How AMD And Others Are Weakening Intel's Hold On X86

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About: Intel Corporation (INTC), Includes: AMD
by: MarketGyrations
Summary

For quite some time, Intel’s data-centric business used to outperform its PC-centric counterpart by growing much faster.

Intel’s earnings release in Q1 reveals that the data-centric business was a weakness instead of the strength that it has been in the past.

Intel’s cites China as part of the reason for this change and certain developments in China could ensure that more weakness is in store for Intel.

If more weakness is to be expected in future earnings releases, then the stock is unlikely to do well as long as these issues have not been addressed.

Intel (INTC) recently released Q1 2019 earnings and the results were fairly disappointing. While revenue was flat YoY at roughly $16.06B, operating income declined from $4.47B to $4.17B and earnings per share fell from $0.93 to $0.87. The table below lists some of the relevant results for Q1 and compares them to a year ago.

Q1 2018

Q1 2019

YoY change

Net revenue

$16066M

$16061M

0%

Gross margin

$9731M

$9089M

-4%

Gross margin %

60.6%

56.6%

-4%

Operating income

$4470M

$4174M

-7%

Net income

$4454M

$3974M

-11%

EPS - basic

$0.95

$0.88

-7%

EPS - diluted

$0.93

$.087

-6%

Source: Intel

If we break down revenue and look at individual segments, we can see that the Client Computing Group ("CCG"), which falls under PC-centric business, grew by 4%. On the other hand, the Data Center Group ("DCG"), which falls under data-centric business, negated this growth by falling 6%. Overall, PC-centric revenue grew by 4%, but data-centric revenue declined by 5%.

Segment

Q1 2018

Q1 2019

YoY change

CCG

$8220M

$8586M

+4%

DCG

$5234M

$4902M

-6%

IOTG

$840M

$910M

+8%

Mobileye

$151M

$209M

+38%

NSG

$1040M

$915M

-12%

PSG

$498M

$486M

-2%

Other

$83M

$53M

Total

$16066M

$16061M

The PC-centric outperformance relative to the data-centric business in the most recent quarter is noteworthy. It's a reversal of what we have observed in the past from Intel where the data-centric business used to outperform its PC-centric counterpart. The table below shows how the data-centric business increased by $10B in the previous years, more than double the amount for the PC-centric business.

PC-centric

Data-centric

Total revenue

Operating income

2015

$32.2B

$23.1B

$55.4B

$14.0B

2016

$32.9B

$26.5B

$59.4B

$13.1B

2017

$34.0B

$28.8B

$62.8B

$18.1B

2018

$37.0B

$33.8B

$70.8B

$23.3B

Obviously, the data-centric business has done well until quite recently and one might wonder what the reason is for the drastic change in fortunes. Intel itself took note of the weakness in the Data Center Group by stating:

"DCG experienced challenges as cloud customers absorb capacity purchased in 2018, inventory consumption in enterprise and government and communication service providers market segments led to a deceleration in spending, and China demand weakened."

Intel cites a number of factors as to why the Data Center Group performed poorly, including weak demand from China. The earnings results from Intel were followed up at the most recent Investor Meeting with the company forecasting that growth in both revenue and earnings per share will be in the single digit percentage range for the next three years.

Naturally, the market did not react well to the latest updates from Intel. But even with all the bad news from Intel already present, there is reason to think that more weakness is in store for Intel and the China market could be big factor why. In fact, it's almost certain that the weakness that Intel has experienced in China will not be something temporary, but only the start of something long term.

Intel chart

Is Chinese demand weak due to China switching away from Intel to alternative suppliers?

For quite some time, Intel could rely on the fact that it faced no serious competition. Many of its competitors that offered alternative solutions have over the years decided to call it quits in the market for high-performance CPUs. At one point, the only real competitor left was Advanced Micro Devices (AMD). However, AMD's processors at that time were no match in terms of performance.

That changed with AMD's introduction of its latest processors based on the Zen microarchitecture. Unlike its previous products, AMD's current incarnation of CPUs are much more competitive in terms of performance compared to those from Intel. But that's not all AMD did. In China, AMD went even further by challenging one of Intel's core strengths that are at the root of the company's dominance in CPUs, the x86 instruction set architecture or ISA.

Why the x86 ISA is crucial to Intel

Software is written for a specific hardware or computer model, the instruction set architecture. One of Intel's core advantages is that a lot of software out there is x86 code, where x86 is the ISA that Intel introduced in the late seventies. x86 is dominant in specific areas such as workstation and personal computing, although it's almost non-existent in other areas.

It's possible to run x86 software on a non-x86 processor through a number of techniques such as emulation and virtualization, but there is significant overhead associated with this route. It will slow down performance, which is generally not something you want from what is supposed to be a high-performance CPU. To run code as fast as possible, you want to run the code on a machine with native support. That means you need a machine equipped with a processor that is x86 compatible.

The problem here is that not every company is legally allowed to make their own x86 cpu. Intel of course has the right to make x86 processors for customers who need them, often because so much of their legacy code is written for x86. If companies want to use processors using a different ISA and don't want any additional overhead, then they will need to rewrite and port their software code to maintain compatibility.

This is difficult to do due to the time and expense required to accomplish such a feat. In practice, most companies would rather stick with a vendor who can supply them with x86 processors. What this means in a nutshell is that Intel is guaranteed to have a captive market for their processors. Demand for x86 processors is out there and Intel can fill that need.

Alternatives seeking to supplant Intel as a supplier of x86 processors in China

However, Intel is not the only supplier of x86 processors. AMD is able to compete with Intel in the market for x86 processors due to the former also holding a license for x86. The x86-64 extension of the x86 ISA was actually created by AMD and later adopter by Intel, the first time that Intel did not originate an update to x86.

For instance, Intel has its Xeon server processors for data-centric computing. But AMD has its own equivalent in the form of the Epyc processor, which is based on the Zen microarchitecture and targets the same markets that Xeon does. Customers can pick between Xeon or Epyc. But in China, there is another alternative to Intel that comes courtesy of AMD.

How AMD is gaining an advantage on Intel in China

A few years ago, AMD established a joint venture with several China entities called THATIC, with the latter in charge of producing and selling x86 processors using the license from the former. The first product from this joint venture was released in the second half of 2018 in the form of the Hygon Dhyana, which is a version of the Epyc processor tailored to the Chinese market.

In return, AMD received cash infusions at a time when the company really needed it. In addition, AMD will receive royalty payments from the joint venture. But the change in competitive landscape doesn't end here. On top of the moves made by AMD, Intel will also have to contend with even more competition in China in the form of VIA technologies.

VIA is back to competing against Intel

Besides AMD, a third company with a license to produce x86 processors is VIA Technologies. The name VIA may now be somewhat obscure to those who have not been around long enough, but the company has a long history that goes back decades when it comes to processors. But until recently, VIA had given up on competing with Intel in the market for high-performance x86 CPUs.

That is no longer the case with VIA establishing a joint venture with the Chinese government called Zhaoxin that is tasked with designing x86 processors. Zhaoxin processors are currently behind in terms of performance, but the goal in the next few years is to offer performance that can match the latest that Intel and AMD have to offer. The latest product announced in the second half of 2018 is the KX-6000, which Zhaoxin believes is equivalent to Intel's processors from 2016.

Why China may be inclined to side with AMD and VIA

The Chinese government is a partner in the joint ventures with AMD and VIA and it's therefore in its own financial interest to make sure that the products coming from these joint ventures do well in the Chinese market. On the other hand, it's of no concern to China whether or not Intel does well because it doesn't have a stake in the company as is the case with AMD and VIA.

China has expressed its desire to reduce its reliance on the U.S. as a supplier of technology that it deems crucial. Sticking with Intel runs counter to this belief. The recent escalation in the trade war between the U.S. and China will only give more impetus to the shift in China towards alternatives to Intel.

In addition, both Zhaoxin and Hygon seem to include hardware support for Chinese cryptographic standards such as SM3/SM4. Prior to this, China had to make do with products that only offered support for hash functions and block ciphers such as SHA and Rijndael/AES that are non-Chinese in origin. This is an important distinction and something that is very likely to be taken into account when the next purchasing decisions are made by China-based entities.

The long-term consequences for Intel

The x86 ISA has been key to the rise of Intel in the past decades and arguably the biggest reason why Intel is the company that it is today. The market for x86 processors is one where the odds are essentially stacked in favor of Intel. It's off limits to all but a few companies and, out of those, Intel has the size and scale advantage that the others cannot match on their own.

However, by partnering with China, AMD and VIA can negate the advantage that Intel has in resources to a certain degree. It's safe to assume that the only reason why VIA decided to go back to competing against Intel is because of China. Without it, VIA would find it hard to justify pursuing the development of high-performance x86 CPUs.

Due to AMD and VIA, the net effect of all these new entrants in China is that there is much less need for customers to stick with Intel now that there are more options available. Intel's Q1 earnings are a reflection of this. The big performance gap of a few years ago that Intel could count on has also shrunk. Intel could even fall behind when AMD releases its Zen2 microarchitecture as a previous article goes into detail here.

More processor choices at lower prices that offer competitive, if not superior, performance means stiffer competition and that tends to hit sales. In the past, Intel could always count on having a stranglehold on the x86 market to ride through a rough patch. But this hold is not as firm as it used to be. With China on their side, AMD and VIA have access to deep pockets that could allow them to do things that previously would not be possible.

Bottom line, Intel specifically cited weakness in China in its Q1 2019 earnings. With all the developments going on in China, it's almost certain that this will not be a one-time thing, but something that will be heard more from in future earnings releases. The trend in China is clear and it's not in favor of Intel.

Source: Wikimedia Commons

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.