In 2007, two-year-old Cameron Gulbransen died when his father accidentally backed over him, prompting legislation which would make rear view cameras mandatory in vehicles. While the legislation has since been delayed for additional review, the message is clear. Automakers will increasingly, by choice or regulation, incorporate high technology electronics in cars. And as cars get more complicated, engineers are increasingly embracing flexible solutions like Altera's programmable logic devices ("PLD").
Whether its automotive sensors, backhaul telecommunications or networking and storage products, manufacturers are discovering they need to do more with less. The ability to easily reprogram PLDs during the design phase offers an attractive alternative to application specific integration circuits ("ASIC") and application specific standard product ("ASSP") technology, which have higher upfront design costs but historically lower per unit costs. As a result, high volume production has long focused on ASIC and ASSP solutions. But as PLDs get cheaper and use less power, they're closing the gap and supplanting ASICs and ASSPs in high volume products.
Altera (ALTR) is well positioned to benefit from a migration from ASIC and ASSP environments to PLDs. The company's field programmable gate arrays ("FPGA") account for 80% of its revenue and its R&D has been laser focused on winning ASIC and ASSP conversions. And for good reason. Altera estimates the ASIC and ASSP addressable market for PLDs is as high as $47 billion.
While ASIC and ASSP growth is estimated at 8.5% a year through 2014, PLDs are expected to see annual growth of 15.6%. Altera is gaining share from competitors like Xilinx (XLNX), long considered the industry leader. Altera's PLD market share rose consistently in 2010, reaching 44% by year-end from the mid-30s in 2009. Of new customers buying Altera's newest Stratix IV solution, 54% have come from ASIC or ASSP environments.
While industrial markets such as automotive are an important revenue source, accounting for 23% of sales, telecom is Altera's biggest revenue contributor. In the first six months of 2011, telecom generated 44% of Altera's sales, up from 41% year over year and good for 33% growth. And, just like automotive, the telecom story is bullish for PLDs.
The advent of next generation smart phones, tablets and wireless connected devices like the Kindle and Nook is taxing telecom provider networks. Slow downloads and dropped signals are no longer acceptable to mainstream consumers. Providers like AT&T (T) are ramping spending to keep customers happy, recently bumping its capex budget by $1 billion to $20 billion this year. And there's still a lot of running room from telecom, given many electronically connected devices that run primarily on Wi-Fi rather than 3G networks. If telecom providers want to capture data revenue from these devices, they need to spend money on their networks, which means sales growth for Altera.
Networking and storage products also rely on chips that do more. As IT departments increasingly shift the burden of managing servers and software offsite, industry demand for faster speeds will continue to drive PLD demand. As a result, networking and storage sales represent 15% of Altera's revenue in the past six months, up from 13% last year
All these factors are driving Altera's sales and cash flow higher. Revenue increased 17% year-over-year to $548.4 million last quarter, with a rising portion coming from new products. In the first six months of this year, new product sales accounted for 18% of revenue, up from 8% the prior year. As a result, margins remained above 71% in each of the first two quarters, nicely above the company's long term 67% target. Higher sales are being leveraged across costs too with SG&A falling to 12.8% of net sales last quarter from 13.8% year over year.
This success is kicking off significant cash flow, boosting the company's cash and equivalents to $9.61 per share and allowing the company to bump up its dividend from $0.06 to $0.08 a quarter. With the company trading nearly 18% bleow its 52-week high, and analysts increasing 2012 earnings estimates to $2.75 from $2.64 per share 90 days ago, investors will be rewarded as PLD demand continues higher.
Disclosure: I am long ALTR.