In 1965, Intel (INTC) founder Gordon Moore theorized that the number of working transistors that fit upon one integrated circuit would double every two years. In laymen's terms, Moore's Law highlighted the idea that electronic machines would be significantly more powerful, yet smaller, every other year. Over the past decade, Intel engineers have literally stood pat, while consumer electronics market growth shifted away from the personal computer and towards smart phone and tablet platforms. Ironically, Moore's Law has emerged to threaten the Intel bottom line and business model. Intel is now dead money as a fast follower behind rival Qualcomm (QCOM). The recent failure of Windows 8 to reignite demand for the personal computer does not bode well for the fortunes of Intel shareholders.
Intel Stock Performance
On October 26, 1999, Microsoft (MSFT) and Intel were both added to the Dow Jones Industrial Average as component stocks. In retrospect, this event marked the pinnacle of the PC revolution, as part of the overall technology economy. At the time, Intel stock then traded for a split-adjusted $27.53 per share. Ten years prior, on October 26, 1989, Intel shares were to be bought for a mere 76 cents. On August 30, 2013, Intel closed out the trading session at $21.98. Over the past fourteen years, Intel has literally done nothing beyond redistributing larger amounts of cash flow to investors in the form of dividend payments and share buybacks. Going forward, conservative investors should consider selling off Intel stock, and putting money to work within traditional consumer staples plays, such as Altria (MO) and Coca-Cola (KO).
The breakdown in Intel stock performance largely parallels the commoditization of the personal computer. In 2007, Apple (AAPL) launched its game changing iPhone as the catalyst that sparked the smartphone revolution. The smartphone is now the focal point of the Apple iOS - Google Android duopoly. Technology enthusiasts will acknowledge that ARM (ARMH), Qualcomm, and the Snapdragon microprocessor have emerged as the primary chip set engines driving the smart phone revolution. A quick review of Intel's 2012 annual report reveals that this microprocessor enterprise did not enter the mobile market until last year. Intel architecture now powers only eight different smartphones. The Intel Inside smart phone line up grew to include such bargain bin handsets as the Acer Liquid C1, Lenovo K900, and Motorola RAZR I.
Intel has historically classified its operating segments according to PC Client, Data Center, Software and Services, and Other Intel Architecture groupings. Other Intel Architecture is an umbrella grouping covering net book, tablet, and smart phone chip sales. Over the past three years, Other Intel Architecture has only generated an average of 8% of sales at this chipmaker. Alternatively, the PC Client Group has historically accounted for roughly two-thirds, or 67%, of Intel's total revenue. The top three customers, Hewlett-Packard (HPQ), Dell (DELL), and Lenovo combined to account for more than 40% of 2012 Intel revenue. Recent data compiled and released out of research firm Gartner, however, confirmed that the personal computer has deteriorated sharply over the past year. Gartner estimated that the Western European consumer PC market collapsed by 26% during the second calendar quarter of 2013. Meike Escherich, Gartner principal research analyst, recently claimed that the looming Windows 8.1 upgrade will "not fully compensate for the ongoing PC decline."
The Competition: ARM and Qualcomm
For several years, Intel executives have maintained a united front in support of their business model and the viability of the personal computer market. A June 29, 2013 New York Times mobile trends piece acknowledged a "PC forever" attitude at Intel, where engineers building out the Atom mobile chip set were allegedly dismissed as "second-class citizens." Recent Intel financials, however, are somewhat contradictory to this reported demonstration of PC solidarity. Over the past three years, Intel has aggressively been plowing cash into research and development. Intel's 2012 annual report language intimated that the dramatic increase in R&D spending was an investment consummated to gain future traction within the mobile market. Research and development costs ate up $10.1 billion, or nearly 20%, of $53.3 billion in 2012 net revenue at Intel. The Intel 2012 annual report forecasted "single-digit" revenue growth for the company through 2013 and into the near future. As such, net income will continue to decline, as this company attempts to ramp up mobile chip sales. Intel net income did decline from $12.9 billion to $11 billion between the 2011 and 2012 fiscal years. Be advised that Intel fiscal years typically coincide with calendar years.
The Intel business model is now caught between the proverbial rock and a hard place. Taken together, multiple reports have estimated that the ARM - Qualcomm alliance dominates at least 50% of the mobile chip market. The ARM company overview has already made the claim that this business supplies chip designs to more than 95% of all mobile phones. ARM has built its empire through the licensing of intellectual property to semiconductor companies, such as Intel and Qualcomm, and original equipment manufacturers like Apple. Alternatively, Qualcomm fashions itself as a chip company that outsources production. Intel is a vertically integrated enterprise that largely conceptualizes, markets, and designs chips, through a network of foundries that is owns and maintains. This business model will ultimately force Intel to embrace volume, at the expense of profit margins upon individual product. Handset and tablet chips are typically less profitable than PC chips, as the emphasis now shifts towards mobile battery life and temperature, instead of raw computer processing power.
At best, Intel's entry into the mobile chip market will drive down gross margins for itself and associated competitors. At worst, Intel will be forced to manufacture mobile chips through reengineered foundries that pile up as inventory to be written down. The maintenance of Intel manufacturing and assembly and test facilities may be categorized as fixed costs. As such, foundries and equipment must run at near full capacity in order for Intel to avoid costly depreciation expenses. Intel will be unable to maintain its hefty 60% gross margins, after moving aggressively into the mobile chip market. At this junction in time, however, Intel executives who failed to appreciate Moore's Law have backed themselves into a corner. Intel must challenge the ARM - Qualcomm partnership because the halcyon days of the personal computer market have already came and went.
The Bottom Line
Intel is dead money. At $21.98 per share, Intel executives now manage a company carrying nearly $110 billion in market capitalization. In terms of valuations, Intel trades for ten times trailing earnings. This trailing price-to-earnings ratio, of course, is misleading when net income is actually deteriorating. Intel has earned $4 billion in net income through the first six months of this current 2013 fiscal year. Intel had already posted $5.6 billion in net income at this very same point last year. Most likely, Intel will close out its 2013 fiscal year having earned nearly $8 billion in net income. In actuality, Intel trades for fourteen times current earnings, while offering 4% in dividend yield. Significant capital depreciation at Intel may cancel out and benefits from collecting dividends at a 4% rate.
Again, Altria is a better option for conservative investors hungry for yield. Intel, as a fast follower, will remain a non-factor in the mobile chip market led by alpha ARM and Qualcomm. Expect Intel to re-test 52-week lows beneath $20 per share through Q4 2013. The secular shift towards smartphones and tablets at the expense of the personal computer is another example of Moore's Law at work. Ironically, Intel now finds itself on the losing side of Moore's Law and ledger.