Mentor Graphics (MENT) new issue 02/27/06

Original research

I would use L+400 as the credit spread for the new MENT $175M 6% up 65 convert issue with 7 year put. Proceeds will be used to retire the existing $171M 6.875% convert. After the offer, MENT will have $95M in cash and $$285M in debt ($175m new converts and $110m floating converts w/2010 put). In the last 12 months, the company generated $19m in FCF.

Although MENT is not rated, its credit metrics place it in the B- range. EBIT/Interest is 1.1x, EBITDA/interest is 3.0x, Debt/EBITDA is 4.9, Debt to capital is 49%. Companies with these metrics trade in the L+350 range. However, MENT deserves to trade at a discount because it is a small technology company ($1B market cap) with uneven FCF. On the positive side, the company has high gross margins (80%) and whether any downturn with cuts in SG&A and R&D.

MENT makes software for the semiconductor industry (EDA). Revenues are tied to the R&D budgets of semiconductor companies, which have grown steadily in the 8-10% range over the last 10 years. Sales do not typically fluctuate with semiconductor capital spending. Its peers include Synopsis and Cadance. MENT stock tends to be more volatile than its peers because the company operates in more niche markets and do not sell subscription contracts, which provide predictable revenue streams.

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