In this article I assess the long-term 5-10 year performance history of Intel (INTC) and Microsoft (MSFT) and their stocks, and what this history means for the future, specifically, whether to expect growth or stagnation. The reason why I assess these companies together is because they have both seen little price growth in the past 5-10 years (see below), and their close relationship in the IT industry makes for a valuable comparative case study. In the past, when Intel grew, then Microsoft grew, and vice versa. Any investor who invested in one had to seriously consider investing in the other. In the future, I think this may change.
In my assessment, both companies are basically fairly stable, but I conclude that Microsoft may be heading towards stagnation, whereas Intel in the next 1-2 years may be heading towards serious growth. I also address some fundamental analysis in the semiconductor and software industries, probing into the technical nature of these companies, and the nature of technology growth and development. I will mainly be addressing qualitative issues (fundamental analysis) rather than quantitative issues, but if you want to delve into the numbers, I think you will see that they back up what I'm saying. Lastly, I apologize in advance for the length of this article, but I always prefer to be comprehensive in my writing.
This article is motivated by a dilemma, namely, that Intel and Microsoft stock prices have shown little growth over a long-term period of 5-10 years. They haven't dropped by any means, and they've paid solid dividends, but they haven't shown any major growth. At the same time, some of their competitors like Apple (AAPL) and Qualcomm (QCOM) have posted substantial gains. Furthermore, if you look at the numbers, these price movements appear well justified by the earnings, so it really isn't a question of the competition being overvalued -- at least, not drastically. So, why have Intel and Microsoft earnings and price lagged behind the competition? Moreover, does it point to stagnation, or should it be taken as a positive indication for future stability and growth?
Probably the first and most obvious distinction is that Intel and Microsoft are much larger than many of their competitors. Qualcomm was much smaller 5 years ago and Intel would have seen them as a little brother, at most -- though in 2012 they broke Intel's market cap, a major competitive achievement. In my opinion, when companies get very large, it becomes fundamentally more difficult for them to grow. There are a lot of reasons for this, and I don't claim to completely understand it, but a good example is IBM (IBM). IBM has been growing well over the past 3 years by increasing margin, year after year. This strategy is intentional -- it's simply much lower hanging fruit to raise your margin than to raise your revenues when you're already bringing in $100 billion per year. At the same time, the risk factors for pursuing 10% growth at $100 billion per year are massive. That's equivalent to adding another $10 billion company, which is big enough to bring down the entire house if it fails. The point is that expectations on growth for Microsoft and Intel may have to be tempered, at least when comparing them to their formerly much smaller competitors.
Then again, you don't have to look far to find a counterpoint. Apple was a huge company in 2006, and it's much larger now. OK, so we need to manage our growth expectations for large companies, but we also need to be aware that large companies should be able to grow if they do things right. So, no "get out of jail free" card there.
The next salient point then is to consider, well, do Intel and Microsoft actually want to grow? Now, it's easy to say "of course! every company wants to grow!", but I think there's a lot of factors that make the situation more complicated. For one thing, Intel and Microsoft both posted massive growth in the eighties and nineties. There can be good reason for management to want to stabilize and solidify those returns before getting too aggressive and taking unnecessary risks. There's also what might be called bad reasons for not wanting to grow. When a company grows, it needs to expand management, share more duties, and generally spread the load among more people and give trust to more people. This is where I see a problem with Microsoft, in terms of current CEO Steve Ballmer. I believe management quality is an extremely important aspect of any business, and when I smell problems here, it can be hard to get them out of my nose.
Now, Ballmer runs a good business, but I question his real desire for innovation and growth, or what is more material, his ability to manage delegation of these tasks to others. I've just seen too much criticism of him to give him the benefit of the doubt. This is criticism from former Microsoft employees, from outside of Microsoft such as through the admirably outspoken investor David Einhorn, and in my personal opinion, after watching videos of Ballmer in interviews and in speeches, I find his quality somewhat unconvincing.
However, the question about Ballmer's quality is actually much less important than the problem of Ballmer's tenure -- 13 years as CEO and counting. This speaks to me of a man who refuses to let go of the reins, considering the stock price has not performed. Thirteen years is a long, long time in a job of this nature in the rapidly changing and highly competitive IT industry. I'm sure Ballmer is a very competent manager -- you just can't run a massive company like Microsoft without a high level of competency, without running the company into the ground, anyways -- but part of leadership is knowing when to step down. Ballmer's continuing and apparently stable leadership over an extended period of price underperformance is a strong indicator of stagnation for Microsoft.
So now we have one piece of the puzzle for Microsoft -- we can hypothesize some management stagnation for the company, leading to the situation of stagnation in price growth. What about Intel's management? Same situation? I think the answer is no. Intel, on a management level, seems just fine to me. A new CEO will be announced this year and in my opinion, the appointment of a new CEO for a well-managed company is a very positive sign, because they never want to bring a guy right into the firing line on his first day in the job. When viewing interviews of Otellini and Intel management, I have found the quality level convincing. However, I think a new appointment is well justified, after 8 years in the job for Otellini. I will be excited to see the new CEO appointment in the coming months.
This brings me to my third and final consideration for the article -- the nature of technology growth and how it has influenced Intel and Microsoft growth. Research and technology development is hard work, and I think expectations need to be managed for R&D and technology companies, with an understanding that major innovations can take long (to an investor) 5 or 10 year periods to develop. You can think of these time scales as being roughly measured by an academic yard stick -- it takes roughly 5 years to get a Ph.D., constituting a single, new contribution to the state of the art, and industrial R&D work expectations should roughly follow. Now, that being said, I think this is one of the biggest reasons why we have a dilemma concerning the lack of growth for Intel and Microsoft. Namely, they've had 5-10 years and they still aren't showing appreciable innovation. Or are they?
In the case of Intel, I think it actually has been showing steady and strong innovation and I view the company innovation very favorably. The semiconductor industry is the best in the world at technology roadmapping, which in my opinion, is the crucial management technique for advancing technological progress. Of the semiconductor industry, Intel is unquestionably the leader in device manufacturing (along with IBM and more indirectly, ASML) and computer architecture, although the field there is extremely competitive, with capex barriers to entry being much lower. To understand just how competitive Intel is, through their tick-tock roadmap, they've advanced processor speed by an average of (conservatively) at least 10-20% every year for the past 5-10 years, at constant energy consumption.
Compare this with a heavy technology company like GE (GE) or Ford (F), who make engines. If they innovated as much as Intel, this would mean your car or plane would have doubled in speed in the past 5-10 years, at constant fuel cost. Now clearly, this comparison is only meant to be suggestive, and I don't mean to imply anything about GE or Ford per se. All I'm saying is that the engineering improvements we see from Intel would be considered blockbuster in almost any industry. Intel, among others, is actually enabling entire economies through all the business software applications that run on their hardware. (Unfortunately, the business market is much smaller than the consumer market -- see below.) Another example of technology leadership is the Intel Xeon Phi product introduced in last November, a truly remarkable commercial product with outstanding potential, both technologically and as a market mover.
Now what needs to be addressed is why the Intel price and earnings have remained flat if so much innovation is being achieved. I think the reason why Intel's innovation hasn't led to growth is twofold. Firstly, the semiconductor market is closely tied to consumer consumption. And unfortunately, there haven't been widely available software products to take advantage of all this computing power provided by Intel. Unfortunately and ironically this is another heavy criticism that you have to level at Microsoft. It's been in a great position to provide innovations to use all this new computing power, but it just hasn't happened.
The days when Microsoft could just release an OS and let the software developers do all the work are gone. The developers aren't pulling their weight anymore. It's been a long time since gaming software really drove PC sales. (What happened to Microsoft's excellent gaming products of the nineties, like Flight Simulator? Those actually gave you a reason to need a good OS and a great computer.) Microsoft's core products like Windows and Office are very useful, but they have remained virtually unchanged for over 10 years. Now, I do like the latest release of Windows 8, but even though it can run with a touch interface, and possesses some solid evolutionary improvements, it's basically very similar to all the old releases. The OS has shown nothing like the 10-20% improvements per year like the Intel hardware has shown. Now, Microsoft is understandably moving to the new device markets along with the rest of the industry, such as with their new Surface Pro tablets (which I also happen to like), but I think they would really gain most by developing innovative new software. They're simply already positioned there to make the gains. To give them some credit, they have released a good search engine in Microsoft Bing -- but Bing doesn't run on your computer -- it's an internet application! What a frustrating situation for Intel.
Moreover, unfortunately for Intel, the entire consumer software and services industry (think Google (GOOG), Apple, and many others) also haven't figured out how to use all this onboard processing power. While academic researchers and HPC users are eating this stuff up, and Intel HPC is growing double digits, the consumers don't have much reason to need anything beyond a budget computer. There is a ripe opportunity for new software to come out to exploit this, and personally I'm looking for when business analytics software, which has pushed IBM forward the past 3 years, makes its move into the consumer market, in terms of next generation web search and exploration software that visualizes the internet and intelligently navigates information space.
While we wait for the software to catch up, the other issue troubling Intel has been radio technology development. Intel has been slow to introduce things like the 3G and 4G cellular modems that go into mobile phones. One way to see this is just as further evidence of how technology development can be extremely difficult and time consuming. If it were easy to do 4G modems, Intel would have done it a long time ago. Trust me, start looking into modem technology on Wikipedia and you'll see that this isn't trivial stuff. Aside from the difficulty of the technology, 5 years ago, mobile revenue was still so small (see ARM's (ARMH) current revenue for example) that it wouldn't have even pushed the needle for Intel. At the same time, it could have been dangerous to enter the market too soon, because of two main factors. Firstly, while Intel could have licensed some of the tech or partnered on it, quite possibly with Qualcomm itself, this would have disrupted Intel's well established premium business model. Secondly, five years ago, Intel was still facing stiff competition from other established x86 vendors like AMD (AMD), and to lose focus in that battle could have threatened its core business, let alone its potential for future growth. Overall, that's a very consistent theme I find when I analyze Intel's performance, that much of its difficulties can be attributed to the fact that it must simultaneously compete with such a large ecosystem of competitors. Greater difficulties pay off in greater rewards in the end, of course.
On the bright side, radio technology (i.e. telecommunications technology) has been showing tremendous technical progress in the past 5-10 years, really a great thing for the industry as a whole. Qualcomm was able to capitalize on this largely by being well positioned, already sitting on the tip of the spear, as it were. They do good work as well, credit to their engineers, but now, Intel is beginning to catch up. They will have strong competitive advantages when they do catch up, because they will be able to innovate in both design and manufacturing at once. Players like Qualcomm can only manage one set of technologies at a time.
Furthermore, at IDF 2012, Intel announced that they were beginning to perfect digital radio manufacturing, a significant, 10 year technological breakthrough. Most radios are manufactured on much larger process sizes (65 nm) than the CPU/SoC because the difficulty of miniaturizing analog circuits. Apparently, Intel has figured out how to manufacture radios mostly on the same process. This will lead to substantial radio power reductions, smaller circuit board size, and longer battery life. Once Intel introduces its fully integrated SoC's with 4G capabilities, slated to begin 2014, they will be able to break into the mobile telecom market in a big way. I expect the Intel price and the multiple to begin rising strongly in 2014, if not sooner.
So, to summarize, what I wanted to do was understand why Intel and Microsoft price have been oscillatory or flat overall in the past 5-10 years. Here are my conclusions:
- Microsoft just hasn't innovated enough. Key management personnel have stayed on too long. Major opportunities in their core products are being missed, and I don't see any immediate signs for hitting them. For this reason, I think Microsoft's 5-10 year track record has to be viewed as a period of stability which may be leading to stagnation. That being said, I think they are still in a very stable position, largely due to their monopolizing of the consumer PC market. I reiterate Microsoft is a great company with great engineers and research, and my analysis of the company leads me to being more disappointed than upset. But if Google releases an x86 PC OS, I can only tell you the following: watch out.
- Intel has been innovating strongly, but the industry has been driving gains in areas that were simply way outside of Intel's focus 5-10 years ago. Expectations for Intel over the 5-10 year history have to be managed sympathetically considering the nature of technology growth and development. Furthermore, consumer software just hasn't caught up to the hardware that they're currently providing. Intel processors are getting ever smaller and faster, more feature capable (graphics, encryption, WiGig, etc.) and their HPC products (Xeons and Xeon Phi) are consistently outstanding. New CEO appointment is highly reassuring. New telecommunications technology is near on the horizon. For these reasons, I think Intel's 5-10 year history should be viewed as a period of positive stability, leading to serious growth sometime soon, which I expect will come at least in 2014.