Intel: My 2016 Price Target Is $48 Per Share
I believe that Intel (INTC) is probably the best risk/reward large-cap play on the market today. Right now, shares can be purchased for a tad over $21/share, and the dividend yield is ~4.2%. Intel generated more than enough FCF to cover that dividend, so very worst case, I treat this stock like a bond. But I'm pretty young and I ultimately want to make investments that help me build substantial long-term wealth, which means that while the dividend is a very nice safety net, I do expect capital appreciation. So, how in the world did I sit down and come to the idea that Intel will more than double within ~4 years' time? Well, let me walk you through my process.
Multiple Is Significantly Compressed In Light Of Uncertainty
There is one chart that explains exactly why Intel is valued for the absolute worst case scenario:
In terms of market capitalization, Intel is trading almost at the same level as Taiwan Semiconductor (TSM), a pure play foundry. While Intel's manufacturing lead over TSMC is noteworthy, and further that Intel makes a hell of a lot more money as it collects both design and foundry margin, I note that the market is generally pricing Intel for the absolute worst case in that it becomes a pure-play foundry:
But see, this is nonsensical. Intel not only has the best chip manufacturing technology in the world (that it will be leveraging for a high-margin boutique foundry business), but it can leverage that manufacturing to maintain a sizeable price/performance/power consumption lead over its competitors. Intel has the PC and high end server space on lockdown (and these are very profitable businesses, mind you), but this leadership in manufacturing, in my view, will translate into leadership in terms of both product quality and scale in the new markets.
The Mobile Argument Is Tired...And Wrong
I hear often that Intel "missed" mobile, but quite frankly, I see this as an opportunity now to expand the business further. With a $54B/yr business built on server chips and PC chips, doesn't it excite real long-term investors that Intel can also take some nontrivial share in tablets and phones to grow that revenue? Further, tablets and phones are certainly not the first, nor will they be the last products that require strong performance/watt characteristics. Everything in the world will have some sort of computing capacity, and I believe that Intel will successfully leverage its technological investments to keep growing here.
The notion that Intel can't get into "mobile" is also borderline ludicrous. While a lesser company without the hardware and software manpower would have had a very difficult time bringing a new instruction set to new platforms, Intel's army of software engineers have successfully optimized Google's (GOOG) Android to run on its chips perfectly. I had my doubts back in 2011 that this could be done, but I have used Intel powered phones...they work, they are fast, and they are viable. The only thing that has held Intel (and anybody else not called Qualcomm (QCOM)) back in penetration in the US is the lack of an LTE solution. This has now changed as Intel will be shipping its multi-mode, multi-band LTE solutions to customers in the first half of this year.
Further, the folks saying that Intel isn't in major designs yet, so they're locked out forever - are you serious? It's been about a year since the first Intel phone chip made its way into a design. It takes time to establish credibility as a new entrant as a component supplier! Intel has forged the right partnerships with key players in the growth segments - Lenovo (OTCPK:LNVGY), Motorola, ZTE, Huawei, and others - and I believe that as trust is built, more phones with "Intel Inside" get sold.
The tablet argument is even easier...Intel has only one competitor in the Windows 8 tablet space, and while AMD (AMD) will take some share, it is likely that Intel dominates this space as it does in Windows PCs. Microsoft (MSFT) and ARM (ARMH) are puffing smoke about Windows RT, but the sales numbers have proven that backwards compatibility is important, especially if you can get the same (or better) battery life and performance characteristics along with it. The significant work done to enable Intel on Android will also pay off here as Intel becomes a major player in the Android tablet space. Intel's process lead will manifest itself here, and its design expertise will also come into play as the latest 22nm "Bay Trail" Atom SoC comes out with a new processor core, new graphics, and lower power all around.
Bottom line is, Intel will become a major player in tablets and phones...to expect otherwise is to ignore both history and the massive R&D and marketing resources at the company.
Capital Expenditures...Nobody Gets A Free Lunch
Everyone is so worried about capital expenditures, but the reality of the situation is that increasing capex hits everyone in the industry, whether you're fabless or not. Do you think TSMC is shielded from rising capex and R&D? Do you not believe that as TSMC's costs go up, the costs for their customers will also go up? This will make the "me too" ARM SoC business completely non-viable for all but a select few with real competitive advantages.
Right now, mobile SoCs are $20/pop primarily because everyone and their dog thinks that they should be in this business of making generic ARM based chips. Hey, they can license all of the hard-to-design IP, right, so why not? Well, too bad nobody makes any money at it, and that's why you're seeing Freescale (FSL), Renesas, Texas Instruments (TXN), say "screw this" and leave the business. But good luck to any of the other "me too" folks when they get hit not only by rising wafer costs, but by increased R&D necessary to take advantage of new process nodes. The product cycles in this business are short, so it will be very, very difficult for anybody but a select few to really profit from this venture long term at these prices. Intel has a lot of leverage with its designs, and it keeps the foundry margin that it leverages from existing infrastructure, so it will be profitable. Nvidia (NVDA) and Qualcomm are the two "big" guys in the SoC race now, and given their technological strengths, I expect them to be viable too, albeit they still have to fork over TSMC's foundry margin and probably can't spread the fixed costs across as many units as Intel will be able to over time.
Ultimately, $20 mobile SoCs are not likely to be sustainable, and once the majority of the commodity "me too" guys get slapped with reality, it will come down to only a handful of players, and then from there prices can rise. Look at what happened in the hard disk drive space for a preview of the future here. Or what happened in the X86 space! People forget that everyone from IBM (IBM) to Cyrix to Honeywell (HON) had an X86 license...how many players are left? Two. ASPs for PC processors are now reasonable, and there's less of the pie to share.
People also forget that Intel owns Infineon Wireless, so it will be able to sell modems too. $20 for the apps processor, then throw in another $10 - $20 for the modem, and now you're selling $30-40 of content into a smartphone - very similar to a low end PC chip. Now, with much greater volumes, and fabs that are basically paid for by the PC business, don't you think that Intel's cost structure will be excellent?
Intel will be fine in mobile...being late doesn't matter as long as you can come in, build great products, and keep winning customer trust. It'll take a few product cycles, but eventually you will see plenty of "Intel Inside" of mobile chips.
I expect Intel to, within 3-4 years, take ~20% of this market. So, if the projections of ~1.2B units by 2016 are correct, and if we assume that Intel sells both modem/RF as well as apps processor, then we're looking at $30/phone against 232M units and, hey, that's $7B right on the top line! At 60% gross margin (Intel has indicated that gross margins are not the problem for these phones, so I assume they are at the low end of corporate average), we're looking at $4.2B worth of gross profit. Given that R&D is at the right run rate, according to the most recent conference call, this is all pretty much gravy.
Tablets? Same thing. Let's assume 20% market share again, not selling a modem into this so ASPs of $20/chip, against 2016 projections of 389M units, and all of that at 60% gross margin, this gives us $1.6B at the top line and $933M in gross profit.
PCs: The Red Headed Step Child
It's hard to get a handle on this, since the PC and tablet end up converging over the next couple of years, but let's assume that we are separating "tablets" from "PCs". Let's be pessimistic and say no growth! Zero! Nada, zilch, zippo! That's right, the PC is dead as far as my conservative estimates go - zero growth!
According to the recent form 10-K, Intel's PC client group did $34B in sales during 2012 and spat out a respectable $13B in operating income. Let's assume the same in 2016 until further notice!
Servers: The Real Moneymaker
Yeah, everyone's really excited about these little phone chips while conveniently ignoring Intel's major cash cow - servers. The Data Center and Connected Systems Group did $10.7B in sales and $5.1B in operating income during 2012. Intel says double digit growth until 2016, so let's assume top line growth at a 12% CAGR (2012 analyst meeting said 15%, but I will again be conservative), and let's assume 1:1 correspondence of top and bottom line growth (actually a conservative assumption). This gets us to $16.8B in sales and to about $8B in operating income.
Coming To The Fair Value Estimate
Well, if Intel actually makes the headway in mobile that I think it will, then the multiple expands. Let's give it an IBM -like multiple of ~13x earnings, and let's assume no reduction of share count at that point.
We have $13B in operating income from the PC client group, $8B from data center, and from mobile we assume that opex for "Other IA" (Atom) is pretty flat and so our phone/tablet numbers are incremental. This brings us from a $1.4B loss in 2012 to a $3.7B operating profit (this is a very important thing to note, as "Other IA" actually significantly detracts from earnings due to the highly aggressive investment levels). Software and Services seems to growing, and at the 2012 analyst meeting the expectation was low double digit growth for 2013, so let's say this still doesn't contribute positively to the operating income during the year.
Tallying it up, we see $24.7B in operating income during 2016. Note that this estimate is mind-bogglingly conservative as it assumes:
- No contribution to operating income from software & services
- No contribution from Intel Custom Foundry
- No PC growth for 3 years
- Modest smartphone and tablet market share
Guided full year tax rate for 2013 is 25% so let's assume that this also still holds in 2016. This gives us net income of $18.5B. If the assumptions hold true, then Intel's viability will no longer be in question, so I would expect the Street to value the company at an IBM-like multiple of ~13x earnings (still conservative in light of TSMC's ~17x, Qualcomm's 20x, etc.). This, assuming no share buybacks, against a diluted share count of ~5B yields $3.7/share. At a 13x multiple against $3.7/share, we arrive at $48/share by 2016, or well over double the current price.
This is attractive in light of the worst case downside scenario of ~$12/share, seen during the financial crisis. Back then, yield support wasn't there, the economy had gone to hell-in-a-handbasket (so earnings were quite down), and in general it was the worst scenario imaginable. I see realistic downside risk of $17 - $18 per share, where the yield at current levels would be a tad over 5%. So, with Intel, you're paying $21/share for $4/share of downside risk and $27/share of upside potential...along with a dividend that would rise commensurate with my projected EPS increase.
You can see why I own Intel...it has great risk/reward, and I think the pessimism surrounding the company is way overdone. I make a number of assumptions in generating my price target, but I believe that I am erring on the side of conservatism rather than optimism. Custom Foundry, greater mobile share, and PC growth resumption (even single digit CAGR...) are additional upside drivers that I have not factored in to my estimates. The 4.2% dividend isn't bad, either.
Additional disclosure: I am short ARMH