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Hip to Programmable Chips

Column
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6/22/2000

In the technology market rally of the last few weeks, investors seem to be more focused on companies with strong fundamentals. This has turned much of the investment action toward the semiconductors--especially the larger, profitable companies in the communications market that are benefitting from an upswing in the cyclical chip market. At the same time, these companies are enjoying growth linked to the emergence of powerful new telecom applications.

There are, of course, a wide range of players in communications chips--big-name semiconductor plays such as Broadcom http://www.broadcom.com (Nasdaq:BRCM), PMC-Sierra http://www.pmc-sierra.com (Nasdaq:PMCS), and Applied Micro Circuits Corp. http://www.appliedmicro.com (Nasdaq: AMCC) all make chips for gear ranging from cable modems to network switches. But another subsector--the market for Field Programmable Gate Arrays (FPGA)--looks attractive. The leaders in this sector include Xilinx Corp. http://www.xilinx.com (Nasdaq: XLNX) and Altera Corp. http://www.altera.com (Nasdaq: ALTR).

An active debate in the communications field revolves around whether systems vendors should custom-design their own Application Specific Integrated Circuits (ASICs) or purchase the raw chips: FPGAs, or programmable logic. With an FPGA, you can take the chips in-house and use software to configure the logic circuits for your own purposes. One example of a company using such an approach is Sycamore Networks Inc. http://www.sycamorenet.com (Nasdaq: SCMR). In a recent visit to Sycamore Networks, I noticed that a bevy of their high-speed networking cards held Xilinx chips. On the other end of the debate, there is a company such as Redback Networks http://www.redback.com (Nasdaq:RBAK), which is focusing on using the expertise from its Siara acquisition to build custom ASICs.

Although supporters of custom-designed chips point to their advantages--notably, that you can make a higher performance chip for your application--there's plenty of room for both approaches, and the numbers show that the programmable logic market is experiencing enormous growth. These flexible chips can be used for just about any kind of sophisticated communications hardware, and they are being sold in large quantities at high profit margins. For example, for the fiscal year ended ending on April 1, Xilinx' revenues rose 54 percent from the previous year's levels to $1.02 billion. Net income before an accounting change totaled $652.5 million, up from $129.2 million. Altera recently reported that during the quarter ending March 31, revenues rose 46 percent to $272.8 million. Net income rose 60 percent to $75.2 million.

"In programmable gate arrays, the market really boils down to Altera and Xilinx," says Cliff Hirsch, publisher of the Semiconductor Times http://www.semiconductortimes.com, a chip newsletter. "If you talk to a lot of networking companies they won't buy ASICs--but now Xilinx is up to 12 million gates, which makes it for all purposes, a custom ASIC. Even if a field programmable part is 10 times more expensive than a custom ASIC, it doesn't matter, because it's the time to market that counts. You can program your own programmable chip in hours."

Xilinx and Altera certainly look attractive, as their stock charts have taken off in the last month. They are both growing their revenues at a rate of about 50 percent and they both have gross margins in excess of 60 percent. And unlike more hyped companies such as Broadcom--which trades at a price-to-earnings ratio of nearly 330--the two of them trade at more reasaonable valuations, despite that fact that both of them are larger than Broadcom in terms of revenue. Xilinx is trading at a P/E of 46 and and Altera is trading at a P/E of 86.

Don Luskin, CEO of Metamarkets.com http://www.metamarkets.com and advisor to the Open Fund http://www.openfund.com, follows both companies. The Open Fund has been in and out of both stocks, more prominently focusing on Xilinx, which Luskin says the fund has held periodically since its inception. Open fund currently holds Xilinx but does not hold Altera.

"We believe in the paradigm," of programmable gate arrays, says Luskin. "We're in the age of open architecture. The ultimate open architecture is field-programmable!"

Mr. Luskin says that because the Xilinx and Altera are uniquely identified as the market leaders, you can often play both of them as proxies for the market. "Sometimes we play them both on the spread, as they tend to helix around each other."

Good reasons, all, to take a look at the leaders in the programmable chip market.

--R. Scott Raynovich, Executive Editor, Light Reading (http://www.lightreading.com)

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