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

Includes: INTC, WIND
by: Ockham Research

“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 (NASDAQ: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.WIND

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.INTC

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.

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