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INTC: A Case For Strong Medium & Long Term Growth

|Includes: Intel Corporation (INTC), QCOM

In 2012 I bought into INTC for around 10% of my portfolio. The stock price has declined roughly 20% since I bought in, but I remain bullish about the medium term (2-3 year) and long term (4-5+ years) prospects for the company.

Since making my investment I've done a lot of reading and digging around, and here I'll try to summarize my reasons for why I think Intel can experience dramatic growth, and get into some of the details of what is generally a very interesting and evolving semiconductors and technology market. I admit I am a relatively inexperienced investor, so I welcome feedback and discussion. In this article I assume the reader has basic familiarity with Intel's role as a leading supplier of computer microprocessor technology.

Let's first discuss some market background. Intel is the leader of the semiconductor market by revenues (~ $50 b), with closest competitors being Flextronics ($30 b), Qualcomm ($19 b), and TSMC (~ $15 b). For the last 10 years, INTC experienced flat revenue growth during the financial crisis, but it had some good growth before it, and then also in FY10 and FY11, but then flat growth or mild decline in FY12 (Q4 data still to be released.) The stock price has declined in the last 6 months due to weak revenues in the PC market, with corresponding hits to companies like HP, Dell, and AAPL.

Aside from the behemoth companies like Intel, there are about 10-20 more semiconductors players that are also large companies with revenues in the multibillion dollar range. There are a lot of different focuses in the semiconductors market, from computer design, manufacturing, packaging, tool design, integrated electronics, and so on. Roughly speaking, the industry can be divided into two core segments, a lower tier segment (with companies like Flextronics, Texas Instruments, etc.) which typically works with specialized applications that have become commoditized or very application specific, and then a higher-tier segment (like Intel, Qualcomm, TSMC, etc.) which services the individual (PC) and large-scale (server/HPC) general computing market.

The players in the high-tier market segment are as much technology houses (similar to Google, Facebook, etc.) as they are commodity suppliers. Intel plays a very interesting role in the high-tier segment, because it both designs and manufacturers its goods in house. This means it competes especially broadly across the sector, with the largest specialized foundries (e.g. TSMC, Global Foundries) but also with the largest specialized computer design houses (Qualcomm, ARM, and others).

What's more, the business realities for design and manufacturing are strikingly different. This is a good point to bring up ARM, a much talked about competitor to INTC, which has grown to become the primary smartphone microprocessor designer, with major (hundreds of percentage points) growth in the last 5 years. ARM's revenue is paltry compared to Intel, at roughly $0.5 b, but it trades at a much higher P/E. The reasons why ARM is valued so differently from Intel are partly due to short term explosive growth in the mobile market, which has driven major growth in ARM, but also partly due to differences in the business structure of ARM.

Due to these massive differences in business structure, in my opinion, ARM and Intel shouldn't really be compared and much of the talk about such comparisons is misguided. Because Intel is as an integrated device manufacturer, it has to be compared to an entire ecosystem which includes ARM, Qualcomm, TSMC, Global Foundries, and many others. Then again, there are also some companies like ASML which provide important tools for both Intel and TSMC, so the division of the ecosystem into Intel & non-Intel isn't completely accurate.

So, roughly speaking, the Intel ecosystem has suffered recently (-19.8% 5 yr) and non-Intel has done great. We've already mentioned the reasons for the latter, namely, the explosive growth of the mobile device market. This has led to dramatic growth in ARMH (434% 5 yr), QCOMM (75.2% 5 yr), TSM (80% 5 yr), and many others, including many players in the OEM computer supplier market like AAPL (158% 5 yr). Those percentages include the drop due to the financial crisis, so those are spectacular numbers for the non-Intel ecosystem and its business partners. The reason why Intel hasn't done as well in this same period is because of weakness in the PC market, but growth in the server and HPC market has been strong. This isn't a case of Intel versus non-Intel; it's a case of non-Intel versus a ripe and untapped market. In other words, Intel and non-Intel (up to the present) haven't been competing, and furthermore, they've now reached a certain degree of monopolization of their respective segments (i.e., PC/server/HPC vs. mobile).

Alright then. So far, everything I've said has dealt with the market and industry background concerning Intel and its current valuation. Now I'll get into some of my opinions and predictions for the future, which are obviously speculative but hopefully well reasoned and justified.

I'll come right out and say it -- I think Intel could witness dramatic growth in the medium (2-3 year) and long term (4-5 year+), potentially even rivaling its growth in the nineties, when the stock and the industry in general made millionaires and billionaires out of many. During the last 10 years, Intel has transitioned this wealth into a leading (if not the leading) resource base in high-tier semiconductor capital and intellectual expertise, both of which are highly nontrivial assets to manage and develop. This resource development was so vast that just to stabilize and integrate it has been a major achievement, but this has received little recognition in a competitive marketplace.

The market has a short memory, but long term employees like current CEO Paul Otellini witnessed ~60,000% stock price growth during their tenure in the nineties. This provides part of the explanation for the reputation of Intel's corporate culture as bullish, even arrogant at times, despite the fact that the price has remained flat over the last ten years. Still, dividend growth has been strong and steady, and revenues have not been uncompetitive by any means, so long term INTC bulls might feel like there aren't even any weaknesses to explain.

In my view, the growth in the non-Intel ecosystem ironically is going to be a major driver for Intel's medium and long term growth. The case for this is obvious by now, having understood the background; the development of the mobile market has opened up a huge new demand for potential Intel technology entrance. The only reason why they haven't been able to enter the market so far is because a lack of mobile wireless technology and licensing. That's not because of any fault or oversight on Intel's part, although to be fair, Intel could possibly be criticized for not reading the market trends and acting more quickly and innovatively. But these were historically largely independent businesses, with PC's coming into play way before cell phones, with little reason for these technologies to overlap, and with substantial barriers to entry that take time to overcome.

This obstacle is set to be defeated in 2014, with Intel widely understood to be releasing fully competitive (both processor and wireless 4G/LTE technologies competitive with the best solutions from ARM, QCOM, etc.) mobile products at that point. Their processors have already been shown to be competitive, as of FY12 with the Medfield platform. Even earlier than 2012, Intel has repeatedly showed it could beat the other foundries in terms of yield, efficiency, and margin. In 2014, it will show that it can beat Qualcomm, the next biggest specialist competitor in advanced integrated circuit design -- this time, radio technology. It will be a huge year for Intel.

From a short term investor's standpoint, one has to be frustrated that Intel is taking so long to get to this point. How come it's been 5 years since the iPhone and Intel still hasn't come close to being inside of it? But from the engineering and business standpoint, I think one has to reemphasize that Intel is taking on a whole other ecosystem, and the transition can't be expected instantaneously. Most of all, I think what this shows is that Intel management is focused on long term (i.e., decade scale) massive growth, and to them, managing/growing their existing business was just as much of a priority as being patient with their technology development team. For example, Intel could very well have contracted with Qualcomm (or someone else) much earlier to produce fully competitive smartphone solutions, at the cost to their margins and eventual leverage in the market. Rather than doing this, the management explicitly chose to develop its own technology in house. This was a direct tradeoff of short/medium term growth for long term growth. It was also a calculated gamble that the long term growth potential would exceed the short/medium term potential. Was it a bit of hubris on Intel's part to think that it could afford the time to develop its own technology, without getting locked out of the market, or worse? I don't really think so, but it might be a fair point to make.

So, although the PC market has been flat or weak for FY12, once 2014 rolls around, because of Intel's new solutions (PC in a smartphone type technology) the PC and mobile markets will effectively be collapsed into one. Then, it's not a question of if Intel will acquire a slice of that formerly non-Intel pie, it's merely a question of how much. And given Intel's massive stature and capabilities, and the extreme barriers of entrance to other competitors, I believe the answer to that question is a lot. And one more thing -- when the PC and mobile markets are viewed together, and Intel starts growing massive revenues through it, I think one might find that the PC market at large may have never slowed at all.

The other driver for massive medium and long term growth will be HPC and server computing technology. Here, market growth is driven by (a.) ever increasing demand for computing power, coupled with (b.) outstanding engineering work that has given exponentially better performance over time -- the famous Moore's law growth. Intel, once officered by Moore himself, is by far the established leader in pushing Moore's law outward, and it has said that this can go on for at least another (roughly) ten years. It is actively advancing and leading this field with spectacular new technologies like Intel's Xeon Phi. Intel's stock price hasn't been driven by this technology in recent times, because it was formerly only one part of a very diversified product base, dominated by consumer PC sales. This is of course in contrast to competitors like IBM. But, to summarize, in the medium and long term, there are no signs that market demand (reason a.) will abate, and Intel has said that its engineers (reason b.) can push out comparable returns for at least the next ten years.

So, in conclusion, I think I've made a strong case here for why Intel can experience massive growth in the next 3-5 years. I expect performance over the next year to follow one of three scenarios. In one scenario, the case presented here will be increasingly acknowledged, especially as 2014 approaches, and the company will start pushing up strong gains in 2013. Increased PC growth (including in different form factors like tablets) and/or server/HPC growth will contribute to this scenario. In another scenario, Intel will remain neutral or weak over 2013, taking 1-2 years (especially until 2014) until producing fully competitive solutions across the board, at which point strong revenue and stock price growth will kick in.

In a third scenario, by far the least likely in my mind, flat growth or decline will continue into 2014 and 2015 -- my predictions will fail in the medium term. This could occur due to technology setbacks (extremely unlikely, since Intel is extraordinarily roadmap oriented) or by greater erosion in the PC market. It can't occur due to being outcompeted by Qualcomm (for example), since right now, Intel doesn't even compete with them, and Intel's presence in its key segments (PC/server/HPC) is extremely well fortified for now. Erosion in the PC market is I think widely misunderstood -- as I said, the mobile market will soon become just another facet of the PC market. Anyways, even if the traditional PC market is saturated, it shouldn't shrink, and soon enough, the server/HPC segments will reach the revenues to provide growth for the entire company.

Lastly, since we are talking advanced technology development, there's always the chance in the next 3-5 years that some revolutionary computing technology will emerge and displace someone like Intel. This should be taken as an advisory, something to keep an eye out for, potentially working in favor for Intel or against it.

Thanks for reading!

Disclosure: I am long INTC.