"Logic will get you from A to B. Imagination will take you everywhere."
While rumors between Apple and Intel have been going on for a while, a recent report from Reuters sparks the interest again. "Intel's next CEO is likely to shepherd the top chipmaker into a growing contract-manufacturing business, a strategic shift that could lead to a deal with Apple Inc. and give it a fighting chance to make inroads in the mobile arena," as reported by Reuters on March 7, 2013.
It may be the best time for Apple (AAPL) to consider adding and incorporating the new meaning for its letter "i" for iPhones with "Intel Inside." For Intel (INTC), moving beyond the glory of Wintel with Microsoft (MSFT) involves strong growth in the mobile market. A little bit of imagination may be required now to boost Apple and Intel's share prices.
Fallen Share Prices
The share prices for Apple and Intel have been declining in the past 6 months. Intel was down 7.21% and Apple had declined 34.85% while Nasdaq had gained 4.51%, as seen from the chart below. Both Apple and Intel need a strong, positive catalyst to reverse their falling trend.
Source: Google Finance
Mobile is Key for Intel, New CEO
In late November 2012, Paul Otellini announced his resignation as Intel's CEO. Andy Bryant, chairman of the board of Intel, stated the importance of utilizing Intel's technical strength to boost its presence in the mobile market. However, Qualcomm's (QCOM) dominance in the wireless market remains a challenge for Intel. QCOM is expected to deliver two new processors, Snapdragon 800 and 600 processors, this year. Intel is working aggressively to catch up and had upped its capital spending budget by $2B to $13B this year. The new Intel's CEO will have a big task to ramp up Intel's mobile efforts to take Intel to a new level. Wall Street is concerned about the lack of Intel chips in mobile phones and tablets. Intel needs to prove it can win in the mobile chips markets to boost its share value. The new Intel CEO needs to find the right balance to achieve mobile growth without compromising too much of its lucrative margins.
According to the latest data ending in January 2013, Apple's smartphone market share increased 3.5 percentage points to 37.8%. Apple, as the dominant smartphone player, undoubtedly is the new CEO's best target to expand the mobile market. JMP analyst, Alex Gauna, stated,
"The new CEO will have a very large opportunity to take this to the next level. Those discussions about taking on Apple as a foundry customer are going to be very complex and very contentious."
Foundry Business for Intel
In the past, Intel has based its business on using its manufacturing prowess to offer its own PC chips superior to rival products. However, the trend is changing. According to the report from Reuters, "Intel said last week it will open up its prized manufacturing technology to make chips designed by fellow chipmaker Altera -- snagging its first sizeable customer in a contract manufacturing, or "foundry," business expected to grow." Although it is still pure speculation, the following Reuter's report may show some signs of Intel's progress on Apple,
"Sunit Rikhi, vice president and general manager of Intel custom foundry, told Reuters last week his group is ready to take on a potential large, unidentified mobile customer, although he declined to discuss Apple specifically. Intel spokesman Chuck Mulloy said the chipmaker is in constant discussions with Apple, which buys its PC chips, but he would not comment on negotiations about a potential foundry relationship. An Apple spokesman declined to comment."
Samsung Inside Remains a Concern for Apple
Apple's best strategy is to end its foundry relationship with Samsung (SSNLF.PK), which competes directly with its own iPhones and iPads. The on-going patent case between Apple and Samsung further complicates their relationship. Apple currently designs its mobile chips with technology licensed from ARM Holdings (ARMH), which competes directly with Intel.
Apple has invested heavily in developing its own chip designs based on the non-Intel, ARM architecture to power its mobile devices. With a common processor base, Apple has more control over and all applications could run across its product families without modifications. The A6 chip that powers the iPhone 5 was built by Apple, after spending $400M to acquire chip companies, PA Semi and Intrinsity, and millions to license the ARM chip technology.
Intel Offers Leading Technologies and Capacity
While it could become more complicated for having different processors in Apple's mobile devices, Apple may be contemplating a new relationship where Intel would build Apple's self-designed ARM-based smartphone chips in exchange for Apple using Intel's X86 processors in certain new devices, like the next-generation iPad, according to RBC analyst Doug Freedman (in late 2012). By working with Intel, it could be one way for Apple to secure enough capacity and use chips on the leading edge of technology.
Impact on Intel and Apple
Shifting production of iPhone and iPad chips to Intel could lead to an additional $4.2B in revenue in 2015 for Intel, with a gross margin of around 50 percent, according to Macquarie analyst Shawn Webster. Analysts are currently estimating revenue of $54.07B for the fiscal 2013 and $56.64B for fiscal 2014 for Intel. As PC sales slow, the additional $4.2B revenue is definitely a big boost for Intel's revenue. However, Intel's gross margin may be impacted on the downside as Intel's gross margins are expected to be about 60 percent this year (which is down from 62 percent in 2012).
For Apple, by working with Intel, the complicated relationship with Samsung could be eased and future conflict of interest can be avoided while Apple focuses on mobile devices and Intel specializes in chip designing and manufacturing. Apple could leverage Intel's leading technologies and strong production capacity. For Apple's shareholders, there are more to gain than lose.
Fundamentally, Intel and Apple are both generating strong cash flow with a solid balance sheet.
There are a few key positive factors for Intel:
- Higher revenue growth (3 year average) of 14.9 (vs. the industry average of 11.9)
- Higher operating margin of 27.4% and net margin of 20.6% (vs. the industry average of 22.7% and 17.1%)
- Stronger ROE of 22.7 (vs. the average of 20.2)
- Low P/E of 10.1, P/B of 2.1, and P/S of 2.1 (vs. the industry averages of 24.2, 2.6, and 2.4)
- Lower Forward P/E of 9.7 (vs. the S&P 500's average of 13.9)
- INTC generates an operating cash flow of $18.88B with a levered free cash flow of $4.48B
- INTC currently offers an annual dividend yield of 4.17%
There are a few key positive factors for Apple:
- Higher revenue growth (3 year average) of 53.9 (vs. the industry average of 8.0)
- Higher operating margin of 33.5% and net margin of 25.4% (vs. the industry averages of 11.5% and 13.6%)
- AAPL has a total cash of $39.82B with zero total debt
- Lower P/E and P/B of 9.8 and 3.2 (vs. the industry averages of 15.0 and 3.9)
- Lower Forward P/E of 8.2 (vs. the S&P 500's average of 13.9)
- AAPL generates an operating cash flow of $56.73B with a levered free cash flow of $34.38B
- AAPL currently offers an annual dividend yield of 2.46%
With or without partnership, Apple and Intel are operating solidly on their own. With such strong cash generation ability and low Forward P/E of 9.7 for Intel and 8.2 for Apple, it is hard for investors to find such bargains elsewhere. By working together, a win-win situation could be easily achieved and possibly boost the share prices for both companies. Partnership is a logical decision for Apple and Intel with limited downside risks now. Perhaps, iPhones are destined for Intel, which both focus on quality and innovation.
Note: Investors and traders are recommended to do their own due diligence and research before making any trading/investing decisions.
Disclosure: I am long INTC.