Mentor Graphics' Software Helps Design Chips

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Just as architects use software to design buildings, so doesMentor Graphics ( MENT ) help engineers design chips for the semiconductor industry.

The Wilsonville, Ore.-based firm makes design automation software and hardware. Its products are used to conceptualize, design, emulate and test various electronic systems and components.

Mentor is the oldest and third-largest company within the electronic design automation, or EDA, space. The other two players areSynopsys ( SNPS ) andCadence Design Systems ( CDNS ).

"Typically, about three-fourths of the total industry's revenue is comprised of these three companies. And the remaining one-fourth is proportioned over many other smaller, mostly usually privately held companies," said software analyst Jay Vleeschhouwer at Griffin Securities.

"Everything that we take for granted and have for many years . .. none of that could exist without the technology of these companies. It would be humanly impossible to get the degree of complexity and microscopic scale that we see in semiconductors and chips without the software tools that are used to create this," he said.

Strategic Focus

Mentor's strategy is to focus on areas with the largest market share and the best capability, said Mentor's chairman and CEO Walden Rhines.

"That's a little different from others who spread themselves more broadly. One of the reasons that we are doing well is that there's a whole new generation of semiconductor technology coming along and Mentor is the leading supplier of physical verification tools for integrated circuit design," Rhines said.

The new generation is referred to as the 28/20 nanometer design, which is part of the constant move to smaller, deep sub-micron range of designs. With the device complexity and number of components increasing, the semiconductor industry's demand for power and capacity of design and verification tools is rapidly increasing.

Mentor's flagship product is Calibre, which is a software used in the verification and analysis of chips.

"Before you spend millions upon millions of dollars putting a new chip into production and then, sometime later, discovering that there may actually be something wrong with it, you don't want to get to that point without having tested and verified the chip design," said Vleeschhouwer.

Mentor also does chip verification via hardware. Its latest product is Veloce 2, where you can emulate a prototype of a chip.

"In years past, it was a fairly special-purpose kind of product, used only by certain kinds of chip designs. Now, in the last two years, it's ... used much more broadly by a wide range of people who do complex chip designs," said Rhines.

"It's become the most cost-effective way for people to verify that their designs are, in fact, correct in doing what they are supposed to do," he added.

The company expects the emulation portion of its business to grow 100% for the year.

Mentor also has strong technology in the design of printed circuit boards, or PCB. These are the laminated boards that are populated with electronics that go into phones, tablets and computers.

"Mentor is by far the market leader in that PCB category, which, even though it doesn't get a lot of attention from investors, happens to be part of the largest end-markets in EDA," Vleeschhouwer noted.

Software comprises more than 90% of Mentor's business and three-quarters of that goes into designing chips, while the other quarter goes into designing systems.

The latter is another fast, though at times bumpy, area of growth for Mentor. The systems include everything from printed circuit boards to automobiles to airplanes.

"The systems business, surprisingly, is very rapidly growing because planes, trains and automobiles have traditionally been designed by more manual methods and they're in the process of automating their design processes," said Rhines.

The cost of products usually ranges in the five- to six-digit numbers. About half of a booking is recognized as revenue when the company delivers the product.

The remainder is either delivered as support over the life of the contract or as services that go along with the contract, explained Rhines.

Some of Mentor's semiconductor customers are Toshiba, Freescale Semiconductor andIBM ( IBM ) . Systems customers includeBoeing ( BA ), BMW, Airbus, Honda andGE (GE).

The average life of a contract is three years and customer relationships tend to be long-standing.

"They are extremely long relationships, the majority of our revenue comes from customers that we've been doing business with for decades and last year, our average three-year contract increased between 25% and 40% compared to the prior contract of the three years before," Rhines said.

He estimates similar increases this year, with some quarterly variability.

Often, customers will buy products from multiple vendors, and will assemble and mix and match various software. There is a relatively small pool of customers and within that set, an even smaller number of engineers who work on designing electronic products.

"These companies, Mentor, Synopsys and Cadence, have increasingly overlapping product lines," said Vleeschhouwer. "They increasingly either try to diversify or bulk up in areas where they are already strong."

Asian Growth

Geographically, the fastest growth in the past decade has come from the non-Japan Asia, especially China, Korea, Taiwan and India. Mentor has the No. 1 market share in China and India, said Rhines.

"A lot of the customers have put more and more engineering resources into India, and so the revenue follows where the engineering bodies are," said Vleeschhouwer.

Also, structural and organic growth contributes to the region's growth.

"In Korea, you've got customers like Samsung that are putting a ton of money into R&D and China is trying to build up its industry, so they'll have to consume and hopefully pay for software," he added.

Europe, while it doesn't represent the largest region in terms of revenue, is a region where Mentor has the best market share.

"It's a very esoteric industry. It's probably hard for most people to really get a feel for how a chip is designed. Everyone takes it for granted, you turn on your iPhone and that's it," said Vleeschhouwer. "It's an extraordinary engineering accomplishment. If you think about the capabilities and the speed and the memory storage that gets packed into this extraordinarily small thing, that doesn't happen unless you have the right software tools."



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: BA , CDNS , IBM , MENT , SNPS

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