Synopsys

Synopsys delivered another solid quarter, with results exceeding our estimates on the top and bottom lines. Revenue grew 42% year over year, incorporating Ansys, and encouragingly, management raised the full-year outlook by slightly more than the quarterly beat.

Why it matters: We are impressed by the broad-based performance that Synopsys presented this quarter. Electronic design automation, or EDA, remained healthy (growing 8.5% year over year), Design IP continued its positive momentum after hitting a trough in first-quarter 2026 (while also up 10.8% year over year) and Ansys did well. EDA momentum is accelerating, supported by a mix of software and hardware sales. We are particularly happy with the double-digit EDA growth outlook for the full year, driven by artificial intelligence and high-performance computing design complexity, advanced packaging, and multidie architectures. Design IP grew both sequentially and year over year, supported by AI infrastructure demand and IP design wins. The IP setup has improved meaningfully, and we expect further sequential growth in the fourth quarter while reiterating our midteens IP long-term growth estimates.

The bottom line: The quarter's results improve our confidence in the firm's recovery, but our long-term assumptions are intact ahead of the investor day. We maintain our $520 fair value estimate for wide-moat Synopsys, and we believe shares are undervalued at the current price.

Long view: We believe agentic AI can increase EDA consumption rather than cannibalize it. As agents automate more engineering work, they will run Synopsys tools more frequently, increasing workloads and creating incremental monetization opportunities. Synopsys is already in advanced talks with customers around these new agentic workflows and pricing models, with more details expected in the upcoming investor day. We also anticipate updates on fiscal-year 2027 growth, Ansys synergies, and potentially the long-term IP growth framework.

We are impressed by Ansys performing ahead of expectations as cost synergies are running ahead of schedule. We expect the monetization and revenue synergies to begin in 2027, as Synopsys integrates Ansys’ multiphysics capabilities directly into EDA workflows through solutions like Multiphysics Fusion. We think this could be a key catalyst to help shares continue to re-rate higher, even after the 12% bounce following earnings.

We also appreciated the additional commentary on the threat of internal design tools given the progress OpenAI made with its Jalapeno chip. We broadly agree, viewing customer-built AI tooling as complementary, still requiring key EDA tooling inputs and bases. Overall, this should encourage even more third-party chip design activity, which again could lead to more EDA usage. The tricky part is we do not know how the ecosystem will develop over the long term. If a model company like OpenAI can develop internal tooling, where do the internally developed capabilities stop once we are 10 years further down the road? This is a tough question to answer. We think no matter what, certain workflows are quite safe, including certain deterministic simulations and integrations with the fabs—that said, this will be a key area to watch going forward. For now, we view it as a net positive.

Our fair value estimate of $520 per share implies a fiscal 2026 adjusted price/earnings multiple of 35 times.

Over the next five (10) years, we forecast Synopsys’ EDA segment revenue to grow at a 10% (10%) CAGR and the IP segment at an 11% (11%) CAGR. Overall, we believe Synopsys will grow at a 10% (10%) CAGR from 2026 through 2030 (2035), driven by AI-related demand, and above the historical industry growth rate of mid to high single digits. We believe this above average growth is warranted by several key trends, including AI demand, increasing chip complexity, the increasing proliferation of EDA tools to “systems” companies, the physical AI buildout, and ability to monetize AI tooling.

We are seeing generative AI demand leading to more chip design starts and R&D investment, fueling growth in EDA tools. Growing chip design complexity and the slowdown of Moore’s Law have led to a shift to multi-die architectures, necessitating more sophisticated EDA solutions and increased use of EDA tools. We also expect rapid adoption of silicon content, that is, more chip demand from systems companies across various industries like automotive, high-tech, industrial, and aerospace, thus increasing adoption of Synopsys’ EDA products, with increased robotics adoption another potential large tailwind.

We view the strategic acquisition of Ansys as expanding the total addressable market in these same systems companies. We think substantial growth will stem from the firm’s competitive advantage in simulation and the ongoing rise in global connected devices and 5G rollouts, and Ansys will benefit from digital twins and predictive maintenance as these trends gain more popularity. We also expect Ansys to see increased annual contract value from increasing partnerships with CAD providers that are meeting new needs--such as visualization of simulation.

We also see growth opportunities in IP, as companies need the reusable design blocks—not only for prioritizing differentiated design elements while outsourcing the basic design work through IP—but also for accelerating design cycles and go-to-market strategies.

We expect GAAP (adjusted) operating margins to continually increase, from 13% (29%) in 2025 to 34% (40%) by 2035. This will be driven by strong growth and repositioning in the IP business (where we expect margins to improve as the business scales), AI-driven efficiencies, pricing opportunities through selling higher-value-added products (value-add increases driven by increased demand along with product innovation, like AI enhancements), and more typical scale-based efficiencies (software companies do not need to double the salesforce or general and administrative expenses to double sales, for example). Management targets adjusted operating margins in the mid-40s.

A stable business model and low cyclicality in revenue thanks to resilient demand during economic downturns gives us confidence in assigning a 7.5% cost of equity.

We believe Synopsys warrants a wide moat rating as a result of switching costs and intangible assets associated with the firm’s vast product suite. Synopsys provides leading-edge electronic design automation tools and intellectual property that are critical to the semiconductor chip design process. In our opinion, this customer stickiness and profitable IP portfolio will drive excess returns on capital for Synopsys over the next 10-20 years.

Engineers use electronic design automation software to design and build semiconductor chips. This software is indispensable, functioning as the backbone for developing advanced microchips. Without EDA software, there would be no modern semiconductor industry. The EDA industry is dominated by three key players that control over 90% of the market: Synopsys, Cadence, and Siemens EDA. Synopsys and Cadence are the most dominant market leaders, with 38% and 36% share, respectively, collectively capturing over two thirds of the industry. This dominance is reinforced by near 100% retention rates and an 80%-85% recurring revenue model, reflecting both the critical role that EDA tools play in chip development and the loyalty the top EDA firms have from their clients. These are essentially the strongest retention rates a software company can have, implying customer lifetimes well over 20 years.

Switching costs represent the primary moat source for Synopsys. Chip design is an intricate process involving thousands of hours dedicated to fine-tuning workflows, integrating tools, and aligning processes. Synopsys’ tools are tightly integrated within its clients' workflows, and transitioning to an alternative could lead to significant implementation risks such as a drop in productivity and complex data migration challenges. In a rapidly moving technological industry, we believe that the costs of switching vendors far outweigh the small technological benefit the client would get in switching vendors. In addition, engineers invest considerable time in becoming proficient with specific tools, and changing vendors would mean more training, additional ramp-up time, disruption to ongoing projects, and delayed time to market. Minor design flaws can result in significant disruptions and exacerbated losses down the line, making it necessary for these tools to be reliable and trustworthy. Clients would find it impractical to change providers without jeopardizing project deadlines and the quality of the final product.

In support of intangible assets, we point to the overall reputation of top EDA firms, like Synopsys. We find it highly unlikely that a company would entrust its design processes to an unknown, unproven upstart. It is simply not worth the risk. This hesitancy toward new vendors, along with gradual industry consolidation over time, has led to minimal investment in new alternatives.

The barriers to entry in the EDA business are substantial, requiring considerable upfront capital, deep technical expertise, and cumulative industry experience that cannot be easily replicated. A major advantage that Synopsys has over smaller competitors is its ability to offer an end-to-end design flow—a full suite of tools needed to design a chip from start to finish—thus reducing the appeal of small competitors that have fragmented solutions.

Another industry feature that gives us confidence in the wide moat rating is the fact that EDA is not cyclical. During uncertain times and economic downturns in the semiconductor market, firms can cut budgets, but one area they are loath to reduce is their core R&D budget. Over the long term, we expect demand for EDA to only increase. As chips get smaller and more complex, and therefore more expensive to design, customers are willing to pay a premium for the latest tools that Synopsys has to offer. Increasing complexity and increasing difficulties in chasing improved performance also increase the value of the solutions EDA firms offer.

Synopsys' other primary business is its IP segment. Synopsys’ IP solutions can be compared with LEGO building blocks. When designing a chip, it is helpful for engineers to use prebuilt blocks for parts of the chip that are common and undifferentiated, allowing designers to focus on customizing the differentiated aspects of their creation. This allows clients to purchase these modular, undifferentiated parts of a chip’s design for a fraction of what they would cost to develop in-house with their own engineering team. Synopsys can sell this IP at an attractive price because it is able to depreciate its cost of development over a large base of clients. We believe this business benefits from an intangible asset moat source, driven by the breadth of its IP library and Synopsys’ unique position at the center of the semiconductor design workflow.

Synopsys has steadily expanded its IP library (through acquisitions and internal development), building a robust repository of standardized and custom solutions that differentiate it from smaller competitors. The extensive library, combined with continuous innovation in sectors like automotive and AI-focused applications, keeps Synopsys at the forefront of client demands and the pace of technological developments. This breadth makes Synopsys a natural first place to look for IP solutions as a designer.

Generally, it is more efficient at the industry level to have one or two firms create IP blocks and then sell those standardized design blocks to the rest of the industry, as opposed to having each design firm rebuild what are functionally the same design blocks for every project. This allows a firm like Synopsys—which is naturally already at the center of the design process for the industry with its software—to have a natural distribution advantage. This further allows Synopsys to depreciate the cost of development for each IP block across a wider base of customers.

Synopsys’ wide moat stems from high customer switching costs and intangible assets that virtually no other software vendor or startup can match.

Secular tailwinds will drive new chip design starts, raise R&D intensity, and open up new markets for semiconductor-focused EDA and systems design tools, leading to excess revenue growth for 10 or more years.

Synopsys’ margins should only improve, supported by improving IP margins, greater AI-driven wallet share, and internal AI/ML optimizations that enhance operational efficiency.

Slower growth in IP revenue and even lower margins could continue as the business transitions to more custom, chiplet-focused sales.

The Ansys acquisition is complex, and may not produce the synergies or growth Synopsys is counting on. If Intel's foundry fails on 14A, it could be shut down, representing a material headwind to Synopsys.

Geopolitical tensions with China and China’s focus on supporting domestic companies could affect Synopsys’ ability to do business in the region and lead to slower revenue growth.