The market for field-programmable gate arrays (FPGA) is a big one, and it is expected to get even bigger by the end of the decade. According to Grand View Research, the size of the FPGA market can hit almost $10 billion by 2020. The bad part is that there are not many options to benefit from this growth. In fact, there are just two companies that can claim to be leaders in FPGAs -- Altera (UNKNOWN:ALTR.DL) and Xilinx (NASDAQ:XLNX).
The good part is that one of them has been making some eye-catching moves to get ahead of the other. Xilinx's market share in the FPGA market is around 45%-50%, while Altera commands 40%-45%. Altera, however, is trying to get ahead of Xilinx by focusing on product innovation.
Stealing a march over Xilinx
Last year, Altera entered into a foundry partnership with Intel to push its 14-nanometer chip platform, based on the chip giant's second-generation 14-nm Tri-Gate process. Altera believes that it will be able to capture 50% of the FPGA market with the 14-nm platform. If Altera manages to achieve this target, then its annual revenue can go up to $5 billion (because the market is expected to be worth $10 billion) -- almost three times last year's revenue of $1.7 billion.
In comparison, Xilinx is currently busy ramping up its 20-nanometer platform, and isn't revealing much about its 16-nanometer process. According to Xilinx, it has "the industry's only high end family offering of 20-nanometer" chips. However, this advantage might not last for long as Altera has also started sampling its 20-nanometer process with its customers. The company's management is confident that it can outpace Xilinx on the 20-nm platform, driven by its software capabilities, despite being two months behind in hardware technology.
But the bottom line is that Altera is focusing on a smaller die size, which is expected to deliver higher efficiency in a smaller package.
Aiming for the cloud
Altera has now trained its sights on the software-defined data center market, and has tied up with Microsoft (NASDAQ:MSFT) to tap this opportunity. According to Altera, FPGAs are an integral part of software-defined data centers as they are able to process large amounts of data on servers, handling big data needs and huge distributed workloads.
Currently, Altera is helping Microsoft address the "challenging workload requirements of high performance computing, while they help data centers stay within necessary cost, power efficiency and space limits," according to Altera executive Michael Strickland. Microsoft is rapidly expanding its cloud offerings, which bodes well for Altera.
In fact, around 8,000 customers sign up for Microsoft's Azure cloud every week. As a result, Microsoft is now bringing another two Azure regions online. The company recently invested $350 million to expand its data center in Virginia. Microsoft currently has over 200 cloud services that are used by more than a billion customers in 89 global markets. As demand for data grows, Microsoft will continue investing in data centers in order to satisfy demand for its growing cloud services.
Altera's product innovation and partnerships are tailwinds that will propel its business in the long run. Additionally, the stock's valuation is enticing. Altera's trailing earnings multiple of 25 is slightly lower than the industry's average. Moreover, a forward earnings multiple of 19 points toward earnings growth.
Another attractive fact about Altera is that it carries a dividend yield of 1.70% at a payout ratio of 40%. The company has a strong balance sheet, with its cash balance almost double of the debt. Operating cash flow generation is also strong. It plans to return 60%-80% of its cash flow to investors this year, estimating a dividend payout of around $200 million and share repurchases of $700 million.
The bottom line
Altera is trying to capture a bigger share of a sizable market, it lays strong emphasis on product innovation, and has robust fundamentals. As such, it looks like a smart investment option.
Harsh Chauhan has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.