When Intel (INTC) guided to a "flat" 2014 off of what wasn't exactly a great 2013, the market gave the stock a gigantic thumbs down. In a market where high growth is probably the most important share price driver [even at the expense of the bottom line; see Amazon (AMZN)], this isn't exactly a recipe for significant, market-beating returns.
So, what Intel investors really need to ask themselves at this point (and as a very vocal Intel bull, you will see my answers to those questions here) are the following:
- Why are you long the stock?
- What do you think the shares will ultimately worth?
- When do you expect the appreciation that will justify (1) and prove (2) materialize?
With that in mind, I'll go ahead and provide my answers to these three questions.
Why Am I Long The Stock?
It is my belief that, over the next generation or two of its mobile products, Intel will finally begin to take meaningful share in both tablets and phones. Given that this is a multi-billion, mostly incremental opportunity (there is tablet cannibalization of low end PCs at play), there is a real opportunity for the company to return to revenue growth on the back of mobile alone during 2015 and beyond. Long term, I believe Intel will capture at least 40% of the smartphone/tablet markets (i.e. within 5 years).
Furthermore, I don't believe that the PC is "dead". What I do believe is going on is that with the advent of tablets, the overall market for computing has expanded but that traditional PCs will have a much lower share of the overall market. Eventually the major shift from PCs to tablets at the low end will run its course, setting a new baseline for PCs and then from there the units can grow at a low single digit pace. Once this business is viewed as a slow growth rather than a negative growth business (and it is in the US with emerging markets still in free-fall), then the company's multiple can see meaningful expansion (as the decline here has proven a major headwind to the top and bottom lines)
Next, I think that the server opportunity is quite robust. This is a business that has ~50% in operating margin (and at $11B/year and growing, this is >$5.5B in operating income per year) and it's growing at a low to mid double digit CAGR over the next several years. While many have thrown a fit about potential ARM (ARMH) based servers, I largely believe that Intel will succeed here for the exact same reason that Intel won in the high end of the server market: scale, manufacturing leadership, performance-per-watt leadership, massive software install base, and many years of experience designing the world's best server chips and surrounding server infrastructure.
Finally, I think that if Intel can drive nice profitability in its "custom foundry" business WITHOUT building products that eat into sales of its own products in any meaningful way, and if the company can build its software and services group out to generate about $1 billion/year in operating profit (guide for 2014 suggests ~$200M in operating profit up from breakeven in 2013), then this could be nice growth on top of the core businesses.
What's Intel Worth?
Intel is on track to post about $12.5 billion in operating profit during 2013. Note that this breaks down into:
- PCG: $11.6B
- DCG: $5.3B
- Other IA: ($2.5B)
- SSG: $0
- All Other: ($2.1B)
Now, next year, this is probably going to look more like:
- PCG: $11.6B
- Other IA: ($3.5B)
- SSG: $0.2B
- All Other: ($2.1B)
Pretty ugly on the Other IA side, right? Now, let's think a bit longer term (2-3 years out). Let's suppose the PC bottoms out, but doesn't grow much (but thanks to aggressive cost cutting thanks to die shrinks/optimizations, operating profit can outgrow sales), Intel is competitive in mobile/Other IA and finally breaks even ($1B of losses vanish in 2015 as the platform subsidies go away), SSG can turn $500M in operating profit, and even foundry is starting to contribute somewhat.
I get the following 2015 estimates:
- Sales: $34B (+$1B over 2013)
- Operating Margin: 37% (+200bps)
- Operating Profit: $12.58B
- 70 million tablet chips at $20 ASP = $1.4B
- 50 million smartphone chips @ $20 ASP = $1.0B
- Intelligent Systems: $2.64B (15% CAGR thru 2015)
- 20% of $20B cellular baseband market (+800bps of share) = $4B
- TOTAL: $9.04B
- Gross Margin: 55% (below corporate avg)
- Opex: $4B
- Operating Profit: $972 million
Data Center Group
- Revenue: $15.2B (15% CAGR thru 2015)
- Operating Margin: 50%
- Operating Profit: $7.6B
Software & Services Group
- Revenue: $3B (10% CAGR thru 2015)
- Opex: $2.5B
- Operating Profit (software is ~100% GM): $500M
- Operating Loss: $2B
- Revenue: $61.2B
- Operating Profit: $19.2B
- Tax Rate: 26%
- Net Profit: $14.59B
- Earnings Per Share (4.98B shares outstanding): $2.93
Assuming that Intel trades at modest 12x these estimates, Intel could be worth $35/share. Expanding the multiple to 13x (which would likely be justified if Intel can actually gain meaningful traction in mobile), and the shares could be worth $38/share.
When Do I Expect This To Play Out?
I expect this to play out during 2015. I expect that 2014 will be a year during which Intel is laying the groundwork to win designs in mobile, even with sub-optimal parts (from a BoM/cost structure perspective). In 2015, Intel should have its cost structure more or less sorted out, which leads to the significant improvement in other IA profitability.
PC demand has already shown signs of bottoming out in developed markets, so it's only a matter of time before emerging markets follow suit. Server demand should continue to be insatiable (especially as Intel takes share in entirely new segments of the datacenter). Software and services group should have some nice leverage, although I admit that I'm flying a bit blind on those estimates.
Admittedly, things could fail to play out as I expect and, in that case, the shares will trade meaningfully lower than what I'm expecting here. Alternatively, I could end up too conservative on the multiple that investors would be willing to pay for an Intel that can actually make money in mobile. At 14x or 15x my estimates, we are looking at a $41-$44 stock.
At any rate, the risk/reward here is quite good, and I'm happy to hold onto my Intel shares for as long as I see meaningful progress towards the company becoming a profitable mobile player. If 2015's "Broxton" chip fails to deliver and doesn't gain traction, then this thesis could be broken and in that case, I'd probably sell.