Ironically, Intel (INTC) is one of the more highly covered and fiercely debated upon investment holdings between Silicon Valley techies and Wall Street money managers. Indeed, the company has earned the staunch support of electrical engineers, rank-and-file employees, and loyal computer geeks, also known as, fan-boys. Alternatively, financial professionals cannot afford to analyze Intel, or any security for that matter, through the lenses of rose colored glasses. The war over Intel may effectively be described as much ado about nothing, considering the fact that this company has offered shareholders nothing, besides buyback and dividend increases, for close to fifteen years. Long-time Intel watchers should already know the drill.
On November 21, 2013, CEO Brian Krzanich hosted his first investor and analyst meeting at Intel. In a move that may be equitable to conceding defeat, Intel announced plans to open up access to its foundries to outside semiconductor firms. Over time, Intel's newfound embrace of made-to-order manufacturing for other companies may further erode bottom line profitability at a corporation accustomed to gross margins above 60%. A surprisingly sheepish Intel also noted that it would be expecting zero revenue growth through 2014, before literally slamming the door shut upon this analyst meeting. Wall Street clearly was not pleased with this turn of events, because investors unceremoniously dumped shares of Intel to $23.87, for a 5.4% loss on the November 21 trading session. The Intel business model has run into a brick wall.
Where is The Beef?
Be advised that Intel fiscal years typically coincide with calendar years. Paul Otellini, former Intel CEO, pitched the strength of the corporation's mobile edge within his 2012 letter to shareholders. At the time, Otellini honed in upon Intel's manufacturing prowess, and foreshadowed the installation of 14nm production technology heading into 2014. At the time, Intel also projected single-digit revenue growth through 2013. The advances of Intel manufacturing technologies appear to be only slightly delayed, as 14nm Broadwell chips are set for delivery some time during Q1 2014. Going forward, however, major design wins and product acceptance are much more important than the raw horsepower of factory specifications. As a foundry business alone, Intel shareholders may expect gross margins ranging between 40% and 50%, which again, would be less profitable than in-house vertically integrated product.
Current CEO Krzanich's aforementioned projection of flat revenue through 2014 was especially damaging. Intel has failed to leverage three years worth of aggressive capital expenditures into real growth. Management has also dismissed any ideas of tapering off research and development and additions to property, plant, and equipment spending, going forward. Intel has already thrown $7.8 billion in cash at research and development, while also using up $7.8 billion in cash upon additions to property, plant, and equipment, through the first nine months of 2013. Intel did generate $38.9 billion in revenue and $14.7 billion in cash flow from operations during this same time frame. For the sake of comparison, this semiconductor company used up less than one-third of its cash flow from operations upon additions to property, plant, and equipment, as recently as 2010. Intel research and development spending, as a percentage of revenue, has also increased from 15% towards 20%, between 2010 and 2013.
Investment bank Goldman Sachs is now infamously bearish towards Intel stock. On November 25, a report out of Goldman Sachs identified Intel as the number one leader of a Very Important Short Position list for hedge fund traders. A few days prior to the release of this short list, on November 22, 2013, Goldman Sachs confirmed its Sell rating on Intel and set a price target of $16 for the chipmaker. Goldman Sachs analyst James Covello attended Intel's analyst meeting and walked away with feelings that he termed as the 'exact opposite,' of bullish on the stock. Covello went so far as to describe Intel 2014 flat revenue projections as 'aggressive.'
Other Intel Architecture
Intel has classified its businesses according to PC Client, Data Center, Other Intel Architecture, and Software and Services operating segments. Other Intel Architecture was designated as an umbrella grouping above netbook, tablet, and smartphone chip sales. Intel managers have aggressively marketed the capabilities of the Bay Trail system-on-a-chip line as a powerful engine for "2-in-1" machines that bridge technical gaps between conventional tablets and laptop computers. The 2013 Intel Holiday Season Buying Guide presented Microsoft (MSFT) Windows 8.1 '2-in-1' machines ranging in price from $349 to $999, out of Dell (DELL), Hewlett-Packard (HPQ), and Lenovo (OTCPK:LNVGY). Additionally, the Intel smartphone lineup includes the Motorola RAZR I, Acer Liquid C1, and Safaricom Yolo. Bargain bin Intel Inside handsets retail in Thailand, Turkey, and Kenya.
Projections for flat revenue through 2014 may also confirm that management has already acknowledged the idea that Intel will be left without a major Holiday Season mobile design win, yet again. Intel has literally bet the farm for growth out of mobile, but has come away with nothing. In 2012, Other Intel Architecture accounted for 8%, or $4.3 billion, of the $53.3 billion in net revenue at the company. Through the first nine months of this year, Other Intel Architecture has held steady at 7.6%, or $3.0 billion, of the $38.9 billion reported Intel total net sales. The Other Intel Architecture division has racked up $1.8 billion in operating losses through the first three quarters of 2013.
Prospective investors may still expect the PC Client Group to generate roughly two-thirds of annual revenue at Intel. Broken down further, top-three customers Hewlett-Packard, Dell, and Lenovo often account for more than 40% of all sales at Intel. Ironically for Intel, Moore's Law will continue to drive sales dollars towards mobile devices, and away from the personal computer platform. On September 11, 2013, research firm IDC presented a report that broke down the smart connected device market according to desktop personal computer, portable personal computer, tablet, and smartphone unit sales. IDC has projected torrid growth rates above 70% for the mobile space between years 2013 and 2017. IDC also estimated the desktop personal computer market would decline by 8.4% during this same time frame. A brief overview of the empirical evidence may suggest that the Intel business model has already been left behind. Again, Intel's recent move to transform itself into an accommodating foundry may be interpreted as a somewhat humbling concession.
The Bottom Line
Investors should begin to evaluate Intel as if it were a staid utility, instead of a technology growth stock. Rather than a warning, this latest flat revenue announcement should be interpreted as par for the course. If anything, Intel owners may be more so up in arms over dividend payments, instead of any alleged growth projections. Intel now offers a 3.8% dividend yield. Conservative investors in the market for income, however, may consider buying into Altria (MO), which pays out dividends at a 5.2% rate, with far much less financial risks associated with its business model and future cash flow. Coca Cola (KO), with its 2.8% dividend yield, may also present a superior risk versus reward income investment profile to Intel.
The stock market is a pricing mechanism that discounts future growth. Intel revenue and earnings have actually deteriorated slightly over the past thirty-six months. This trend is likely to continue through 2014. On November 26, 2013, Intel stock closed out the trading session at $23.65 per share, which did calculate out to $117.8 billion, in terms of market capitalization. Intel may close out this 2013 year with $10 billion in net income on the books. As such, Intel now trades for roughly 12 times current estimated earnings. This valuation does appear as a steep price to pay for a declining business.
Proponents of various discounted cash flow models, of course, may simply argue that Intel can slash capital expenditures, which would also eliminate depreciation costs, and improve earnings performance. The financial engineers, however, must be willing to acknowledge the idea that Intel has no other option, but to take a long-term gamble upon mobile. The Apple (AAPL) iPhone and iPad were the one-two combination deathblow to the viability of the personal computer market ever resuming real growth.