Does Altera Make a Good Long-Term Investment?

For years, programmable-logic-device maker Altera  (NASDAQ: ALTR  ) has been holding the number two spot in its industry behind competitor Xilinx  (NASDAQ: XLNX  ) . However, thanks to its new partnership with Intel (NASDAQ: INTC  ) , Altera claims that it is poised to increase its share at the next generation of programmable chips, and that its addressable market is set to expand. What are Altera's prospects, and would it make a good long-term investment?

Altera's markets 
Altera's main product are programmable devices, particularly FPGAs. Unlike traditional integrated circuits, FPGAs can be programmed once they are created, which gives them the flexibility of software and the performance of a chip. FPGAs are finding use in an increasing number of large, expanding markets, and this is the first reason to like Altera's long-term prospects. 

Chief among Altera's markets are wireless providers, revenue from which was up 20% sequentially in the first quarter. Like its competitor Xilinx, Altera's wireless segment has been benefiting primarily from the rollout of 4G LTE, which is taking on massive proportions in China, but which is just starting in Europe and other regions. LTE rollouts should continue for several more years, and Xilinx and Altera predict that FPGAs will be used increasingly in LTE base stations. 


Altera's chips are also used by service provider customers, who are currently in the middle of a seismic shift toward cloud-based computing, a market that industry analyst IHS estimates will triple from 2011 to 2017. Altera's performance in this market has been choppy, as its large customers tend to implement projects for several quarters and then slow development, but this choppiness should improve over time. Looking over the longer term, the company should benefit nicely from this huge opportunity.

New products
The FPGA industry's current generation of products is built on the 28-nanometer node, with Xilinx controlling 70% of the market at this geometry. Altera expects to gain some share in the current year as its customers ramp up production using Altera's high-end 28-nm FPGA, but its growth here is still lagging Xilinx's.

Rather than the 28-nm products, the second reason to like Altera is the company's position in the next generation of FPGAs. Altera recently formed an exclusive partnership with Intel to build 14-nm FPGAs in Intel's world-class foundry. TSMC, which fabricates Xilinx's chips, is not expected to implement its 16-nm node until late this year or early next year. This means that Altera might be a year or more ahead of Xilinx in the new generation of FPGAs.

According to both Altera and Xilinx, next-generation FPGAs will be increasingly competitive against application-specific chips such as ASICs and ASSPs. Altera estimates that this could eventually open up a market worth almost $50 billion, a ten-fold increase over the $4.5 billion that the FPGA market was worth in 2013. Therefore, dominating at the next generation is a huge opportunity for Altera, and a much bigger deal than just swapping positions with Xilinx.

Cash for shareholders
The third reason to like Altera for the long term is its policy of returns to shareholders. Over the last four years, cash returned to shareholders has grown each year, from $67 million in 2010 to $361 million in 2013. Much of this was through dividends -- currently at $0.15 per share -- though CFO Ron Pasek said that Altera will also continue to pursue opportunistic share repurchases. Going forward, management has pledged to give back 60%-80% of cash flow from operations to shareholders.

How is cash flow from operations doing? In 2013, Altera had total sales of $1.73 billion, from which it managed a healthy $590 million, or 34%, in cash flow from operations. At its investor meeting in November, management explained that operating expenses had been higher for the past several years due to R&D investments, but going forward, the company expects operating expenses to grow slower than revenue. This suggests that cash from operations, as well as cash returned to investors, should be stable or growing in the future.

In conclusion
Several of Altera's major markets are large and should continue to expand for years. Also, Altera is in a good position to dominate the FPGA industry at the next generation of technology, and to benefit from the much wider market that these FGPAs will address. For these reasons, as well as for its policy of returns to shareholders, Altera is worth a look as a long-term investment.

 

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