Intel’s Surprise Advance May Be a Mirage
Investors really want to believe Intel is finally putting its failures in the rearview mirror.
The Santa Clara, Calif., company reported better-than-expected financial results Oct. 24. Shares of the semiconductor giant promptly surged 8% as managers raised guidance for the rest of the year.
It is human nature be drawn to comeback stories. The reemergence of Intel as a tech chieftain would be a great story. It would be like Microsoft (MSFT) remaking itself into the largest tech company in the world after completely missing the smartphone revolution. It would feel good.
However, Microsoft’s comeback stemmed from accomplished managers relentlessly executing well.
Under the leadership of then-CEO Satya Nadella, the company moved aggressively to the cloud in 2014. Product managers strategically pivoted away from the “Windows everywhere” business model. With a more platform agnostic approach, the company was free to build products around enterprise customer needs. Sales boomed.
Today Azure, Microsoft’s cloud business, has $20 billion in annual sales. That business is growing at 63% annually, according to Christopher Eberle, an analyst at Nomura.
When bundled with its cloud software products — Office 365 and Dynamics 365, a customer relationship management suite, gross profit margins soar to 66%. And that’s only the beginning.
The company is developing saleable Azure add-ons for artificial intelligence, data analytics and the Internet of Things to connect devices to the edge of the network and its massive data centers. Starbucks (SBUX), uses an Azure IoT add-on to run preventive maintenance on its coffee machines.
Intel’s interim CEO Bob Swan would like investors to believe his company is ready to participate in these new markets. The Oct. 24 conference call was filled with buzz about IoT and building next-generation silicon for analytics and AI.
Given Intel’s higher earnings guidance — of $4.60 per share, higher than $4.39 estimates — investors naturally got excited.
After all, despite all the talk about the future, Intel is still mired in the past.
The company raised guidance because Swan says Intel’s PC client-supply business is expected to improve by double digits in the second half of the year. At $9.7 billion in sales during the most recent quarter, that business represents over half the company’s revenues.
The next-largest business is the Data Center Group, with $6.4 billion in quarterly sales. The IoT segment represents only $1.2 billion.
Even worse, the company has a long history of poor execution. The outcome has been huge write-downs and lost markets.
For example, in 1999, Intel managers acquired Level One Communications and DSP Communications for $2.3 billion and $1.7 billion, respectively. The goal was to get ready for mobile.
Four years later, the company exited mobile and sold most of its smartphone chip business assets to Marvell Technology Group (MRVL) for $600 million.
A second foray occurred in 2010 when Intel purchased wireless intellectual property from Infineon Technologies for $1.4 billion. Intel’s mobile chip division then proceeded to lose $3.1 billion in 2013, and $4.3 billion a year later.
And those billions of dollars in losses weren’t exactly offset by big sales.
By 2016, weak sales of its Atom processors forced the company to exit mobile processors and focus on 5G modems. After failing to make a profit, Intel sold that business to Apple (AAPL) this past July for $1 billion. Recode reported May 2016 that analysts believe Intel lost $10 billion trying to win mobile.
Sadly, its business model means this experience is probably going to play out again in value-added chips for AI, data analytics and IoT.
Four large companies dominate semiconductor manufacturing: Samsung, Taiwan Semiconductor (TSM), GlobalFoundries and Intel.
The first three companies are pure-play foundries that manufacture silicon for other companies based on bespoke specifications. Intel mostly makes and sells processors under its own brand.
That model is under attack …
Just as Intel lost mobile to Qualcomm (QCOM), Apple and Samsung, new players are lining up to design and commission AI chips for data centers and IoT.
The Financial Times reported in February that Amazon.com (AMZN), Facebook (FB) and Alphabet (GOOGL) are building custom AI chips for data centers. And Microsoft (MSFT) began hiring AI chip designers in June 2018, according to a CNBC story.
Keep in mind, data center processors are Intel’s second-largest business, and Swan says IoT represents its future.
But there is a positive in all this.
Intel managers are furiously buying back stock. The October earnings statement noted an increase of $20 billion for share repurchases during the next 15 months. And a page at the company’s investor relations site indicates the repurchase of 208 million shares in the open market through the first three quarters of 2019.
Since 2005, this program has spent a staggering $82.8 billion buying back stock.
This kind of insider buying generally points to their faith in the brand, the business and the potential not just for the company, but for the shares. While it’s good to see managers investing so heavily, that doesn’t mean you should follow their lead. At least, not in the foreseeable future.
Intel shares trade at 12.3x forward earnings and 3.5x sales. While this is not expensive, Intel is no low-risk investment in the semiconductor space.
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Jon D. Markman