EDA Vendor Strategy for Acquisitions

A frequent occurrence in the EDA industry and elsewhere is the announcement of a merger or acquisition. Already in 2004 examples include Synopsys to Acquire MoSys and Accelerant Networks, Synopsys to Acquire Analog Design Automation and Cadence Acquires Q Design Automation. From 2001 through 2003 the leading EDA companies (Synopsys, Cadence and Mentor Graphics), who account for 90% of EDA revenue, combined for more than 20 acquisitions whose purchase prices totaled $2.65 billion.

For comparison purposes consider the R&D expenditures for the most recently completed fiscal year: Mentor $184 million, Synopsys $286 million and Cadence $340 million for a total of $810 million. The ratio of average annual acquisition cost to R&D is 60%, 160% and 93% respectively.

EDA companies are not the only companies involved in M&A. In 2000 American companies were involved in 8,505 deals with a total value of $1.75 trillion. The market for M&As plunged in 2001 and 2002, making a comeback to $200 billion for the fourth quarter 2003.

Rationale for M&A - General reasons

a) Improve competitive positioning
The action instantly reduces the number of competitors. This may improve the firm's pricing power over its products and services, its ability to compete for higher-quality opportunities, its ability to recruit talented personnel, its ability to develop new products and technology, and its ability to reach a greater number of customers.

b) Revenue Enhancements/Expansion
The combined company can offer a broader array of products and services, exploit broader marketing channels and leverage greater market presence. The company can cross-sell products from one to the other's customer base. Expansion can be in terms of new markets, geography, or product set.

c) Cost Savings/Economies of Scale
Cost savings can be achieved through sheer scale efficiency, elimination of redundant functions (particularly in consolidation of back-office operations and facilities), or through more efficient utilization of development and market resources.

d) Acquire Key Technology or Expertise
In high tech arena, smaller and more agile firms have frequently been able to identify and target new market opportunities with leading if not bleeding edge technology that larger firms have been unable to match. M&A is the result of a make versus buy decision.

e) Risk and Market Diversification
Market diversification can be achieved by broadening the geographic or product marketplace in which the company operates, diversifying the customer base and the demographics of the market and lessening the impact of a downturn in any particular market segment or geographic market. Simply increasing the size of a company can make it less reliant on any single customer, marketing channel or product line.

f) Strategic Opportunity
The acquisition may be undertaken to preclude being shut out of a particular market, or, alternatively, as a defensive mechanism to preclude others from entering the market.

g) Synergy
This is where the whole is said to be greater than the sum of the parts or where 2+2 equals 5. Synergy is a much abused word, a catchall phrase.

The primary motivations for EDA vendors is to acquire technology and/or broaden their product offering as demonstrated by excerpts from representative press releases announcing past acquisitions.
“The Celestry acquisition is part of Cadence's ongoing strategy to acquire companies whose technologies complement its own product development and strengthen its ability to provide customers with the most complete, end-to-end design solutions available.”

“The proposed acquisition will significantly broaden Mentor's position in both the PCB systems and wire harness design markets through the integration of Innoveda's complementary solutions”

"Numerical's direct adjacency to our traditional business will not only allow us to grow in the rapidly emerging DFM market; it also strengthens our existing physical products and increases the value of our recently announced Galaxy Design Platform (Synopsys)”
In a phone conversation from Morocco Ray Bingham, CEO of Cadence, said that he viewed acquisitions as an opportunity to acquire R&D (innovations, secret sauces) in the form of new emerging technologies that were not on anyone's roadmap and also as an opportunity to get into the market quickly in response to market needs and demands. He sees acquisitions are an efficient way to create new products.

Randy Tinsley, relatively new (8 months) Synopsys VP of Business of Development but with ~18 years M&A experience, see future acquisitions as a way to fill gaps in the product portfolio, to quickly address needs, to move to new markets and to augment the firm's own R&D. The large ($1B) acquisition of Avant! which occurred before Randy's tenure in June 2002 was a case of broadening the offering (back end tools) and increasing revenue ($400M/year).

Dennis Weldon, Treasure and Director of Corporate Business Development at Mentor Graphics, says his firm prefers to develop their own products internally and uses acquisitions to augment that strategy. They seek to strengthen their leadership position. Occasionally Mentor will acquire a company to get a toehold into a new space but only if they can become #1 in that space. He believes that most market segments within EDA will not profitably support two major vendors.

Initial Dialog/Negotiations
While price is always an issue, it frequently is not “the issue”. Randy Tinsley, Synopsys, says that the crucial element in negotiating and then successfully integrating another company is a shared mindset among the principals. Do the two companies have similar business philosophies and visions regarding how they will operate in the evolving space? Do both companies share the same expectations about where the marketplace is headed and how best to take advantage of opportunities that are being presented? Do the principals of the target firm embrace the reasoning of the acquiring firm? If it is difficult to achieve vision alignment, then there is a big problem.

Ray Bingham says the asset being acquired is people, brainpower. It is necessary to portray a future for the target company that satisfies, even accelerates their vision and dreams. After all they did or could have worked for a large company with less risk, less pressure and more salary.

Dennis Weldon says a critical factor is that key personnel must want to join Mentor. The reason behind the majority of failed acquisitions is that some or all of the key personnel leave post transaction. Mentor seeks firms with good technology that are channel limited where Mentor can provide value through its world wide sales and marketing presence.

In a company, culture simply defines how things get done. A corporate culture is identified by the values and practices shared across all groups within the organization. It is imperative to quickly determine how likely the cultures of the two firms will mesh.

The target firm has several constituencies that may have different agendas. Venture capitalists and shareholders would tend to treat any proposal from a purely financial perspective. Founders would have a pride of authorship, it's “their baby”. Current management would be concerned about their roles and responsibilities in the new organization. It is necessary to come to closure before egos on either side become an issue.

There may be concerns that between an initial understanding and final closure some negative financial or operational event may impact one of the firms. To cover such an eventuality there is often a “material adverse condition” clause which sets forth the basis by which the agreement can be unilaterally terminated. Other protection mechanisms include breakup fees, price adjustment if stock values change materially, escrow of a portion of the purchase until certain issues are resolved, earn-out arrangements if acquired company exceeds revenue or earning targets and insurance policies for certain contingencies. Where there's a will, there's a way.

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