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If you do some Google searches for the term “how to invest in artificial intelligence stocks,” you’ll find a plethora of opinions about what companies you ought to be looking at. Typically, you’ll get the “invest in everything with Google” type recommendations which just list some popular tech stocks along with the obligatory NVIDIA (NVDA) mention. (NVIDIA produces artificial intelligence chips – commonly called GPUs – that are used ubiquitously for machine learning, at least for now.)
Aside from investing in AI chips with NVIDIA, pure-play AI stocks have been far and few between. (Unless you’re a Nanalyze Premium subscriber, in which case you’ll know about 12 pure-play AI stocks to invest in.) Now that most companies use machine learning in some way, the definition of an “AI stock” is becoming ever more blurry. As with any disruptive technology, machine learning is changing quickly. Today’s leader can quickly become tomorrow’s laggard. That’s why chipmakers like NVIDIA are constantly investing in R&D to ensure they don’t get left behind. (The U.S. semiconductor industry is second only to the U.S. pharma & biotech industry in terms of the rate of R&D spending as a percent of sales – 17.4% and 20.1% respectively.) One company that stands to benefit from all this R&D spend, regardless of which chipmakers come out ahead, is Synopsys (SNPS).
How Synopsys Powers AI Chips
As the world’s 15th largest software company, Synopsys has a long history of being a global leader in electronic design automation (EDA) and semiconductor intellectual property (IP). Founded in 1986, the $18 billion American firm focuses on “silicon design and verification, silicon intellectual property, and software security and quality.” All three segments are complementary, but present different growth trajectories.
Let’s talk a bit about each of these business segments.
Electronic Design Automation
The biggest and oldest segment is “electronic design automation” in which Synopsys happens to be one of “the Big Three EDA companies,” the other two being an $18 billion publicly traded firm named Cadence Design Systems (CDNS), and Mentor Graphics which was acquired by Siemens in 2017. These companies sell the software tools used by chipmakers to design new electronics systems such as printed circuit boards or integrated circuits. Given it’s an established business, it’s the slowest growing segment for Synopsys, with mid-to-high single-digit growth expected moving forward.
There’s an interesting business model used by the semiconductor industry which involves the same pieces of intellectual property being used by everyone while the intellectual property holder benefits from licensing fees and royalties. Also referred to as the “semiconductor intellectual property core,” it’s best described by Wikipedia as follows:
In electronic design a semiconductor intellectual property core, IP core, or IP block is a reusable unit of logic, cell, or integrated circuit (commonly called a “chip”) layout design that is the intellectual property of one party. IP cores may be licensed to another party or can be owned and used by a single party alone.Credit: Wikipedia
The article goes on to talk about how the most widely licensed IP cores belong to a very concentrated number of companies. At the top of the list is ARM Holdings (owned by Softbank), and in second place is Synopsys which has been growing their market share meaningfully.
Synopsys expects revenue growth from software IP to be in the low double-digits going forward.
The Synopsys Software Integrity platform is a comprehensive solution for building integrity—security, quality, and compliance testing —into their customers’ software development lifecycle and supply chains. It’s the smallest but fastest growing segment for Synopsys, with Gartner listing them as the market leader in application security testing (AST) saying it is relatively new yet broadly adopted, and well-positioned in the Internet of Things (IoT) AST space. Synopsys expects growth for their software security segment to be in the 15-20% range as the space evolves rapidly and the company continues to make multiple acquisitions every year to fuel growth.
Synopsys and AI Chips
In looking at the latest investor deck from Synopsys, they’re clearly touting artificial intelligence as a growth driver for the company. In particular, they cite four main areas where AI chip growth will come from:
- Mobile – All premier smartphones will integrate AI Processing Capabilities by 2021
- Data Center – More than 50% of enterprises will deploy AI accelerators in their server infrastructure by 2022
- Auto – Volume production of autonomous vehicles will begin in 2020
- IoT – More than 20% of IoT devices will have AI Processing Capabilities by 2022
In June 2018, Synopsys unveiled their “AI-enhanced Digital Design Platform Bringing Artificial Intelligence to Design Implementation” which means machine learning is now being used to help design better AI chips quicker. The machines have now begun working on themselves.
If we start to think through all the companies involved in the areas where AI chips are expected to see growth – mobile, data centers, auto, and IoT – it quickly becomes clear how broadly AI is being adopted and how it will eventually become pervasive in all electronic systems – a $1.68 trillion dollar market.
The value chain seen above shows how the two largest business segments at Synopsys – electronic design automation and semiconductor IP – are the foundation on which the entire value chain of electronic systems gets built.
A Global AI Chip Battle
U.S. exports of semiconductors were worth $44 billion in 2018, fourth highest among U.S. exports behind only airplanes, refined oil, and crude oil. It’s just one of the interesting facts you’ll find in the 2019 Semiconductor Industry Association Factbook which talks about how global semiconductor sales reached $468.8 billion in 2018. It’s quite remarkable to see market share by country change over time. While the U.S. has dominated global semiconductor sales with around 50% market share since forever, looks like Korea has been slowly stealing some of their thunder. Hopefully, the U.S. isn’t going to start making the long slide down to the bottom like Japan has been doing for the past 30 years.
All of these countries are developing their own machine learning chips for their own applications, and nothing says there has to be one winner. Since all leading semiconductor companies in the world use Synopsys technology, you’re able to benefit regardless of which countries and companies come out ahead. The company isn’t purely reliant on the growth of the semiconductor industry either. Around 40% of Synopsis’ revenues come from systems companies which develop chips as an input to an end product, rather than selling the chip itself.
When it comes to stock price performance, the 5-year return for Synopsys (+177%) trounced the iShares PHLX Semiconductor ETF’s return (+110%) and the broader Nasdaq return (+51%) over the same time frame. While past performance is no indicator of future results, Synopsis’ strong share price performance lends credence to the company’s strong thought leadership in the semiconductor industry. Okay, maybe we made that last part up. It’s the sort of weak explanation you’ll hear from finance experts when they can’t pinpoint – because absolutely nobody can – why a stock performs the way it does over time. We apologize for slipping back into those old habits.
Trying to pick the winning stock for any investment theme is nearly impossible for professionals whose job it is, so retail investors shouldn’t think they can do better. Many of the experts will tell you that investing in artificial intelligence means going out and buying the FAANG stocks (Facebook, Apple, Amazon, Netflix, Google) all over again, but that’s weak. Dig around a bit and you’ll find companies like Synopsys that are positioned to benefit regardless of who ends up using machine learning to achieve the best outcomes.
All leading semiconductor companies in the world use Synopsys technology in some form or another. The rate of U.S. semiconductor industry R&D spending is among the highest in key major high technology industrial sectors. Barring a decrease in R&D investment by the semiconductor industry, Synopsis provides retail investors with a great way to benefit from the growth of the AI chip market in all of its disruptive manifestations.
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