq: SNPS), for $507M. With Magma ranked as the 4th largest company in the EDA industry in terms of revenue, this low valuation stands in dramatic contrast to other large EDA acquisitions over the last 12 to 18 months. At the close of trading just before the deal was announced on Wednesday, Magma had a market capitalization of $391.53M, and a share price of $5.72. Synopsys' offer then represents a premium of just $115M - less than Magma's most recent reported annual revenue of $139.29M at the end of April, 2011.

Contrast the Synopsys-Magma marriage to the most recent large EDA M&A transactions:
  • (May 13, 2010) Cadence announces plan to purchase Denali Software Inc. for $315M. Estimated annual revenue = $43 M
  • (June 10, 2010) Synopsys announces plan to acquire Virage Logic for $315M. Virage's previous year annual revenue = $47.4M
  •  (June 30, 2011) ANSYS announces plan to acquire Apache Design Solutions for $310M. Apache reported 2010 revenue of $44M.
With three times the annual revenue of these recent EDA acquisition targets,  should Magma have commanded a much higher premium over their smaller industry colleagues?  Did Synopsys just steal a competitor, who they had previously sued for patent infringement? (For which Magma paid Synopsys a $12.5M settlement).

Much of the answer to the apparent discrepancy in valuations can be discerned from the chart of Magma's 5-year trailing annual revenue. Comparing financial performance for Magma's most recently closed fiscal year with their 2007 results shows a Compound Annual Growth Rate (CAGR) of approximately -5%.In their 2011 Annual Report, Magma stated:
We have a history of losses, except for fiscal 2003 and fiscal 2004, and we had an accumulated deficit of approximately $387.1 million as of May 1, 2011. If we continue to incur losses, the trading price of our stock may decline.
If Magma were to continue to decline at a rate of 5% per year, their next 5 year annual revenues (in thousands) would look something like this:
  • 2012 projected: $132,321.70
  • 2013 projected: $125,705.62
  • 2014 projected: $119,420.33
  • 2015 projected: $113,449.32
  • 2016 projected: $100,000.00
  • 5-year Total:     $590,896.97 
In other words, based on this model, Synopsys achieves a positive return on their $507M investment in the 5th year.

Compare this to the most recent acquisition from the $40M+ club, ANSYS' acquisition of Apache for $310M. The Form S-1 which Apache had filed for their aborted public offering shows a 3-year revenue history of:
  • 2008 Annual Revenue: $25,695
  • 2009 Annual Revenue: $34,601
  • 2010 Annual Revenue: $44,047
Prior to their acquisition, Apache had a CAGR of 20%.  Projecting that growth forward for a 5-year period, the same ROI period  as the Synopsy-Magma acquisition, we see:
  • 2011 projected:  $52,856
  • 2012 projected:  $63,428
  • 2013 projected:  $76,113
  • 2014 projected:  $91,336
  • 2015 projected: $109,603
  • 5-year Total:     $393,336
So, just like Synopsys, ANSYS would also achieve a positive return on their investment in the 5th year. While these models are somewhat simplistic, they nevertheless serve the purpose of demonstrating how a company like Magma, at more than three times the size (in revenue) of Apache, could agree to be acquired at a price that it only 63.5% higher. With a deficit of $387M, and prospects for further share price declines, LAVA stockholders should be thrilled to cut their losses in this deal.

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