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Akshay Singal

ALTR AT A GLANCE

P/E ► 26.7 AVG EV/EBITDA ► 25.6 AVG ROA ► 11.3% HIGH ROE ► 25.2% HIGH Debt to Equity ► 1.24 VERY HIGH Current Ratio ► 4.03 AVG Interest Coverage Ratio ► 34.0 HIGH

 

 

 

 

 

 

Altera Corporation (ALTR) designs and manufactures programmable logic devices (PLDs) and application-specific integrated circuit (ASIC) devices. A programmable logic device is an integrated circuit that can be programmed by the buyer to perform multiple functions. This contrasts with application-specific integrated circuits, which can only be programmed once, by the vendor, to perform only one function. The added adaptability makes PLDs more valuable since they can be used multiple times for different projects. Both devices can be found in a range of electronics including DVD players, GPS systems and modems.

Altera and its main competitor Xilinx (XLNX) have a combined market share of over 80%.^[1] While both offer PLDs, their products are different enough that the two companies' chips can't be used together in the same electronic device, and engineers using these chips must invest time to learn proprietary software tools used to program the PLDs, creating very real switching costs. As a result it is difficult for ALTR to attract customers from XLNX and vice versa.

In recent years ALTR has also benefited from a shift from ASICs to PLDs. Historically, most of the chips in the semiconductor industry have been ASICs because of their lower per-unit costs (assuming substantial production), while PLDs were used more for prototyping, where the re-programmability of the chips is most valuable. The ongoing shift towards PLDs is being driven by several factors:

• the cost of PLDs is falling due to technological development associated with their manufacturing,
• electronics have shorter life cycles, so the buyers using PLDs see less benefit in customizing ASICs for the electronics. The shorter life cycle reduces the long-term benefit of ASICs (cheaper per-unit) and the developmental cost to ASICs exceeds this benefit in the short term.
• more advanced chip manufacturing technology. The new chip manufacturing technology adds a premium on ASICs - the complicated designs increase chance of failure during production, making ASICs cost more.^[2]

Company Overview

^[3]

^[4]

Altera's two main products are PLDs and ASICs. These products are used in communications, computer and storage, consumer, and industrial devices. PLDs have become more and more popular due to several significant advantages over ASICs. Namely, PLDs are easier to change, have shorter design cycles, and lower development cost. Since the PLDs are programmed by the buyer of the chips, the chips are customizable and usable much more quickly. Additionally, the PLDs have the capability to be changed. For example, after a PLD is used for one project, it can be reprogrammed and changed so that it can be used in the next project. ASICs are static and cannot be changed from project to project. Therefore, developing new devices is more efficient for the PLD users.

The two major PLDs that are used are FPGAs and CPLDs. These two types have several product differences and do not directly compete with each other. FPGAs hold approximately 71% of total PLD sales, and Altera held 33% of the market share in FPGAs in 2007.^[5]

PLDs are used in a wide range of industries, including communications, computer and storage, consumer, and industrial markets. The specific products include routers, cellular base systems, mainframe computers and servers, as well as navigation systems and surveillance. Meanwhile, ASICs are used in a many of the same products, as well as cell-phones, calculators, and alarm clocks.

From December 31, 2002 to December 31, 2007, ALTR common stock was outperformed by both S&P 500 and S&P Semiconductor Index.

Trends / Forces

Changing semiconductor industry dramatically changes Altera's profitability

The semiconductor industry is highly cyclical in nature and these cycles affect Altera's sales and profitability. Additionally, the industry grows quickly - the growth has mirrored Moore's Law for years. Moore's Law states that the number of transistors on a wafer will double every 18 months. In this vein, Altera has started targeting PLDs as the next big thing. The two main products in the PLD market are FPGAs and CPLDs, which account for 90% of Altera's revenues. Altera's PLD market share is estimated at 35% by Gartner Dataquest. The PLD market was estimated at only $3.6 billion in 2007, while ASIC market was estimated at $35.0 billion. Yet, the PLD market grew at a rate of 9% a year from 2002 to 2007.^[7]

A shortage of silicon leads to a sharp increase in wafer prices and decrease profit margins

Altera depends entirely on independent subcontractors for the supply of silicon. In the case of a wafer shortage, Altera’s profitability would materially change. Altera relies mainly on Taiwan Semiconductor Manufacturing Company (TSMC) for the supply of the silicon wafers. Additionally, more than half of the product cost for the chips is due to the silicon wafers. A significant shortage, or surplus, of the silicon wafers can change the revenue and profit margin of the company. As of 2007, Altera did not have a long-term contract with TSMC and did not specify any viable alternatives in the long-term.

Substantial sales occur overseas - changes in foreign policy could shut down markets to Altera

Approximately 78% of Altera’s sales occurred outside the United States in 2007.^[8] This opens Altera to significant currency risk, economic risk, and political risk. Altera claims that if currency rates were to fluctuate by 10%, its financial position would not be significantly affected.^[9] This is because Altera purchases and sells most materals and services in US Dollars. In January 2008, Altera entered into a forward contract for nearly $26 million to purchase Malaysian ringgit to further reduce exposure to rate changes. Altera is planning on building a new facility in Malaysia. Still, Altera is exposed to other risks, such as taxes, tariffs, and transportation costs. With so much business from Asia (especially Japan), and silicon wafers supplied from Taiwan, the potential for a political breakdown in the region is extremely damaging to Altera. In such an instance, the supply of silicon as well as 54% of sales disappears.

Competitors

Altera has one major competitor: Xilinx. Other competitors include Lattice Semiconductor Corporation and Actel Corporation, however their combined market share is approximately 14% for PLDs. ^[10] Competition usually exists in the design phase for the customer. Once the customer chooses a particular vendor, it is difficult to switch to another PLD manufacturer. Each vendor creates their own PLDs with different specifications and their product offering is proprietary. Due to this intense differentation, it is extremely rare for a customer to switch vendor in the middle of development of a product. The differentiation means that each chip has a learning curve associated with it, and switching chips would require starting at the bottom of the learning curve. Thus, the customers prefer to stick with the same chip for the duration of the project so that they do not have to start from scratch with a new chip. Since each customer is usually locked in for several years, trends in the industry may not be noticed until years later. Altera was one of the first companies to develop PLDs, its hold in the market appears to be stable. It has remained in stiff competition with Xilinx, while the rest of the competitors hold a much smaller portion of the market.

Altera is focusing on PLDs and is developing

• higher speed, low power consumption PLDs
• PLDs optimized for low-cost and high-volume
• devices to move from PLDs to low-cost ASICs for implementation

In 2005, Altera owned approximately 33.1% of the PLD market share. Xilinx held 50.3%, while the next closest was Lattice Semiconductors with a paltry 6.4%.^[11]

References

1. ↑ ALTR 10-K for 2007, page 5
2. ↑ ALTR 10-K for 2007, page 4
3. ↑ ALTR 10-K for 2007, page 30
4. ↑ ALTR 10-K for 2007, page 30
5. ↑ ALTR 10-K for 2007, page 6
6. ↑ ALTR 10-K for 2007, page 23
7. ↑ Garter Dataquest quoted in ALTR 10-K for 2007, pages 25-27
8. ↑ ALTR 10-K for 2007, page 11
9. ↑ ALTR 10-K for 2007, page 37
10. ↑ ALTR 10-K for 2007, page 5
11. ↑ No Room for Second Place