On October 26, 1999, both Microsoft (MSFT) and Intel (INTC) were first added onto the Dow Jones Industrial Average as component stocks. In retrospect, this event may have arguably signaled the pinnacle of the PC revolution, as part of the overall technology economy. Over the past decade, Microsoft and Intel shares have done nothing, but return larger percentages of cash flow and income back to investors, in the form of dividends and stock buy backs. Value investors should sell off both Microsoft and Intel, and consider putting money to work in consumer staples stocks, such as Coca-Cola (KO) and Altria (MO).
On August 23, 2013, Microsoft issued a press release indicating that Steve Ballmer, CEO, would retire from his leadership role within the next 12 months. Microsoft stock immediately gapped up to post a 7.3% gain to close out this trading session at $34.75. After enduring years of catcalls to resign, the buck finally stopped at Ballmer. On November 12, 2012, Steven Sinofsky abruptly resigned, after serving his own 23-year tenure as President of Windows. The recent shake-up at the Microsoft corner offices confirmed that Windows 8 has failed to re-ignite the PC market. Going forward, the steady deterioration of the PC market will weigh upon the fortunes of Intel. Meanwhile rival Qualcomm operates with a formidable head start to defend its share of mobile market profits against Intel.
The Intel Business Model
On February 19, 2013, Intel filed its 2012 annual report with the Securities and Exchange Commission. Intel fiscal years typically coincide with calendar years. The report posted general financial statistics covering the past three years and is an ideal starting point to analyze the Intel business model. Intel generated $43.6 billion, $54 billion, and $53.3 billion in revenue between 2010 and 2012. Although revenue has increased significantly, net income has actually remained stagnant during this three-year period. Intel collected $11.5 billion and $11 billion in net income during 2010 and 2012, respectively. Over the past three years, Intel has aggressively put cash towards research and development specifically targeting smartphone and tablet devices. In doing so, Intel has finally acknowledged the writing on the wall. The growth in mobile devices has come largely at the expense of personal computers.
Intel classified its operating segments according to PC Client Group, Data Center Group, Software and Service Group, and Other Intel Architecture. Other Intel Architecture was established as an umbrella category to include smartphone, tablet, and net book sales. At Intel, the PC Client Group has historically accounted for roughly two-thirds, or 67% of total revenue. Broken down further, Hewlett-Packard, Dell, and Lenovo have emerged as Intel's top-three customers. Taken together, these three companies alone put in orders for a respective 43% and 33% of Intel's 2012 revenue and accounts receivables. For the sake of comparison, Other Intel Architecture accounted for only 8% of 2012 revenue. Intel reported that it waited until 2012 to enter the mobile market, when Intel architecture powered only six different smartphones.
Qualcomm (QCOM) and its Snapdragon processor, however, have already emerged as the twin engines of choice to drive Google Android, BlackBerry, and Microsoft Windows handsets and tablets. Beyond the popular Snapdragon chip, Qualcomm has licensed component parts and intellectual property throughout the mobile spectrum, which has grown to include both the premium Apple iPhone and cheaper HTC models sold in the developing world. Various reports have claimed that Qualcomm chips power more than half of the smartphone market. Qualcomm has consolidated power while Intel made the misguided decision to almost exclusively hitch its wagon to Microsoft Windows and the PC market. Going forward, Intel is fighting a losing war on two opposing fronts.
Windows 8 and the PC Market
On October 25, 2012, Microsoft brought its Windows 8 to market. In conjunction with this event, Microsoft unveiled its Surface tablet, while both Nokia (NOK) and Samsung launched premium Windows phones. Microsoft engineered its Windows 8 operating system to bridge the gaps separating conventional smartphone, tablet, and personal computer interfaces. As such, this program is notable for both its use of touch screen commands and the conspicuous absence of a Start menu. To date, technology pundits have authored dismal reviews pertaining to Windows 8. Dan Rowinski of Tab Times immediately dismissed Windows 8 as a "boondoggle." Rowinski went on further to blast Microsoft as an "arrogant tech company that believes it should succeed just because it put a lot of work into a product and throws a lot of money behind it."
A May 2013 report out of research firm Net Market Share may serve as further evidence that the marketplace has rejected Windows 8. The data, of course, did not bode well for Intel and the PC market, at large. According to Net Market share data, Windows 8 sales have lagged far behind Vista at similar points within the life cycles of both software platforms. The data suggested that consumers preferred to maintain older Windows 7, Windows XP, and even Vista machines, instead of upgrading to run Windows 8. At the time of the Net Market Share report, the Microsoft Windows software family still did operate more than 90% of the shrinking desktop market.
On July 10, 2013, research firm Gartner proposed a thesis that consumers were abandoning the personal computer, in favor of tablet devices. Again, Intel has lacked a serious presence within the tablet market, in comparison to sales generated by its PC Client Group. Gartner calculated worldwide PC shipments of 76 million units during the second calendar quarter of 2013. This figure was a 10.9% decline relative to the year-over-year period. On August 7, 2013, Gartner announced that sales in Western Europe had effectively collapsed through the same time frame. Gartner's latest report estimated a 26% year-over-year decline of the Western Europe PC consumer market during Q2 2013. Meike Escherich, Garter principal research analyst, reasoned that the looming Windows 8.1 launch in conjunction with Intel's new Haswell processing line "will not fully compensate for the ongoing PC decline." Going forward, top-three Intel customers Hewlett-Packard, Dell and Lenovo, may continue to lose significant business.
Global Original Equipment Manufacturer (O.E.M.) Shipment Estimates for 2Q13
2Q 2013 Unit Shipments
2Q13 Market Share (%)
2Q12 Unit Shipments
2Q12 Market Share (%)
Unit Shipments include desktop, laptop, and notebook PCs, but not media tablets.
Source: Gartner (July 10, 2013)
The Bottom Line
The 2012 Intel annual report did project "single-digit" revenue growth for the company through 2013. Wall Street should have then been prepared for net income to deteriorate at Intel through 2013, as the company continued to throw wads of cash into research and development. For two straight quarters, however, Intel has failed to meet analysts' already lowered revenue and income estimates. During the first quarterly period of 2013, Intel earned $2 billion, or 41 cents per share, in net income, off of $12.6 billion in revenue. Intel followed this weak quarter with $2 billion, or 39 cents per share, in net income, off of $12.8 billion in Q2 2013 revenue. Taken together, Intel has generated $4 billion in net income through the first half of 2013. At this point last year, Intel had already posted $5.6 billion in profits.
Business has declined significantly at Intel, after Dean Takahashi and Venture Beat described first quarter PC sales as a "disaster." Going forward, PC sales are likely to deteriorate further, while Qualcomm carefully guards its smartphone and tablet microprocessor empire. Intel founder Gordon Moore once theorized that the number of transistors on integrated circuits doubles every two years. Ironically, Intel has been done it by its very own Moore's Law. Intel has been caught flatfooted by the shift in consumer behavior towards acceptance of smartphones and tablets, at the expense of relatively bulky desktop computers and laptops.
On August 23, 2013, Intel closed out the trading session at $22.44 per share. Wall Street then recently applied a $111.7 billion market capitalization price tag to Intel. At this price, the stock would also trade for roughly 10 times trailing earnings. Intel, however, remains a strong sell. The glory days of the PC revolution have all but come to a close. Today's somewhat misleading trailing price-to-earnings statistic will inflate dramatically, after Intel continues to slog through earnings shortfalls. Most likely, Intel is trading for near 15 times current earnings. At its current trajectory, Intel will finish out the 2013 year with slightly less than $8 billion in net income.
Intel shareholders are effectively paying premium prices for chips and a business model that are rapidly going obsolete.