Shares of Intel Corporation (NASDAQ:INTC) have rebounded off of their 2013 weakness on a stronger push into mobile and a slower decline of PCs, but many investors still believe the company is too big to re-position itself away from fading legacy products. While cash flow and earnings power should limit downside, real growth could be coming from the company's aggressive investment program in start-up tech firms.
Leader in microprocessors and something more
Intel is the largest semiconductor company in the world and controls nearly 80% of the microprocessor market. The $141 billion company is more than twice the size of its nearest competitor Texas Instruments (NYSE:TXN) and many times larger than most peers in the space. Its dominance in the market is maintained by a huge budget for research and development, with more than $10.7 billion in capital expenditures last year alone.
The company's budget for R&D has enabled it to keep a two-year lead on peers in terms of technology. This lead means Intel can develop faster and more efficient chips at a lower cost than competitors. The company has offered new chip manufacturing leaps every two years with new chip architecture in the staggered years, keeping its cycle of innovative offerings fairly continuous.
The story for Intel over the last several years has been the decline in PC usage, especially on the enterprise side. While the segment will probably see further declines, there is reason to believe that declining PC usage could slow, and some sub-segments could actually grow. Intel recently announced a multi-phase agreement with Xi3 Corporation to develop, manufacture and sell next-generation micro-mini PCs. The micro-mini PC is a new segment of the market that offers the performance of larger systems with the modularity of ultra-small form factor computers.
Despite its reputation as a legacy tech giant dying from the shift to mobile devices, Intel invests aggressively in next generation technology and stands to benefit from its funding in start-ups. Beyond its nearly $11 billion in R&D expenditures, Intel spent more than $16.6 billion last year in acquisitions and investments. The company disclosed a $740 million stake in Cloudera Inc. earlier this year, bringing its ownership to 18% in the Hadoop-based data company. Intel is betting heavily on data service and preceded the Cloudera funding with an investment in MongoDB Inc. with EMC Corporation (EMC) in October of last year. These early-stage funding ventures are part of Intel's strategy to fuel innovative technology and get its foot in the door for a possible acquisition down the road.
Rock-solid balance sheet with cash to invest
Intel has a rock-solid balance sheet, given years of strong cash flow in a maturing PC space. Just cash alone of $10 billion nearly covers the company's long-term debt of $13 billion. Debt makes up just 18% of its capital structure, and the company is able to issue ten-year bonds for less than a percent over U.S. treasuries.
The company could finance growth or shareholder return with more debt, but the problem is a scarcity of growth opportunities. Sales declined by 1.2% last year and are down for two consecutive years. Over the last ten years, sales have only increased by 4.4% on an annualized basis. This is where the company's aggressive investments in start-ups comes to focus. Besides the potential for a payoff on the investment, funding in these companies brings the possibility for accretive acquisitions or partnerships in the future.
Despite weakness in sales, Intel is a cash machine with cash flow from operations increasing by more than 10% last year to $20.8 billion. Free cash flow of more than $10 billion is more than enough to increase the dividend and share repurchase programs. Intel has increased its dividend for 10 consecutive years and was one of the first tech giants to pay a dividend 22 years ago. The current yield of 3.3% is on top of a strong share repurchase program that returned $2.44 billion to shareholders last year.
Valuation is a little stretched but room for upside
At $28.30 per share, the stock is trading for 15.1 times trailing earnings, just above the average of 14.1 times over the last five years. This is relatively cheap compared to many tech companies, but still well above the price-to-earnings of around 12 times where the shares traded for much of 2013. On a dividend growth rate between 8% and 10% over the next ten years and a cost of capital of 6.7%, the stock has a fair value of approximately $28.63 per share or about 1.2% above the current price.
The downside to the share price is relatively limited, a 13.5 times multiple on 2015 expected earnings of $2.00 per share would mean $27.00 per share. Even in this scenario, you would still collect the 3.3% dividend yield, which is well above other options in the market. Beyond the cash return and limited downside, I believe the real upside is in Intel's start-up investment program. A stabilization in the decline of PC sales could steady sales while ownership of a few next-generation tech firms could bring strong growth back to Intel.
Disclosure: I am long INTC, EMC. 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.