Intel's Game Of Musical Chairs: Don't Make A Grade-School Mistake

 |  About: Intel Corporation (INTC)
by: Terrier Investing

After a lengthy back-and-forth about whether or not Intel is fudging the math on revenue guidance for 2014.

Stacy Smith, Intel CFO: "We had a positive data point on PCs, we had a little bit of a negative data point on one element of the enterprise, our tablet momentum was good, so you just kinda look at it and our view is consistent with what we had in November."

Stacy Rasgon, Sanford Bernstein analyst: "But you're not booking any revenues on tablets-"

Intel: "Stacy, thanks for the question. We're gonna move on to the next questioner."

Finally. For quarter after quarter, Stacy Rasgon has harassed Intel (NASDAQ:INTC) management on conference calls, nitpicking for precision to decimal points that only a first-year chemistry TA can expect out of the real world, and subsequently issuing bearish notes that range from alarmist to insulting. (It is one thing to be bearish on any given stock. It is another thing entirely to routinely assert that the company in possession of a pristine balance sheet and the world's most advanced semiconductor manufacturing process should be valued at 8-9x trough earnings, especially when these earnings are themselves understated. Rasgon has an impressive resume and is undoubtedly a very smart man, but in my estimation, his analysis of Intel misses the forest for the trees.)

This time, rather than being polite and waiting until he finished his line of questioning to move on, Intel simply shut Rasgon down and opened the line up to other callers who had more useful questions to ask.

The New And Improved Intel

It's a novel approach, but not entirely surprising. I will admit that I was somewhat skeptical of Brian Krzanich, but under his tenure, Intel has adopted a very no-nonsense attitude. This doesn't just mean not taking (blank) from analysts with an axe to grind on conference calls; it means building things like Quark within six weeks of conception. It means standing up on stage and admitting that Intel missed mobile - that Intel needed to shore up the way it anticipated and responded to shifts in the semiconductor landscape. It means taking radical steps like spending $2 billion (yes, that's billion with a B) on contra-revenue rebates and non-recurring engineering charges to establish a strong foothold in the low and mid end of the tablet market.

And most analysts, whether on Seeking Alpha or the sell-side, are starting to get it. As I pointed out several months ago, and as Stacy Smith alluded to on the call today, Intel's massive investments in mobile are obscuring both revenue growth and strong margins. Those who think Intel's Q4 report was a "dud" are missing the point. There were, in fact, several very positive data points:

  • PCCG actually grew in the fourth quarter, and - more importantly - i7 and i5 both saw record unit shipments. (If this doesn't disprove the cannibalization hypothesis, I don't know what will.)
  • Cloud, storage, HPC, NAND, intelligent systems, and networking all rocked the house.
  • Broadwell production starts in Q1.

In spite of a revenue beat in Q4 and positive data points on PC (arguably the thing the market is most scared of), investors focused on the one negative data point: slower than expected recovery in enterprise spend, which was at least partially attributed to the segments affected by the government shutdown and uncertainty around the debt.

So let me get this straight. Apparently, Intel not only has to design and manufacture the world's best semiconductors, but it also has to solve all our political problems too?

One will notice that government agencies that are either shut down or under the threat of being shut down will generally tend to delay ordering expensive computer equipment.

To be fair, Intel did cite inventory burnoff as another reason - and since DCG growth is the primary driver of my INTC thesis, I will be closely watching DCG results in each subsequent quarter.

Still, I checked my model, and small adjustments to DCG's near-term growth certainly don't account for a 5% variation in equity value. Which leads me to my second thesis on Intel...

Musical Chairs

I hate to be one of those people who claims to know what "the market" is doing or what "investors" think, because really, who has the time to survey however many millions of people are participating in capital markets? Seems exhausting; I'd much rather go find a nice park bench and take a nap.

But in this case, I think I have figured out what "investors" are doing with Intel: they're focusing on all the noise and the movement. And when the music stops, they may find themselves without a chair, especially if they're on the short side - because they spent too much time focusing on things that really weren't important.

Let me explain in the context of the Stacy-Stacy back-and-forth I quoted at the beginning. For those of you who haven't heard the conference call or read the transcipt, Rasgon asked how Intel could maintain "approximately flat" guidance when they were slightly lowering DCG guidance and weren't raising PC guidance. Stacy Smith responded by saying that "approximately flat" has some wiggle room, noting that the so-called "guidance change" amounted to a few hundred million in revenue, which mathematically is less than 1%. Okay, servers were a tad light, PCs were a tad strong... so what?

You're really telling me that finding out about quarter-to-quarter fluctuations in order timing makes a business fundamentally worth 5% less (or more) than it was five minutes ago?

There are five core aspects to the Intel thesis that investors need to understand.

  1. DCG growth is underpinned by strong secular trends.
  2. PCs are not yet dead.
  3. Intel's IDM structure not only provides it with a significant process lead, but also with a significantly better margin structure (since it captures both design and foundry margin).
  4. There is no way for Intel to "lose" in mobile. Either they "succeed" in ramping volume to a level where they break even, or they will "fail" and be forced to end their mobile efforts and/or transition to a foundry model. Either way, the net result is that within a couple years, they will no longer have a $2B drag on earnings - which is equivalent to $0.40 in EPS, or an incremental $5 in share price at a 12.5x EPS. This does not even include the possibility of making actual PROFIT from mobile, whether via internal designs or foundry. (Consider that without mobile investments, Intel would have earned roughly $2.30 per share this year, good for a $30 PPS at a 13 P/E. Actual profits from mobile would push the fair value into the mid-$30s.)
  5. Intel has no credible competitors in its traditional markets (aka, DCG/PCCG) that has demonstrated the ability to significantly threaten profits or revenues in the next few years.

If you understand this, then you can simply ignore the noise and focus on the long-term story.

I'm not suggesting that you shouldn't trade around positions based on market movements - doing so can certainly be profitable. That being said, your decisions should always be based on your own analysis and the risk/reward of a position given its current price, intrinsic value, upside, downside, your investment goals and objectives, etc.

When investors lose their conviction because of a little volatility - or normal fluctuations in the course of doing business - it usually means they'll lose money. And while the stock market is certainly not a zero-sum game, that means that somebody else can make even more money than they would have otherwise.

Be that somebody else.

Disclaimer: This is solely my opinion, not an investment recommendation or solicitation, and may not represent the views of my employer(s), associates, or other related parties. No guarantees made to accuracy or completeness. I am long the companies mentioned in the disclosure and may change my position at any time without notification. Please see the full disclaimer in my profile, and do your own due diligence before making any investment.

Disclosure: I am long INTC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.