It is not very often that I write about options plays, particularly as my writings have mostly focused on the long-term fundamentals of the companies that I cover, but the poorly guarded secret on Wall Street is that while there is money to be made owning equity, there is an order of magnitude more money to be made (and, conversely lost) on the derivatives market. However, in a secular bull market where it is very difficult to find value in equities, it very often pays to look for catalyst driven trades and to properly set them up with the appropriate options. I believe that Intel's (INTC) upcoming earnings report should drive a substantial leg up. While I certainly believe that the shares are worth buying on weakness, I think that the July $26 calls could offer a real bang for the buck for those looking to bet against the negative consensus view on the market.
Intel is a name that has been punished over the last 12 months as the PC industry has seen a form factor shift towards tablets and other thin and light devices running operating systems other than Microsoft's (MSFT) Windows. The common perception on Wall Street was that there was an inherent inefficiency with Intel's X86 instruction set architecture, and that as a result Intel would be unable to penetrate the lucrative tablet and smartphone markets. Fortunately for savvy Intel investors, many of whom knew this to be patently false and based on the misconception that Intel's lack of presence in this market was due to anything other than simply not having chips aimed at the right design point, this myth - very widely propagated by ARM Holdings (ARMH) - has begun to crumble. As a result, there has been renewed optimism in Intel shares and dramatic multiple compression in ARM's.
However, I believe that while the sell-side has begun to warm up to Intel, it is clear from the consensus analyst revenue estimates that the Street does not yet believe that Intel can hit its full year 2013 guide, particularly on the top line. Should my thesis that Intel will indeed meet, and perhaps exceed, this guidance, it will be evident in the Q3 guide that is set to be announced on the 7/17 earnings release and will drive the next leg up in Intel's shares. The tenets of my thesis are outlined below.
Data Center & Connected Systems Group Should See Substantial Growth
The sell-side has not yet properly acknowledged in my view the effects of the upcoming server chip refresh cycle and the introduction of several new product categories that had not previously been a part of the Intel lineup. In particular, I characterize the upcoming product cycle as benefiting from the these three drivers:
- Big iron/enterprise segment should see a refresh of the Xeon E7 product line intended for ultra high end/mission critical computing. This particular product line has been in desperate need of a refresh (the current E7 parts are based on the "Westmere" generation of processor), so a new platform coupled with a substantially faster/more feature rich platform should offer a compelling TCO savings and as a result could drive unexpected upside in the data center
- HPC, workstation, networking, and comms are already secular growth markets, and for these segments a processor refresh on the existing "Romley" platform should re-energize sales which have likely waned in the current quarter in anticipation of the upcoming "Ivy Bridge EN/EP" parts
- Micro-servers, cloud, storage, routers, and switches represent the largest secular growth market for Intel, particularly as the buildout of the cloud remains robust. This bodes well for Intel's Xeon E3 parts as well as the firm's upcoming "Avoton" micro-server parts. In addition, Intel is making a foray into low end storage with its "Briarwood" SoC as well as a leap into lower end networking/comms infrastructure with its "Rangeley" system-on-chip which is essentially the "Avoton" part with an integrated cryptography engine
Intel is projecting "double digit" growth in this space and has been cautious to suggest that this will be "low" double-digit growth. I believe that this is extremely conservative and there is room for 15% Y/Y growth in the data center segment (or at least dramatic acceleration in Q3 and Q4), particularly in light of the vast numbers of new markets that Intel will be addressing by Q3 and Q4. In the worst case, I could see some of this growth spilling over into early 2014, which would delay - but not invalidate - the acceleration of data center growth thesis.
Mobile Upside To Drive Sentiment, Multiple Upward
I believe even the most bullish of the sell-side analysts dramatically underestimate Intel's potential in the mobile space, and I believe this is what primarily drives a below-market multiple. While the firm's recent design wins in the Samsung Galaxy Tab 3 begin to scratch the surface, I am confident that the potential here, too, is underestimated. My thesis here is driven by the following hypotheses:
- Windows 8 tablets will see strong adoption in professional/enterprise environments, which is evidenced by the fact that Intel was able to take ~6% of the branded tablet market in a mere quarter (Windows RT did not fare so well)
- Windows 8 tablets will trickle down into the 7" - 8" range, which should further open the floodgates to consumer adoption; Intel once again has a clear advantage should smaller Windows tablets catch on as Intel's chips run full Windows 8 while competitors' chips are forced to run the hamstrung Windows RT
- Intel has already won some key Android designs at ASUS, Samsung, and others, and with "Bay Trail" I expect adoption to accelerate, particularly as Intel's software/developer relations team has managed to remedy the vast majority of software compatibility problems that were initially associated with Intel-On-Android
- Intel is rapidly advancing its cellular/communications technologies, and should have an LTE-enabled platform for tablets shipping in 2013 and a multimode voice/data LTE solution with "Merrifield" set to launch at Mobile World Congress 2014
Ultrabooks/Convertibles Should Gain Traction In 2H 2013
A major technical limitation of the previous Ultrabook chips is that idle power characteristics and power management was insufficient to enable "all day" battery life. Further the multi-chip platform took up additional board space and power consumption (particularly as the PCH was built on the ancient 65nm process), which hamstrung the "Ivy Bridge" and "Sandy Bridge" Ultrabooks from a portability/battery life perspective. Additionally, there was very little in the way of form factor innovation at reasonable prices during Holiday 2012, which further mitigated any potential growth in the PC space.
Heading into 2H 2013, Intel has solved the power/battery life/form factor problem with Haswell-ULT, which is aimed at Ultrabooks and should deliver a dramatic increase in battery life and should enable more innovative form factors. However, the story doesn't just end with Haswell - it's really "Bay Trail-M" (the laptop/convertible version of the tablet oriented "Bay Trail-T") that should democratize high performance, fanless, and sleek notebooks. Intel expects designs based on "Bay Trail-M" to retail for under $399, which should help to regain the share that the firm is currently losing to tablets in this price band:
The Bottom Line
My expectation is that Intel common stock should continue to trend upward through the end of the year, and I would not be surprised if once Intel issues Q3 guidance, the bearish analysts - many of whom expect a Y/Y drop in sales - scramble to turn positive on the name. Do keep in mind that ~224M shares of Intel are sold short, and that the majority of this short interest seems to have piled on when the "death of the PC" rhetoric started to become commonplace during 2H 2012 into the first half of this year. My view is that these short sellers will end up covering their positions, but it is very likely that they will cover at substantially higher prices than the most recent close.
Buy Intel on weakness, particularly ahead of the Q2 report. The expectations are still so low that should Intel merely come in line with its own guidance for the year, there should be substantial upside to the shares.
Additional disclosure: I am short ARMH