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The Bull Case

Intel (INTC) holds sustainable long-term advantages over its rivals. While there is fear that Intel will continue to have trouble competing with ARM Holdings (ARMH) etc., this is a short term problem. In fact, we have already seen exactly how this story will play out. One need look no further back in time than to 2006, when rival AMD (AMD) bought out ATI, a move designed to give Intel's smaller rival the know-how and technology to offer platform solutions able to compete with those at the big firm. This time will be no different, and for the same reasons.

When looking at technology companies, one should focus on market share and not the products. It is true that the product continually changes, but some companies, the one's with true economic moats, are able to maintain market share. If you look simply at Intel's current products, most of them will be obsolete in 2 or 3 years. But you cannot conclude simply from this that the company has no moat.

The continual success that Intel has had in the processor market can be traced back to the source of the firm's economic moat. As the world's largest semiconductor company, Intel has a research and development budget that is larger than many of its competitors' entire market caps. As such, the company has the resources to invest in cutting-edge technologies. These advantages enable Intel to increase processor performance and lower manufacturing costs at a pace no one else can sustain. Although ARM and AMD have been able to better Intel for a time, neither will be able to maintain a lead.

In short, eventually Intel will simply beat the competition at its own game, or mobile devices will become sophisticated enough to require Intel's superior processors.

Bulls say

  • Intel is a best in breed company
  • Creates the most cutting edge technology
  • Has an R&D budget greater than many of its rivals market caps
  • Has a near 80% market share of the microprocessor space
  • Intel's platform strategy, in which processors are bundled with chip-sets, allows the firm to incorporate more features into its products
  • The firm subsidizes marketing efforts by customers when they highlight the Intel brand. As a result, it benefits from powerful brand recognition.
  • Integrating McAfee Security features to its chips and hardware gives the company a unique value added product
  • The firm's growing server processor segment ensures Intel's place in the cloud

The Bear Case

Intel is in a bad business. The products that it makes are commodity products pure and simple. Thus, the company is in a constant race to the bottom to produce increasingly expensive products at lower and lower prices. Intel is a textbook worthy example of what happens when you have a competitive advantage in a commodity type business, i.e. a chart that has been flat for ten years going.

The biggest threat to Intel is the maturation of the PC market. Consumers simply do not need to replace their PCs every two years as they have previously. Thus, Intel is facing an insurmountable secular headwind. The market for the product that they create is now smaller than it used to be.

The second biggest threat to Intel is ARM Holdings, whose more power efficient chips have become the first choice amongst tablets and mobile devices. As the line between PCs and mobile devices becomes blurred, ARM based tablets will eventually become powerful enough to win market share from Intel powered PCs.

Bears say

  • Intel competes in an unattractive business
  • A capital intensive industry
  • A cyclical industry
  • A pure commodity business
  • The PC era is over, and with it the prospects for Intel's growth
  • ARM-based processors power most of the phones and tablets on the market today.

My Two Cents

Some cyclical businesses, and even some commodity businesses, are still high quality. And evidence is in the firm's attractive returns on assets and returns on invested capital. Intel currently offers a yield that is competitive with the broad utility sector. The company has built its dividend growth and payout ratio in such a way that ensures the dividend is safe even in bad years.

I have no idea what Intel is "worth." I do know that right now the chip industry is not at a cyclical peak, because of the slowing global economy and the transition to mobile devices from older PCs. I lack the macro-economic foresight to call a bottom. If you can find a yield that you are comfortable with, whether you're making that investment decision based on just dividends or free cash flow or whatever else have you, then just go ahead and build your position. But make that decision based on what you think Intel can earn throughout a complete cycle.

From a simply big picture perspective, the growth in mobile devices, or any other device that use chips, has to be good for Intel in the long run. More products that need chips equals more opportunity for Intel. As adoption of these devices rises, it will provide a long-term tailwind for the growth of infrastructure needed for so-called Cloud services. Intel's server processor segment just happens to be its highest margin business segment.

In short, I think Intel's future looks just like its past. Growing earnings, rising dividends, relentless competition.

Source: The Case For Intel