Intel (INTC) lowered its Q3 outlook today from $13.8B - $14.8B to $12.9B - $13.5B, a fairly significant miss. Further, gross margins are expected to come in at 62% plus or minus a percentage point, down from 63% plus or minus a "couple" of percentage points. Intel blamed this weaker-than-expected demand on a "challenging macroeconomic environment."
While the natural reaction to this revenue miss is to mash the "sell" button and join the masses chanting for Intel's head at the hands of the smartphone and tablet, it is imperative that the investor take a broader view of the semiconductor landscape to understand just what exactly is going on.
It Ain't Just Intel
A number of folks will likely assume that Intel's miss is due to the dominance of ARM Holdings' (ARMH) chips in the smartphone/tablet space eating into the sales of the PC. While this may or may not be true, the fact is that ARM CEO Warren East just two days ago warned of a slowdown in sales of mobile chips utilizing ARM's designs:
"Many of the chip companies are indicating that they are not expecting an uplift, and mathematically, that will hit us"
This implies a broader industry-wide weakness and not Intel-specific weakness. While unconfirmed, it will be imperative that investors now watch the ARM licensees such as Nvidia (NVDA), Texas Instruments (TXN), and Qualcomm (QCOM) very closely. If these companies beat or report in-line results, then this would give more credibility to the notion that Intel's sales are being eaten up by tablets. However, given Mr. East's comments, I'm still unconvinced, and the savvy investor should not so blindly follow the herd mentality.
Warning Was Expected And Probably Priced In
While I was not convinced that Intel would warn (or that even if it did, that it would matter), the street had obviously been expecting it. Several analysts, including Miller Tabak and Merrill Lynch, have recently issued notes cutting earnings estimates for the company. Further, the Dell (DELL) and HP (HPQ) reports further added fuel to the fire beforehand. I am therefore convinced that such a warning was broadly expected and priced in.
My suspicions here seem to be verified by the relatively small (~3%) haircut that Intel's stock took today.
It's Not All Terrible
While investors will likely focus on the negatives here, it is imperative that the long term investors keep in mind that the company is still fundamentally strong despite having to operate in an unfavorable macroeconomic climate.
Windows 8 Launch
While sales of consumer chips in the third quarter may have been weak, a good part of the weakness could be due to consumers delaying purchase of new PCs in anticipation of the Windows 8 launch. The launch is likely to delay customer purchases of current Windows 7 based notebooks/ultrabooks for a couple of reasons. First, consumers are likely to believe that waiting for the new Windows 8 based models will allow them to get a discount on current models. Second, those looking to spend more do not want to purchase something that will be obsolete within a matter of months.
Interestingly, Microsoft (MSFT) has partnered with OEMs to allow for users to upgrade to Windows 8 Pro for $15 with the purchase of a Windows 8 PC. It is unclear how much this offer will sway users holding off for the Windows 8 launch. As Apple (AAPL) has proven, people do not want complexity or hassle; it just needs to work right out of the box.
With the launch of Windows 8, a number of Windows 8/Windows RT tablets will be available. Intel will show up to this fight with its "Clover Trail" 32nm Atom lineup of chips. Sales of netbooks have been taking a huge hit these days especially as the two largest netbook vendors have reportedly halted any further plans to produce products in this form factor. While netbooks do not comprise a significant portion of Intel's revenue, any increase in sales here would be welcome to Intel's top and bottom lines.
A major risk here, though, is that with the concurrent release of Windows RT (Windows 8 on ARM), there will be much more competition in this space. Qualcomm's Snapdragon S4, Nvidia's Tegra 3, and Texas Instruments' OMAP 5 are formidable competitors to Intel's Atom. The advantage Intel holds is compatibility with existing Windows applications, so the battle will likely come down to price. If Windows RT tablets are significantly cheaper than the Atom-based Windows 8 tablets, then this could pose a significant problem for Intel's budget play. If prices are nearly identical, then I suspect users will opt for the more compatible x86 tablet.
Haswell: The High Performance Solution To A Low Power Problem
Intel's major focus over the years has been on bringing more power efficient solutions while improving performance and feature sets. Intel has been steadily improving its micro-architecture to gain roughly 10-15% performance per clock per generation beginning with the "Core 2 Duo" lineup. As performance has improved, Intel has also been lowering power consumption, dramatically raising performance per watt in its focus on laptops.
Further, the focus on performance per watt has translated nicely to the data-center, super-computers, and networking products, where power savings translate into significant total cost of ownership savings.
The next interesting development on the PC/datacenter side is the next generation micro-architecture codename "Haswell". While full details will be revealed about the micro-architecture at this week's IDF, Anandtech summarizes why Haswell is a "big deal" quite nicely,
"Internally Haswell is viewed as the solution to the ARM problem. Build a chip that can deliver extremely low idle power, to the point where you can't tell the difference between an ARM tablet running in standby and one with Haswell inside. At the same time, give it the performance we've come to expect from Intel."
To support this view, I present the following facts about Haswell:
- The low power "Ultrabook" targeted Haswell chip will have a 10W thermal design power, down from the equivalent Ivy Bridge part at 17W
- Haswell, being a "tock", will have numerous micro-architectural improvements to increase performance while at the same time achieving better thermal characteristics
- Haswell's integrated graphics should be a significant step up from its current offerings, which will allow fundamentally new capabilities, such as higher end gaming, to come to the "Ultrabook" without the need for discrete graphics chips from Nvidia or AMD (AMD)
In short, Intel is focusing on bringing higher performance and lower power consumption to its designs. Evolutionary, but absolutely critical for Intel to continue to give users a reason to upgrade their older machines.
Data Center Still Intact
A major bright spot in the earnings warning was that the demand in the data-center was still in-line with previous expectations. The data center is arguably Intel's most exciting market segment as it sports a projected 15% CAGR that appears to still be on track. As the mobile computing continues to grow, the high powered server backbone of the "cloud" will also need to expand accordingly to accommodate this growth.
The risk here is that due to Intel's 94.5% x86 server market share, the firm will need to simultaneously fend off any attacks from rival AMD looking to eat into that share. Further, there is a chance that the push from a number of ARM vendors including Applied Micro Circuits (AMCC), Nvidia, and others could lead to non-trivial competitive pressures in certain low-power segments of the server space. Intel has "Atom" chips designed for server use to address this threat, but it remains to be seen if Intel can provide a superior solution.
There's no two ways about it: Intel missed and missed badly. However, it is not far-fetched to believe that this is actually due to macro-economic weakness and not due to fundamental issues with the company.
At these levels, the company's shares are priced attractively for the long term investor. A 3.72% dividend yield coupled with a solid balance sheet and best-in-class products across a number of segments (data center, PC client, and an expanding presence in smartphones/tablets) should allow Intel to thrive in the long term. In the short term, however, the major risk is that Intel may provide weak Q4 guidance. This, coupled with the fact that the major indices are trading near multi-year highs, may mean more short term pain for Intel shareholders.
In the long term? If Intel can maintain its technological leads in its core businesses and branch successfully out into the smartphone/tablet spaces, it should be just fine. Further, Intel's valuation is already at rock bottom compared to peers, trading at just 10.25x past earnings against a median semiconductor P/E of about 15, making it an attractive value play.