Altera vs. Xilinx. Who is better ?

In the semiconductor business, there are two niches that have had gross margins in excess of 60%. One of them is programmable logic. I worked for ten years in companies that wanted to emulate the success of Xilinx and Altera. It took me ten years [and a $35 million dollar judgement against my last Programmable Logic employer] to figure out that this duopoly will own the programmable logic [FPGA and PLD] till the end of time [with a small market-share conceded to Lattice, Actel, QuickLogic, Atmel and Cypress Semi].

ALTR and XLNX make chips that can be programmed to perform any function you would want a chip to perform. Meaning, they make "blank slate" chips that can be configured to implement any logic function that you can dream of. In fact, Intel uses huge boards made of tens of these chips to make sure that their logic works - before they get their CPU's fabricated into silicon. Smaller ASIC companies have become smarter over the last decade and make prototypes of their chips [using programmable logic] before they start mass-production.

The elegance of this solution is obvious - when you take into consideration - the amount of $$$ it takes to design a chip. By the time you design, commit to a mask-set, run a few wafers through TSMC, UMC/whoever, get the chips back and test them, you'd be out $10M. The only drawback to this approach is that the programmable chips run slower than a custom designed silicon solution, and one could not possibly mass-produce using the prototyping chips - as whatever gains you might have in time to market, are erased by the expense for these chips - that can cost up to $1000 a pop. If you use a PL chip, all you do is to erase its original configuration, load a new one, and repeat till you succeed [easy eh ??]. Yes, there are exceptions to every single statement that I made here [which is what makes analyzing semiconductors - interesting].

Companies that tried to compete with the two big boys include Intel, Motorola, AT&T, AMD. Needless to say, they either failed or divested their business. Actually, AMD deserves credit for creating the first PAL [through their MMI division - now part of LSCC]. The reason why all these brand-name companies tried to get into PL, is the gross margin number that I mentioned in the first sentence of this article. The reasons as to why they failed are many-fold, but this article is about which of the companies is the better investment - looking forward the next two to five years.

Both Xilinx and Altera recognize the fact that the business that they are in [however profitable it may be], is mature. Any attempt by either company to enlarge their SAM [served available market] always resulted in decreased gross margins - this is due to the fact that all programmable logic chips can be replaced by an ASIC. In fact, both ALTR and XLNX have a path that they offer - which will allow one to go from a "changeable" programmable logic chip to a "fixed" ASIC, but they both do it for a reason [Bapcha at Gmail if you want to know why]. They both generate prodigious amounts of cash, and pay a small dividend that they easily earn - as they recognize the fact that they are in a niche in semiconductors that is not expanding at the rate that it was in the last decade.

Looking at the prior quarter's numbers, Altera had revenues of $359M and gross margins of 67%. Xilinx's numbers were $488M and 64% respectively. Their revenue growth rates were 12.5% and 9.4%. ALTR bought back 15% of their shares vs. 7.26% for XLNX [yoy fully diluted]. EPS was 32c/share in 2008 and 22c/sh in 2007 for ALTR. XLNX's earnings were 30c/share in 2008 and 28c/sh in 2007 [last reported quarter]. Dividend was raised by ALTR from 4c/sh to 5c/sh yoy/qtr. XLNX went up from 12c/sh to 14c/sh.

Before looking at the numbers, I thought that my decision would be easy, but it sure wasn't. While Xilinx has always had an edge over Altera in terms of market share, profitability, and earnings predictability [historically], ALTR is growing faster, has slightly better gross margins, and most significantly, better employee morale. Xilinx might be a better stock for total returns as it pays a significantly higher dividend, has a CEO in place who is determined to contain costs, but a work-force with a lot lower employee morale.

I started writing this article, wanting to pick Xilinx over Altera, but I have to pick the real growth stock among the two - ALTR. The market seems to agree with me - rewarding ALTR with higher multiples than it does for Xilinx. When the semiconductor market heats up, both these stocks have traded at PS numbers in the double digits [but that was when they were real growth stories].

Bottom-line: ALTR for growth.

Bapcha

Notes: I have NO positions in all of the stocks mentioned. Statements about employee morale constitute my opinion. Both companies have employees that are happy and vice-versa. Both companies have significant software investments, but it is a means to an end [selling chips].

SunPower is a Semiconductor Company, and deserves to be valued like one.

SunPower is on a roll. Revenues for Q2-2008 were $383 Million - up 120% yoy. Guidance for 2009 was excellent, I think that SPWR's management is excellent, and their products are the best in the industry. Until someone comes up with a cheap multi-junction solar cell, SPWR will be the top dog for cell efficiency - a measure of how much of the sun's energy can be converted to electricity. SPWR depends on polysilicon to make their solar cells - in other words, their technology is mainstream - the only differentiator are the dyes used in processing - while that is interesting for a guy who designed chips for a decade and was issued four patents, that is a discussion for another day.

Let me get to the point. SunPower is a semiconductor company. They use semiconductor technology, processing to manufacture their solar cells, and ultimately will be valued like semiconductor companies are. So, let us analyze SPWR like a semiconductor company. As a semiconductor company, they are very richly valued at 5 to 6x sales. Do their gross margins justify such a rich valuation ? Absolutely NOT. Let's look at some numbers. SPWR's gross margins are about 20%. INTC, BRCM and TXN are at around 54% gross margins - but BRCM is fabless. Note that traditional semiconductor companies are not affected by government subsidies, and coal, nat gas and oil prices to the extent that SPWR is but these are not a big deal for a cutting-edge semiconductor company with a defensible technology that is either patent protected or hard to duplicate.

But that is not the case with SPWR. The technology to produce poly based solar cells is [in my eyes] primitive. So primitive that there are one hundred and seventy chinese companies coming online in the next year and a half. SPWR charges a premium for their solar cells that are a few percent more efficient than the ones made by SunTech or Yingli Green [STP, YGE].... and the kicker - that brought SPWR down from the triple digits - Spain cannot afford their huge solar subsidies for much longer [which have been the driving force behind the adoption of PV in Europe].

In short,
1. SPWR is a semiconductor company that has fabs [not fabless].
2. Has lousy gross margins for a semiconductor company.
3. Are subject to more vagaries of the market than traditional semiconductor companies like....
a. Subsidies in Spain, Germany and the USA
b. Oil prices [and nat gas and coal]
4. Is not made using very sophisticated technology that prevents the competition from getting into the business.
5. A gazillion chinese companies will make this a commodity business in under two years.

The bottom-line: SPWR deserves to be valued like a semiconductor company with gross margins of 20%, and not much of a technological edge over its peers. That would put the stock at below $40/share. Of course more subsidies and triple digit oil will put a temporary floor on this stock's price, but it will not last for long - as I expect polysilicon prices to be much lower in the next eighteen months - which will encourage more competition at the bottom end of the PV market.

Bapcha