ARM's David Vs. Intel's Goliath: Outcome Uncertain?

Includes: ARMH, INTC
by: Robert Goodwin

Note: The following article started as a comment to another article on the same companies.

In the early 1990s I read an article in a UK publication called Electronics Weekly focusing on a tiny company that was designing CPUs that would consume minimal amounts of power with a view to using them in handheld devices. The only way to invest in this private company was via failed PC company Acorn, which owned 25% of it. I invested £500 (all I had spare at the time) but missed the bottom of 5 cents per share. I bought at 8 cents per share.

Years later Advanced Risc Machines/ARM (NASDAQ:ARMH) was floated in London and the Acorn shareholders received equivalent numbers of ARM shares. The multiple gain was staggering. The best I have ever experienced. I sold out over various tax years at excellent multiples and was delighted to have landed on a multi-bagger.

After the dot-com fiasco (yes, most of us lost money then) I continued to follow ARM and their increasing penetration of the phone market. Interest picked up once again when they launched the "Big/Little" architecture, and I reinvested. This is the light bulb of computing. Imagine a company that gets a small contribution for every light bulb sold - that is ARM's model and vision. Except that in this case the light bulb is replaced by the ARM CPU in intelligent appliances/devices of all kinds. This is the main game - the "internet of things," and Intel (NASDAQ:INTC) has just today announced it is going to adopt this idea. That says it all!

Intel is today where IBM once was in the computer market, in a position of financial dominance. IBM once dominated the computer industry so much so that the rest of the industry was called the "BUNCH." IBM also created and once owned a large slice of Intel but was a forced seller of it in the late 1980's.

Once a corporation is in the top position, the only way is down. All dominant companies and countries for that matter eventually sow the seeds of their own downfall. It has happened throughout history, and every dominant company becomes undone by some tragic mistake on the strategic flight path. All CEOs know this and fret about it but are blind to their own errors until it is too late. For example, Apple is dominant right now. Just one bad product and they are - well, not toast, but a lesser company.

Back to Intel and ARM. After 20 years of total focus on chips with minimal power consumption and having been accepted by more than 95% of the mobile phone market, ARM is now threatening Intel in some of its home markets, and Intel is reacting. Well what did you expect? No dominant company defending a former monopoly position just lies down and dies.

The problem is that ARM is a truly indirect threat, but potentially life threatening for Intel nonetheless. The only short term way that Intel can respond is by buying business. It got wealthy and complacent on fat CPU margins and assumed that the monopoly position they enjoyed would be permanent. It has not been in the game of building a business based on a few cents (or fractions even) contribution per chip sold and is just not set up for that model. ARM created that model, and the small and intermediate chip manufacturers benefit from it - and they like the ARM designs, as demonstrated by the number of licensees for the ARM architecture.

So it is Intel versus the rest of the industry and the rest are happy to pay for a relatively inexpensive but successful sword with which to gain some worthwhile share of a growing market. Somewhat late, Intel is trying to respond and has thrown and will continue to throw some marketing bones to a few dogs, to encourage adoption of their very late-to-market mobile designs, hiding the loss it must currently make with every throw. However, this buys a little time and must be helping debug the first steps to life with very low margins (for Intel) in new markets.

The profits accumulated in the Intel coffers may help them out of this laggard situation by heavy duty spend on technology to regain, albeit temporarily, a lead over the rest of the industry i.e. 22nm, 14nm (and even rumoring 8nm) separation technologies, brought to market faster than Moore's law usually dictates. This is a massive throw of the dice and is equivalent to betting the farm on the success of that heavyweight technology spend. Remember that sometimes the pioneer ends up with an arrow in his back rather than gaining from his venture.

We are nearing the end of Moore's Law and each step of the way is getting much more expensive and more risky. As explained by Bill Maurer the wealth in the Intel coffers is also going down as (Q3) revenue drops and threatens to continue to do so. For the sake of Intel, let us hope that there are no hidden traps near the end of the investment line or it could be a very expensive discovery.

Hey, it could work. Money may be able to buy back the lost decade of the mobile market momentum for Intel, but can it live with the changed position with its key customer, Microsoft (NASDAQ:MSFT), and the inevitable lower margin business models, or will it be forced to retreat to the high end of the market like a Rolls Royce or Ferrari to keep the bottom line positive? Will it merely turn out to be a spoiler to hold ARM at bay for a while? Does Intel expect the rest of the industry to do nothing in response?

Technological advantage is increasingly short term in nature, and it can pay to be second when the risks have all been found by someone else. I offer no predictions, but would say that in spite of the humongous gamble by Intel, history still favors the chances of David's ARM against the Goliath body of Intel.

Disclosure: I am long ARMH. 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.