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Some Thoughts On Intel's Spending

|Includes:ARMH, Intel Corporation (INTC)

(posted as a comment in response to Rolf Winkler's "Intel's Higher Spending May Not Compute," WSJ 01-18-13

Intel has always had a sizable contingent of detractors in the investment community. And with the dramatic changes underway in the consumer PC market, they are better positioned to gloat. That said, to judge from the commentary in the recent earnings call, management seems to have a clearer grasp of the issues involved than its skeptics. Capital investment next year will be essentially flat, once you back out the $2 billion being directed at building a 450 mm R&D facility that will be equipped and utilized years hence. Moreover, they must maintain their substantial competitive edge in process technology just to sustain the business model against the advance of the ARM-centric alternative ecosystem. The suggestion that they spend less would not only halt Moore's Law for an interval, it would expose them to significant market share loss. Finally, due to the laws of physics, if they sustain their lead as they progress down the roadmap, they will automatically overtake ARM's lead in power efficiency while maintaining their 18 to 24 month lead in manufacturing technology. So the suggestion that the company not invest seems unwise, to say the least.

One final comment: while many seem to see a market where the PC is dead and Tablets prevail, Intel is describing a market where a profusion of form factors will arise this year in the PC market, ranging from classic notebooks, through hybrids, convertibles and Windows 8 Pro Tablets and onto ARM-based Windows RT, Android and iPad Tablets. Clearly, Intel will need to supply what demand arises from this market in coming years. But based on how the market has developed in the iPad and Android segment alone, things will likely be very dynamic in the years ahead. Given where Apple's share price is these days, investors are clearly skeptical about their outcome as well

Additional Comments Posted in my Seeking Alpha Instablog:

The comments of Deutsche Bank Analyst Ross Seymore figure prominently in both the article of Winkler and the Q&A of the Intel Earnings Release conference call. In the latter, Ross noted that R&D and capital expense growth had exceeded revenue growth in recent quarters and that some investors were dubious about the likelihood of adequate returns. And in the former Ross noted that ROIC was likely to decline from a recent cyclical high of ~25%.

The trends Ross cites are an unavoidable reality at this juncture. Macroeconomic factors and strong tablet sales have reversed the growth of the PC industry just as major technology transitions loom that require significant investment. Yet technology advances in the semiconductor industry are defined by the Technology Roadmap that arises out of Moore's Law-the notion that the density of transistors on a silicon wafer can double nearly every 18 months. And due to its virtuous character, the cycle requires investment to sustain progress, whatever given industry trends obtain. Yes, invest we must, in good times or bad. The proceeds of this investment will only be harvested as the industry improves, over an as yet unknown interval of time.

It is indeed both a capital and technology intensive business. The transition to FinFET transistors, EUV and 450 nm wafers are surely drivers of higher R&D spending. And the transition from 32 nm and 28 nm to 22 nm and 14 nm process technology is surely driving capital spending higher. Higher spending is thus being driven by technological advancement and the need to migrate volume production to more advanced manufacturing nodes ahead of competing manufacturers.

And indeed, Intel marches on: management indicated that over half of volume production in the fourth quarter was at 22 nm and that "maintenance" capital spending was target at finishing up the 14 nm factories. The extent of Intel's technology lead is visible in the fact that TSMC spent much of 2012 ramping its 28 nm capacity to meet the volume needs of Qualcomm and other IDM working at the most advanced nodes (behind Intel). That said, TSMC, Samsung and handful of other manufacturers will maintain this lagging interval with their own capital and R&D spending, as they advance their own production down the roadmap as well.

Stocks: INTC, ARMH