A Summer Window Of Opportunity For Altera

By Stephen D. Simpson, CFA | May 28, 2013 AAA

With chip companies in the analog (like Analog Devices (NYSE:ADI), wireless (like Broadcom (Nasdaq:BRCM), and other spaces reporting relatively unspectacular near-term demand, it's no great surprise or disgrace that Altera (Nasdaq:ALTR) finds itself in the same boat. While the idea that the programmable logic device (PLD) market should be growing about twice as fast as the overall chip market has been flogged for years (probably nearly to the point of death), it's not sparing Altera from the sluggish conditions in the wireless capex, industrial/auto, or networking verticals. Even so, for a stock that has often seemed expensive to me, this could be an interesting window of opportunity.

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The Transition Is Always In Transition
On one hand, the PLD market is a pretty good place to be. PLDs may not have lived up to the 2x growth projections, but they have outgrown the chip market on transitions away from ASICs. What's more, with the upfront cost of designing ASICs so high now, the volume threshold for potential PLD sockets has improved. It also doesn't hurt that Altera and Xilinx (Nasdaq:XLNX) operate a veritable duopoly in this market and haven't competed away attractive economic returns.

If it were that simple, though, I wouldn't have anything to write about. On the negative side, while it may be true that PLDs win sockets from ASICs, there's still the matter of overall demand for the “boxes” to consider – if and when companies like AT&T (NYSE:T) delay their capital spending, those share gains don't help as much. It's also worth wondering if government efforts in various countries to restrict Chinese telecom equipment vendors like Huawei and ZTE will have any significant long-term ramifications on Altera, as they're both significant customers.

It's also not entirely true that the ASIC-to-PLD transitions are a one-way street – Altera's largest customer (Huawei) recently converted some Altera PLD sockets to internally-designed ASICs. Likewise, companies like Lattice (Nasdaq:LSCC) and Microsemi (Nasdaq:MSCC) are still in the game and chipping away at market share (though not really much of a threat to the core of Altera's business today).

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Can The Next Technology Leap Shift Share?
While there was a time when it seemed that Altera and Xilinx traded market share with each generation of shrinkage in the node, Xilinx has more been more consistently holding on to its share advantage lately, holding about 50% share overall (to 39% for Altera) and 59% share in the still-emerging 28nm market.

Altera isn't taking this lying down. The company has announced a manufacturing agreement with Intel (Nasdaq:INTC) whereby Altera will take advantage of Intel's considerable manufacturing capabilities to produce PLDs with 14nm tri-gate transistor process technology (the same FinFET process I recently referred to in a piece for Investopedia readers on Ultratech (Nasdaq:UTEK)). If Intel has the sort of edge that many analysts believe it does with next-gen fabrication, this could be a significant factor in Altera gaining back share from Xilinx.

Altera is also apparently looking to broaden its technology and product options. The recent acquisition of Enpirion had some analysts and investors wondering if this meant that Altera wanted to go up against the likes of Analog Devices and Linear (Nasdaq:LLTC) in power management chips. I don't think so; what I think Altera is looking to do is leverage the technology, expand its addressable market with its customers, and look to create better power/PLD combinations.

The Bottom Line
Xilinx has definitely been the better stock over the past year, and a bullish call on Altera should not be read as a bearish call on Xilinx per se. Rather, I don't think Altera should be trading only about 10% above its 52-week low. The recent revisions in analyst expectations aren't encouraging (down about 8% over the past two months for both fiscal 2013 and 2014), but I'm cautious optimistic about wireless capex demand later in this year.

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I do presently believe that Altera can grow its revenue and free cash flow at long-term rates close to 8%. With that sort of growth, fair value for the shares is close to $40. That makes Altera one of the relatively few chip companies to be trading at any sort of meaningful discount to fair value, and perhaps a name for more value-oriented investors to consider researching ahead of the potential pickup in business later this year.

At the time of writing, Stephen D. Simpson owned shares of Microsemi.

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