Description

Thesis
   
    ACTL competes in the programmable logic device (PLD) space and specializes in the production of flash-based field programmable gate arrays (FPGAs).  Despite steady cash generation (ACTL's cash position has increased every year since 2002) from its core anitfuse business  and a  rapidly expanding flash FPGA business, the stock has been down to flat for a decade. It's understandable that the market could miss this one given the fact that ACTL has barely been covered since late 2006 due to a stock option review that covers the period since 1993.  The process should be fully resolved before the fourth quarter conference call. Management has assured the investment community that the aggregate value of the restatement will be less than $20 million. On top of that, the company's true growth was masked in 2007 because of the impact of one-time, last-time buys which are scheduled to finish in Q407. The greatest investments are the ones where you can enjoy all the gain with none of the pain.  Shareholders have been patiently waiting for seven years for ACTL to start realizing meaningful revenue from its investment in flash and only now will these investments start taking off.   When all is said and done, ACTL is in the best shape its been in the last ten years: with approximately $7/share in cash and aggressive R&D spending on its new flash product masking substantial earning power in its legacy business, ACTL offers a compelling risk/reward at its current trough valuation.

The Industry
    
    ACTL designs, develops, and markets FPGAs which are a subset of ~$4 billion programmable logic device (PLD) market.  FPGAs can be used in a broad range of applications across nearly all electronic system market segments. As opposed to application-specific integrated circuits (ASICs) which dominate high volume runs, most customers use FPGAs in low to medium volumes in the final production form of their products.  Gartner sees the total  market growing to  $6.8 billion by 2010. In fact, growth in the PLD market  has outpaced  overall growth in the  semiconductor industry as the market is moving from  traditional ASICS (cell based and gate array) to  FPGAs and structured ASICs.  ACTL is banking on the fact that as PLDs have gotten faster and cheaper over the last decade, they will continue to take a sizable share of the $12.4 billion ASIC market.

The Business and the Moat

    ACTL divides its FPGAs into two categories: anitfuse (80% of sales) and flash-based (20%).  Both antifuse and flash are sold across ACTLs four primary revenue categories: Military/Aerospace (Mil/aero) (28.3% revenue); Industrial (43%); Communications (15.4%); Consumer/ Commercial (13.3%).

    Antifuse and Mil/aero: A Moat with a  Barrier

    Antifuse is ACTL's legacy product that has been around for over 18 years (that is how long, believe it or not, they have been selling certain chips to some of its military/aerospace customers without even changing the design).  ACTL's anitfuse technology is popular with OEMs, military/aerospace vendors, and automobile manufacturers primarily  because it offers IP protection  and  is offered in  radiation and temperature  protected hermetic packaging.
  

    If ever there was a business with a moat and  impressive barriers to entry, it would be this product line. Just to get an idea of the level of reliability and testing that goes into making a mission critical logic device for an aerospace application consider that the Aerospace Exploration Agency  determined that ACTL's RTSX-SU FPGA has a failure in time (FIT) rate of 13 to 34 which means the customer should expect  between 13 and 34 failures per billion of device hours. A billion hours is more than 114 centuries. In order to make such a determination, the chip had to be stress tested for over 3 million hours. ACTL employs a very intelligent strategy whereby they deliver products to their commercial customer base and then enhance those products for military and aerospace customers. They also get subsidies from the US government (~$2-3 million/ year) to refine and develop applications for military and space applications. Basically,  they are the world's leading supplier of military and aerospace PLDs and their FPGAs are almost impossible to copy or reverse engineer. Xilinx, one of ACTL's biggest competitors in flash, tried to get into antifuse  in 1995 and abandoned it a year later.
 

    As might be expected, ACTL has considerable pricing power in antifuse, getting its highest ASPs from radiation hardened and radiation tolerant products . Management describes their pricing strategy as "frying the frog:" if you put a frog in a hot frying pan it will jump out; but if you place a frog in frying pan at room temperature and slowly notch up the temperature you can burn the frog alive (experiment has not been verified). Given that most engineers do not "design out" once they have a chip, ACTL slowly raises ASPs over time.  For example, in 2004-2005 net revenues were up 8%. The increase was  due primarily to an 8% increase in the overall average selling price of FPGAs. Unlike so many other semiconductor products, anitfuse has virtually no risk of becoming commodified.  ACTL's impressive cash build over the life of the company has been a testament to its excellence  in these  high-performance and high reliability applications.
    

    ACTL FPGAs have been designed into numerous  military and aerospace applications,  their space-grade FPGAs  have been on board more than 100 launches and accepted for flight-critical applications on more than 250 satellites, and  ACTL provided FPGAs and IP core modules for numerous application on board the Airbus A380 commercial airliner. This segment should grow at high single digit percent rate long term and due to its mature nature earn gross margins in excess of 60%.

     Flash: The Future of ACTL

    With its purchase of Gatefield in 2000, ACTL staked its long term future in flash by  becoming the the first company to sell flash-only FPGAs. The three  main types of memory configurations within FPGAs are static random access memory (SRAM), flash, and anitfuse. Currently 90% of all FPGAs are SRAM based, with Xilinx (XLNX) and Altera (ALTR) commanding ~85% of the SRAM market.  Given such dominant "best of breed" competitors -  XLNX and ALTR spend 3.5x more on R&D than all of their competitors combined -- one has to ask how can ACTL possibly compete?  Going against better financed, dominant, and entrenched leaders with great technology is almost never a good idea.
   

    ACTL's veteran CEO, John East, is well aware of the potentials pitfalls of such an undertaking:  “If you try to compete in today’s market against stronger competitors, you’ll lose.  What you have to do is predict where the market is going in the years ahead, and put your money there. Sometimes you’re wrong, but sometimes you get it right and win."  Given that over the last seven years the rate of flash based PLDs has been growing faster than all others ( the long term growth rate should remain between 40% and 50%), it appears that ACTL has made the right bet. 
   

    So the growth part of the ACTL story  really comes down to ACTL's strategy in flash.  More specifically, how can ACTL differentiate itself form Xilinx and Altera. ACTL's strategy comes down to three issues:

• Superior Technology: The ultimate destination of the semiconductor business has been the savings of power, area, time and dollars. This laundry list of “must haves” creates an opportunity for flash based FPGAs as flash is the newest and most versatile technology. The greatest and most irrefutable indication that flash is the future of PLDs is that Xilinx and Altera have both started producing SRAM with flash embedded in them. This, of course, bodes well for ACTL given that they are the known industry leaders in flash.
  
• Differentiated Price Competition: Xilinx and Altera are focused on the communications data path market and get most of their margins from really high end (>$20), high gig counts, lots of SRAM on board, lots of features, lots of IO standards type of products.  This area is served very well with SRAM technology. So while Xilinx and Altera continue to focus on this segment, ACTL is targeting the  $3- or less per-unit market.
  
• Low Power Movement: ACTL is leading the industry into a new power paradigm. The wind is at their back because green is finally being recognized as being important in their industry. This point cannot be underestimated. Because nonvolatile flash-based FPGAs do not use millions of power-hungry SRAM configuration bit cells, they have significantly lower static power than SRAM-based solutions.  Flash based FPGAs deliver more complexity and features with more than 200 times less static power than competitive FPGA offerings and deliver more than 10 times the battery life of the current leading PLDs in portable applications. Compared with today's low-power, best-of-breed SRAM-based FPGAs, Actel's flash-based IGLOO FPGAs deliver between 100 and 1000 times improvement in power consumption, translating into weeks and months of standby battery life.
  

    So if this is the future of PLDs,  why haven't the  big guys pushed their way in? The answer is that even for Xilinx and Altera it would take several years and a huge R&D spend  that would be roughly equal to each of these firms yearly budgets, meaning that they would have to forgo spending on their existing SRAM technology or trash earnings for a few years - not a very likely scenario. For now  Xilinx and Altera are content with SRAM  that has embedded flash but these FPGAs don't even come close to ACTL's pure flash FPGAs where flash is built into the circuit at the transistor level (see above in the discussion of low power).  On top of this,  ACTL's market is not attractive based upon it size. Altera and Xilinx are looking for the next billion dollar market, not a niche market that requires significant up-front R&D.

 

    So why is flash still only 20% of ACTL revenue? The main reason is that there is a painfully long sales cycle: it can take 18-36 months and sometimes even longer  before design wins generate meaningful revenue.  The first couple years of a product's life  cycle  are subsumed by missionary sells whereby ACTL trades lower margins for design wins. Similar to their strategy with antifuse, eventually these sales turn into long term customer relationship that increase in profitability as time goes by.

 

Management
    ACTL's CEO John East is a no nonsense guy that believes that performance, not road shows and other marketing techniques, is the best marketing the company can do.  His candor is very impressive: he'll tell you two bad for every good. And it is this kind of stewardship that has led the company through tough times without being acquired, without massive, morale-destroying layoffs and re-deployments, and without Silicon Valley’s legendary high turnover rates and short employee tenures.  Investors getting into ACTL now can rest assured that the CEO has taken a very long term view and refuses to pander to short term earnings at the expense of long term durability.

Catalyst

1)ACTL becomes current with its SEC filings
2)Continued stock repurchases
3)Multiple product cycles maturing and accelerating growth