Picks and Shovels for the data driven world

When we think about the economic progress of the human race over the past 50 years, there is probably no more important development than our ever-increasing ability to process data at ever-increasing speeds based on improvement in integrated circuits. Simply put the modern world as we know it would not be possible without this improvement and progress from where we are today will be extremely difficult without this process continuing.

Luckily for us all there are hundreds of thousands of engineers around the world working to make that progress happen and their numbers continue to grow at a very healthy rate. Many are working for large well-known chip designers like Intel, Qualcomm and Nvidia, but there are increasing numbers of smaller companies working on leading edge products for AI and machine learning, autonomous cars, connected everything, virtual reality and many other applications. There are also a growing number of engineers working for what were traditionally the customers of these companies. The importance of controlling how your specific algorithms work on the underlying hardware (IC) is becoming even more important and so many aerospace/defense companies as well as auto OEMs and tier 1 suppliers are designing some of their own chips for their own specific needs as their products become more connected. We can also see that nearly every large technology company such as Google, Facebook, Microsoft and Amazon are investing in chip design as they try and gain advantages over each other in various fields.

For human progress this is very exciting as we can expect to see ongoing improvements in our productivity because of these efforts. As investors, however, we can’t be sure who is going to actually win this arms race in computing power, but we can be sure that this investment will continue to grow in aggregate and that all these engineers are going to need software tools to go about their work.

This is the reason we have invested in Synopsys, which is the leading supplier of electronic design automation (EDA) software tools. It has approximately 30% share in these products and effectively shares the leading-edge design market with just one other company, Cadence.

Together these two companies supply more than half of the EDA software tools currently in use and are the only two with a complete end to end solution for their clients.

They are continually gaining share, year after year. Barriers to entry are extremely high given the significant ongoing research and development (R&D) spend required. Both are spending >30% of sales on R&D and a customer typically pays on an ongoing basis, which means the businesses are very stable and customers remain very sticky.

To us as investors this is a very attractive situation where we have confidence in the growing end demand, predictable and favourable competitive dynamics and very stable business models. While valuation on Synopsys has moved from “cheap” to fair since we first bought, the ability to keep compounding earnings at a 10-15% rate, a net cash balance sheet and a 5% free cashflow yield, means we are likely to continue to hold.

A world of opportunity awaits

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