Intel's Weakness Likely To Extend Throughout Technology Reporting

by: Zvi Bar

On Thursday, January 17, Intel Corp. (NASDAQ:INTC), the world's largest semiconductor manufacturer, reported fourth-quarter 2012 profit that beat average Wall Street estimates and forecast reasonably healthy first-quarter sales expectations. Intel's Q4 net income was $2.5 billion, or 48 cents per share, beating average estimates by two to three cents. Nonetheless, this report will do little to allay market concerns regarding the footing of this technology sector behemoth.

A growing number of investors have become wary of Intel and other traditional personal-computer component makers. Smartphone and tablet sales continue to cannibalize desktop and laptop consumption, and Intel's Q4 revenue declined three percent to $13.5 billion.

While it is true that Intel missed out on much of the mobile device revolution that is largely powered Apple's (NASDAQ:AAPL) iOS and Google's (NASDAQ:GOOG) Android OS-based smartphones and tablets, the company aims to compete there. Intel has acknowledged weakness in many of its traditional markets, but anticipates market consumption of Intel powered ultrabooks will take market share in 2013.

In 2012, Intel bet that coming growth in touch-screen demand would soon run into the supply restrictions for touch screens. Smartphone and tablet growth is increasing demand for touch screens, and coming laptops, ultrabooks, netbooks, desktops and other products will also include touch screens. To prepare for a coming touch-screen bottleneck, Intel contracted with multiple touch-screen makers, including Cando, HannsTouch, TPK and Wintek, in order to secure supplies. This move is not only for the benefit of Intel, but also Intel's partners such as Microsoft (NASDAQ:MSFT) and large device manufacturers like Dell (DELL), Hewlett-Packard (NYSE:HPQ) and Lenovo, who will manufacture Intel-powered Windows 8 devices.

PC demand and shipments declined in 2012 and may decline this year too. Global tablet growth was a robust 72 percent in 2012, replacing the majority of retail personal computer purchasing in the developed world. Tablet growth will likely be strong in 2013 too, especially if tablet pricing continues to decline while functionality increases.

It has been difficult for traditional personal computer makers to compete against the new titans of technology. The traction iOS and Android immediately developed with consumers, suppliers and software developers left companies like Dell and Hewlett-Packard without competitive products. Apple and Samsung, the largest maker of Android-powered devices, together control a majority of the global smartphone and tablet markets. It is also likely that most consumers that purchased an Apple or Samsung mobile device did not consider a competing device by HPQ or DELL.

Most Android devices use processors that are based on technology from ARM Holdings (NASDAQ:ARMH), a British processor that competes with Intel, though some models do have Intel processors. Apple's mobile devices use ARM's technology. Intel chips will likely capture a growing portion of the mobile device processor market, but the transition should take several years, and coming advancements could complicate matters.

Another concern for Intel is that Apple may diversify chip usage within its Mac model. Apple has been using Intel chips in its Macs since 2005. Current versions of ARM chips are low-powered compared to the Intel chips that now reside in Mac models, but they have the potential to grow in power over time. In many ways, as the differences between mobile devices and personal computers approach one another, a single standard for both would appear inevitable.

ARM's low-powered chips generate considerably less heat than traditional computer processors. One advantage of sufficiently low-heat chips is that they will not necessitate a fan, while most traditional computer processors do. A cooling fan ads size, weight, and noise to a device, and uses electricity, causing a decrease in battery life.

While the highest-powered personal computers are still years away from a potential transition to lower-powered chips, Apple could conceivably offer a lower-powered model within the company's MacBook Air line. Apple's Air laptops are its lowest-power computers and are marketed to users who prefer portability and battery life, with the understanding that the models will have slower processors and less storage.

Now that a growing amount of computer processing is done in the cloud, there is less of a need for a user's terminal to be high powered. Many of Apple's current Mac computers, including its iMac and MacBook Pro models, are high-powered machines designed for users performing processor-heavy activities such as video editing. Nonetheless, most users do not end up doing very much video editing or computer programming, instead mostly using their computers for low-power functions like email and web browsing.

As a result, for many consumers, a MacBook Pro or iMac model is substantially overpowered for their needs and probable usage. Several Pro consumers would likely be better off choosing a lower-powered and lower-priced Air model. While many consumers delight in knowing their device is the most powerful available model, despite actual usage, others will always prefer a cheaper, lighter and lower-power device.

Meanwhile, Windows based devices are not yet popular among retail consumers. Few products are out, but many are expected in 2013. It is still too early to determine whether Windows 8 will be successful, but the outcome should be evident by the end of the year. Intel will need for the system to gain traction, and for its products to grab share of the devices running the alternative mobile device operating systems.

Manufacturing processors is expensive. It costs Intel billions to build a facility to manufacture a new chip. When demand exists, computer chips are produced and sold at high margins that quickly recoup those manufacturing costs. Unsuccessful processors quickly lose value and the model must be abandoned. Mobile device processors are cheaper than high-powered computer processors and are also generally lower margin products. This means that even if Intel is capable of taking market share among mobile device processors, it will likely be in a lower margin business.

Intel's miss does not bode well for the reports of Dell and Hewlett-Packard, both reporting in about one month. Microsoft reports on January 24, and its information should help confirm the effect's range throughout the personal computing industry and technology sector. Microsoft continues to evolve and diversify its revenue streams, but it still derives a substantial business through the Windows operating system and its dominance in the desktop and personal computing software.

Recent reduced demand appears was related to the large segment of consumers switching to Mac OS computers from Apple, but also due to some buyers waiting out the next version of the Windows OS and/or ultrabooks that do not contain traditional hard drives. Microsoft has largely relied on corporate demand for Windows-based PCs, as well as Office and server software. Microsoft's other businesses, including Xbox related sales will likely continue to grow in importance to the company as consumers continue to purchase the console, Kinect sensors and its online gaming services through Xbox Live. Microsoft is also likely nearing an update in its gaming hardware, and will continue its integration of Xbox Live services with its mobile platform, as well as competing mobile platforms, through the cloud.

If Microsoft's mobile devices do find a large market in the coming years, it will likely bode well for Intel, but it is entirely possible that Microsoft will also grow to become a significant competitor to hardware manufacturers like Dell and Hewlett-Packard. Unlike in past incarnations of Windows, Microsoft is producing its own models of hardware running its Windows 8 software.

Overlap is common within the computer technology industry. Within smartphones, the two competitors with the largest market share have substantial relationships. Samsung is not only one of Apple's most formidable competitors in the smartphone and tablet markets, but also one of Apple's primary hardware suppliers. This dual identity may actually make Apple anxious to eliminate its dependence upon Samsung as a processor manufacturer.

Intel's newer chips, such as its Clover Trail product, are low-heat and designed for touch-screens, but are somewhat late to the party. Their integration into Microsoft's Windows 8 products is the first real test for Intel in the mobile device market. While this could be a benefit to Intel if its processors again establish superiority over competitors, it is also entirely possible that Apple will begin to manufacture chips for itself.

Apple will report its quarter on January 23, or this coming Wednesday, and one day before Microsoft. Apple estimated that for its first fiscal quarter of 2013, or calendar Q4 of 2012, revenue would come in around $52 billion and diluted earnings would be about $11.75 per share, or roughly $11 billion. Average Wall Street estimates are significantly higher, anticipating about a five percent beat on revenue and about a ten percent beat on earnings.

Apple will most likely beat its own expectations, but Apple must also report numbers better than those anticipated by the market. If Apple does not beat these higher Wall Street expectations and Microsoft follows up with a miss, this information would spark a significant and broad downturn in the technology sector. A strong report by Apple followed by a weak report by Microsoft would also likely still result in weakness amongst computer makers, though to a less pronounced extent. Both companies continue to maintain substantial cash positions, last reporting holding about 20-25 percent of their present market valuation in cash.

Disclosure: I am long INTC. 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.

Additional disclosure: I own one share of INTC.