- Intel has been desperate for growth, while the PC market grapples with secular decline.
- Intel bulls have highlighted Chromebooks as a source of future growth.
- Ironically, Chromebook sales may ultimately erode profit margins at Intel.
For several years running, Intel (NASDAQ:INTC) has been desperately mining the tech space for growth, at a time when the PC market has degenerated amid secular decline. An April 9, 2014 report out of research firm Gartner estimated that global PC shipments deteriorated by 1.7% through the first calendar quarter of 2014. Last quarter, Gartner actually claimed that the end of Microsoft (NASDAQ:MSFT) Windows XP support "eased the severity of the [PC] decline," when compared against the prior two years. The immediate weakness in the PC market may also be an indictment against the very same Windows 8 and 8.1 platforms that Mark Hachman and PC World thoroughly ripped as "fail plus fail equals more fail."
Enter Google Chromebooks. Misguided Intel bulls may praise the Chromebook movement as the chipmaker's silver bullet solution to finally tap into a growing market, while also getting out from beneath the looming specter that is Microsoft. In reality, however, the Intel Chromebook is an admission of defeat. Intel may play up its supporting role within this particular niche, in order to redirect attention from the fact that the company has been thoroughly shut out of the mobile market. At worst, Intel will simply cannibalize sales of its more powerful and expensive chips, if the Chromebook gimmick were to actually take off.
Intel Was Built for Power
Intel may be best defined as a vertically integrated operation that designs and manufactures its own chips. Over the years, Intel has emerged as the go-to name to power high-end servers and computers. For now, the Intel Core i7 is hailed as the gold standard in computing firepower. Fourth generation Intel Core i7 chips drive premium MacBook Pro laptops and Surface Pro 3 tablets that sell for between $1,549.00 and $2,599.00. By itself, one Intel Core i7 Extreme Edition chip retails for $1,200.00. For the sake of comparison, lighter weight Intel Celeron chips generate between $40 and $50 in revenue per unit sold. Intel Celeron and Core i3 chips will emerge as the primary engines driving $250.00 Chromebooks. To state the obvious, Intel bottom-line results benefit most from serving a geek culture that demands raw processing power.
Be advised that Intel fiscal years generally coincide with calendar time. Prior to 2014, Intel divided its businesses according to PC Client, Data Center, Software and Services, and Other Intel Architecture classifications. Data Center, of course, largely referenced server business, while Other Intel Architecture was established as an umbrella grouping above systems, phone, tablet, and notebook chip sales. Taken together, the PC Client (65% of revenue) and Data Center (20% of revenue) operating segments have averaged roughly 85% of Intel total net sales over the past three years. Last year, Intel closed out its 2013 books having tallied $52.7 billion in revenue. Of this amount, PC Client, Data Center, and Other Intel Architecture generated a respective $33.0 billion, $11.2 billion, and $4.1 billion in 2013 revenue. Other Intel Architecture did rack up $2.4 billion in operating losses through this same time frame.
As of March 29, 2014, Intel introduced new operating segments, which effectively broke down the former Other Intel Architecture group into distinct units. The new units included Internet of Things and Mobile and Communications. Systems sales fell into Internet of Things, while Netbook chip sales transitioned into the ubiquitous "All Other" category. The new classifications further confirmed the near-term collapse of Intel's mobile business. For Q1 2014, Intel Mobile and Communications racked up $929 million in losses, after quarterly revenue fell from $404 million to $156 million, on a year-over-year basis. A lumbering Intel cannot compete against the nimble ARM Holdings (NASDAQ:ARMH), Qualcomm (NASDAQ:QCOM), and even Apple (NASDAQ:AAPL), in the mobile space, where battery preservation and cooler temperatures prevail.
The Chromebook Sleight of Hand
Intel's new 2014 operating segments have also exposed the insignificance, if not total albatross, of netbook chip sales at the semiconductor company. Interestingly, Intel has also included notebook and "2-in-1" device chip sales within its PC Client Group. Intel may define the Surface machine as a "2-in-1" device that bridges the technical gaps between tablet and laptop computers. The Netbook Group, again, has been folded beneath the "All Other" operating segment. Last quarter, Intel All Other racked up $796 million in operating losses upon a mere $545 million in segment revenue. The netbook has been all but irrelevant.
In 2008, Michael Horowitz and CNET defined the netbook as "small, cheap, under-powered, and running either an old or unfamiliar operating system." According to Horowitz, netbook computers also retail for less than $500.00. In recent years, Horowitz's netbook definition may have expanded to include Google Chromebooks, which often price out for roughly $250.00. The Chromebook has emerged as another gateway into cloud computing, where users share virtual servers for file storage and retrieval. Be advised that Chromebook owners are required to complete Google Accounts registrations before making full use of these computers. The Chromebook has emerged as the latest wing of the "don't be evil" strategy to give away product, in order to drive traffic towards higher margin Search and online advertising.
On May 6, 2014, Intel hosted an event in San Francisco to showcase the "most powerful OEM Chromebooks on the market." Intel took the time to announce itself as the leading microprocessor for the next wave of Chromebook computers. According to the Intel, twenty new Chromebook models will hit shelves by the end of 2014. Intel Bay Trail-M system-on-chip (SoC) technologies will power Acer, Lenovo, Toshiba, and ASUS Chromebooks. From there, fourth generation Intel Core i3 chips will ultimately support the 64-bit Chrome OS installed within Hewlett Packard (NYSE:HPQ) and Dell machines. In effect, Intel will be upgrading Chromebooks with "2-in-1" and entry-level laptop capabilities.
A weak Chromebook reception would fail to shore up the secular decline in the PC market, at the same time that Intel's mobile presence has collapsed. Ironically, again, the expansion of the Chromebook movement may cannibalize Intel's higher margin personal computer businesses. Going forward, shareholder wealth will be destroyed in this Catch-22 situation.
The Bottom Line
The stock market, of course, is a pricing mechanism that discounts future growth, rather than rewarding the literal snapshot of current business conditions. As such, Intel shares will likely track S&P 500 Index performance, as the company returns larger portions of capital back to shareholders through buybacks and dividends. For several years running, Intel executives have repeated the mantra of "single-digit" annual revenue growth projections. Logically, these projections telegraph ongoing earnings weakness, because Intel has stubbornly committed to aggressive capital spending programs.
In recent times, Intel has even fallen short of its own calls for "single-digit" revenue growth. Intel annual revenue actually declined, from $54.0 billion to $52.7 billion between 2011 and 2013. Between this time frame, Intel also upped the ante in research and development spending, from $8.4 billion to $10.6 billion. Last year, Intel directed a staggering 20.1% of revenue towards R&D. Last quarter, Intel posted $1.9 billion in net income, which was slightly off the $2.0 billion in Q1 2013 earnings.
Going forward, twenty new Chromebooks hitting the shelves will do nothing to reverse deteriorating profitability at Intel. Prospective investors should reject proposals to buy into Intel shares. Ironically, Intel stock market performance has fallen victim to Moore's Law. Again, for Intel, Chromebooks are merely a smoke and mirrors gimmick. Intel largely miscalculated the inevitable transition away from the personal computer and towards mobile computing.