Intel And The Known Unknowns

Apr.17.14 | About: Intel Corporation (INTC)

Summary

Intel has an increasingly complex environment with which it has to operate and succeed.

Mobile PC Processor ASP decline is concerning.

Bay Trail Processor shows mobile PCs and tablets share common underpinnings.

What will Intel financial model look like after 14nm mobile transition?

Intel's (NASDAQ:INTC) Q1 2014 earnings report Tuesday confirmed for some that the company is stabilizing its PC business as it embarks on an all out assault on mobile that reaches a presumably profitable conversion at 14nm. However, the complexities facing the company have never been greater as the mobile market continues to expand and remains outside its control. Therefore Intel has to over invest in R&D for the creation of a multitude of products in order to prepare for every possible contingency that can lead to market share gains although this is less than efficient. In this way they are actually communicating to the world that they see many known unknowns.

Within Intel's current, highly-profitable business there is one large unknown which they know and are managing very closely. This has to do with the decline in processor ASPs serving the PC market. It is disturbing to see an 8% ASP decline year over year in mobiles. On the call they attribute it to the larger uptake for the 22nm Bay Trail SOC processor. For my money, Bay Trail is a fine part and meets the needs of most users but it undermines the rich ASPs that come with the i5 and i7 processors. I predict the slide will continue, however no one knows by how much.

Intel had to move Bay Trail in for several reasons. Bay Trail on 22nm will be the link between mobile PCs and Tablets leveraging common hardware platforms using both Android and Windows. Intel's target to ship 40MU tablets this year is meaningless unless it is driven by their leading PC partners. Intel is now somewhat dependent on the success of Dell, HP (NYSE:HPQ) and Lenovo for their tablets to meet their 2014 goals. This is a turnaround from the 1990s and Intel Inside days when the company had the ability to drive a richer mix (i.e. higher ASPs) regardless of what OEMs wanted.

Bay Trail will be soon followed by a new line of processors that on average will shrink about 30% in die size. Intel spoke about this at the last analyst meeting and this is highly significant. To my knowledge they have never laid this type of strategy out so far in advance. It is an acknowledgement that the war with AMD (NASDAQ:AMD) is over and like the downsizing of the US military after the fall of the Berlin Wall, will lead to cut backs in capex while guaranteeing that they can meet 60%+ gross margins as ASPs fall.

The continued dramatic increases in R&D should be viewed as nothing else but a heavy push to be the only alternative supplier (next to Qualcomm) (NASDAQ:QCOM) to the mobile market in baseband and wireless solutions. However with a 14nm integrated solution not arriving until late 2015 or early 2016 one has to wonder if Intel will not make headway until 10nm. Thus we have another great known unknown. Will communications pay off after the huge investment? As a friend reminded me the other day, 3G chips today go for only $3-$4. Where will 4G LTE chips be in two years? Moore's Law can be cruel when you're on the backend of the market.

The final known unknown for Intel is their overall financial model in the years to come. Intel's rich margins is directly attributable to owning the high end of the server and PC markets. The top 20% drives gross margin dollars unlike the bottom 80%. In the mobile market, Apple (NASDAQ:AAPL) owns the top 20% of the market and will likely continue to do so because 64 bit mobile processors is now part of their overall product and branding strategy. Apple in fact can support a larger die and higher cost to stay in a leadership position if they want as it drives higher iPhone ASPs.

On the one hand Intel is planning to bring mobile chips to the front of the line, however on the other hand they are not expected to generate high ASPs and deliver margin dollars the way server or PC processors do. In the semiconductor industry and at Intel there is always a pecking order and the product that delivers the most money per wafer gets to the front of the line. As the next two years unfold it will be interesting to see how this plays out.

Disclosure: I am long AAPL, QQQ. 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.