Intel's Buy into the Device Software Business: Did They Overpay?

“One of the biggest names Intel, the world’s largest chip maker in the news going on a shopping spree, spending about $880 million to buy a mobile device software company, Wind River Systems. This company, as I mentioned, develops software, Intel making a stance and at least signaling it’s trying to switchgears and switch directions a little.” Fox Business Network 6/4/2009

Intel (INTC) is making a push into the software business, particularly for “embedded systems and mobile handheld devices” with its purchase of Wind River Systems (WIND). The deal is valued at $884 million or about $11.50 per share which represents a 44% premium over the share price as of the close on Wednesday. Wind River is a leading provider of embedded applications software for cars, office equipment, consumer electronics, telecom equipment, and more. As the quote from Fox Business suggests this move is a bit of a surprise as Intel has traditionally been known for its hardware business. Wind River is very much a software developer, particularly in devices. The acquisition could be a spring board to start driving growth for Intel’s development of chip sets for smaller devices.

Intel has been touting the myriad of applications for its low-end Atom processors for netbooks and even consumer electronics. Intel developed its own internal software division, and the Wind River acquisition should be a shot in the arm to those efforts even though they will reportedly continue to operate as a separate division. Wind River is well established in the embedded systems market and its software is in over a billion devices worldwide. However, Wind River was once the dominant player in the space, but has suffered from increased competition in the past few years taking away market share.

How this deal will eventually turn out is anyone’s guess, but it is clear that Intel is going to place more emphasis going forward into supporting its low-end Atom chip. The goal would be to put this inexpensive chip in everyday devices to be the processor to all kinds of gadgets and devices. One key concern of this strategy, will be over Intel’s profit margins because the more powerful chips for laptops and desktops are more expensive but also come with higher profit margins. This is certainly a valid concern, but Ockham’s take is that gaining market share is equally important in the possible explosive growth market for pocket-sized gadgets.

Whenever there is a major acquisition like this, people will always wonder, did they over pay? According to our methodology, we think that $11.50 is a fairly reasonable price for a company with the revenue and earnings potential of a Wind River Systems. Of course we will know more when WIND reports its first quarter 2010 results after the close on Thursday, but from what we already know is that the company is expecting to earn .54 cents in this fiscal year with 22% earnings growth in fiscal 2011. Although, revenue growth and profit margin trends are not hugely impressive. There is a significant growth premium being paid for WIND, which places the valuation a little bit richer than the $10.50 rationally expected price we had for WIND shares. However, clearly Intel believes that it can invigorate the kind of growth to justify the price, but only time will tell if they are were correct. Prior to the announcement, we had rated WIND as Undervalued as the price level around $8 was too low for the current fundamentals.

Original post

Comments

[capgain:]

There is good reason that INTC, as the acquirer, closed up on the day of the announcement. Apparently, more than a few investors believe that the price is a bargain, and likely to face competing bids from the likes of IBM or MSFT. WIND is the leader in their space as a result of a re-vamped sales force offering a proven technology into a myriad of markets. WIND's embedded chips have been successfully applied down here on Earth and as far away as Mars. They are in "smart" refrigerators that scan groceries and advise on the need for replenishment; they are in the Mars landers that have outlived their anticipated lives by more than 10 x!! They are in most of the cars we drive and techies across so many industries are utilizing them to facilitate upgrades in installed hardware.

So, did INTC overpay? We'll see over the next 30-60 days if some of the other big boys refuse to let them slip through their fingers.

Jun 05 12:05 PM

[PhillyDan:]

Agree with your comments. Would like to correct something that may be taken as misleading. WR doesn't make embedded chips but provides embedded software in realtime OS'es for microcontrollers for varied applications as you have noted in your comments.

Any deal like that that Intel does is usually well thought out and done with a lot of due diligence both from the technology, marketing and financial side. This buyout of WR by Intel is a strategic move to enlarge their eco-system of support for the Atom processors. There also may be a play in the graphics processing side as they are rumored to announce a high-performance graphics/video processor and are looking to expand the eco-system for that chipset family.

If they achieve their strategic objectives and we/they won't know this for some time, then they have not overpaid. My money would be on Intel making this acquisition a success.


On Jun 05 12:05 PM capgain wrote:

> There is good reason that INTC, as the acquirer, closed up on the
> day of the announcement. Apparently, more than a few investors believe
> that the price is a bargain, and likely to face competing bids from
> the likes of IBM or MSFT. WIND is the leader in their space as a
> result of a re-vamped sales force offering a proven technology into
> a myriad of markets. WIND's embedded chips have been successfully
> applied down here on Earth and as far away as Mars. They are in
> "smart" refrigerators that scan groceries and advise on the need
> for replenishment; they are in the Mars landers that have outlived
> their anticipated lives by more than 10 x!! They are in most of
> the cars we drive and techies across so many industries are utilizing
> them to facilitate upgrades in installed hardware.
>
> So, did INTC overpay? We'll see over the next 30-60 days if some
> of the other big boys refuse to let them slip through their fingers.

Jun 05 05:56 PM

[jnesbitt:]

As an embedded systems software engineer, I can tell you that wind river software is highly effective, supports many processors and product types, is the easiest to troubleshoot, and that Intel will benefit greatly by being able to bring many end product type examples to market quickly - and more of those will use Intel chips in the embedded space than they did before. Linux variants and Microsoft's WinCE are the leading embedded operating systems. Threadx is up there also. For more on the embedded microprocessor industry see embedded.com

Jun 06 11:42 AM

[TurtleTrader72:]

Trading at just under 20x earnings and with a dividend yield of about 3.50%, INTC does not seem unreasonable at these levels. If the market corrects off its current level, INTC could come down to some attractive valuations (15x earnings).

Jun 08 12:27 PM

[Henry Buttal:]

How big a threat is Open Source here? Is Intel buying market where their biggest future competitor is free?

These questions will keep WIND from drawing a competitive bid, because this is not a good match for IBM, and MSFT won't feel the need to buy.

Jun 08 01:21 PM