I have been researching Intel (INTC) for a couple months now and recently realized that the market may be focused on the wrong area for revenue growth. The focus of Wall Street and the reason for Intel's low P/E multiple is the perception that Intel cannot compete in the mobile market. This year will be the beginning of Intel's aggressive push into that market and will change that perception. Next year will be the year Intel sees exceptional growth in the mobile market if it can execute its mobile strategy and will earn Intel a multiple expansion. In some of my past articles I address my expectation for the P/E multiple to move from its current value of 10 to a P/E closer to 13 in 2014 leading to spectacular returns for the patient investor. But Intel is also in the embedded devices market and this market appears to be the real place for Intel to expand revenues and earnings. Specifically, in the embedded devices market Intel has the Intelligent Systems Group working on solutions for the smaller market sub-set of intelligent systems. According to the International Data Corporation (IDC), the intelligent systems market is poised for 24% growth through 2015 with particular segments like health care seeing growth rate above 40%.
Let's start at the beginning and describe both the market and the products in embedded devices and the sub-set of intelligent systems. I reviewed the report, "Intelligent Systems: The Next Big Opportunity" by IDC to get the information on this market and the definitions used in this article. Traditional embedded systems includes systems with non 32 bit or above architecture MPUs, but might not support a High Level Operating System (HLOS), or be connected. This market has been traditionally very fragmented with a set of disparate industries including communications, transportation, industrial, energy, consumer, and healthcare making up the market. Almost anything that is digital contains an embedded system; the Point-Of-Sale (POS) system, automotive info-center, tracking of freight, cellphones, and systems monitoring energy distribution to name just a few. This large embedded devices market was a $1.6 trillion industry in 2010. The IDC expects this market to grow at a compound annual growth rate (CAGR) of 10% through 2015 ending with a value of $2.6 trillion. The intelligent system sub-set of the embedded device market is expected to grow by 24% over the same time period but is also expected to represent 75% of the revenue, meaning the overall value of the intelligent system market would be $1.95 trillion with 3.8 billion units. The size of this market is staggering and if Intel could capture even a tiny sliver of the overall market will have developed a revenue stream more valuable than its PC group.
An Intelligent System is defined as, "securely managed electronic systems that run a high-level operating system and autonomously, with the following characteristics; connect to the internet, execute native or cloud-based applications, and analyze data collected" (IDC 2012). These systems are growing so quickly because of the changes in how we connect to the internet through mobile devices. Smartphones and tablets are seen as intelligent because they connect to a network and can capture and process large amounts of data. We are already seeing an uptick in servers to support the level of cloud computing that is occurring because of these multiple connections. We will see an exponential increase in the value of intelligent systems as we connect machines to machines to capture and analyze data. It could be in the near future that I will own a PC, a smartphone, a tablet, a smart TV, and smart appliances all networked together through intelligent systems and with improved sensors capturing and analyzing data. When my smartphone identifies through GPS that I am at my local grocery store it can alert me that I am out of milk which is being tracked by my smart refrigerator. In this example you can see the value of different devices being able to communicate with each other over an intelligent network. Typically in a business setting each system does not communicate with each other but separately gathers data. With an intelligent system it could be scaled up to incorporate all the other devices gathering and analyzing data to produce additional value by making the whole ecosystem of that business more effective and efficient. The explosion of billions of users going online through mobile devices, the development of location services, social media, and near field communications is driving the growth in intelligent systems. Below is Table 1 from "Intelligent Systems: The Next Big Opportunity" by IDC
The table above highlights the growth in revenue of the intelligent systems market broken out by each industry. As you can see healthcare shows the greatest growth but is also the smallest market at $12.8 billion in 2012. Energy is another industry with tremendous growth followed by consumer and communications. Intel already offers Smart Grid Energy solutions using computing and communications technology to optimize alternative energy devices like wind turbines that optimize their position as wind changes. This is a good start and I would like to see Intel continue to focus on this industry and the emerging healthcare industry. Intel also offers products in fitness equipment and portable diagnostics systems among other categories in the healthcare industry but with the growth in this area I would like to see even more products being developed.
Interestingly enough the explosion of intelligent systems will produce strong need for servers to compute the data and storage technologies to hold all of the data being captured by the systems. While intelligent systems itself could be a massive revenue stream for Intel it also will produce more revenue in data centers and storage systems which are two areas Intel already has a strong presence. But to get back on topic, intelligent systems are a huge market expected to reach $1.95 trillion by 2015 but this is just the start of the story. IDC predicts, "Beyond 2015 Intelligent Systems market momentum will accelerate as the ecosystem of hardware, software, and services vendors will bring more intelligence into systems through high levels of performance and programmability, more forms of connectivity, increasing penetration of sensors, and a growing base of cloud based applications and data analytics that brings the "Internet of things" closer to reality". So the prediction is growth will accelerate after 2015 and the growth rate is already impressive. Intel is already in position to benefit from this growth with its Intelligent Systems Group. Intel has developed the Intel Intelligent System Framework,
"The new Intel® Intelligent Systems Framework solves the problem with a set of interoperable solutions that can scale across applications. The framework brings together hardware, OSs, and tools for connectivity, security, manageability. The new approach promises to lower deployment costs, ease integration, and enable innovative services. The end goal is an easier, faster path to making buzzwords like Machine to Machine (M2M), Internet of Things (IOT), and Big Data a reality."
This framework allows for the flexible combination of different processor platforms, OS, security, and remote management that will make it easier to connect different devices. This framework also leverages other operating units of Intel like McAfee Security and Wind River's Linux OS. A clear leader has not emerged for intelligent systems as of yet and if Intel could successfully develop a framework that becomes the standard for the industry it would reap massive rewards. This framework would have to allow for the other OSs not developed by Intel like Windows OS, iOS, Android OS, and more in order to become the standard but if it was successful it could develop a market share that would produce extreme revenue for Intel. The fight is just beginning and there are a few key vendors in this space; Intel, Texas Instruments (TXN), Freescale Semiconductors (FSL), and Infineon (IFNNF.PK) according to TechNavio's analysts. I see this market as a major source of revenue for Intel in the future. If Intel can be successful in its pursuit of expanding into the mobile market with smartphone and tablet chipsets and earn the P/E multiple expansion the extra revenue kick from the Intelligent Systems Group could be the catalyst for great stock appreciation and increasing dividends. I have always been a bull on Intel but this market may take Intel beyond even my bullish expectations.