For years, “Intel inside” was a brilliant branding success for Intel Corp. The shiny stickers on the outside of new personal computers turned a simple component into part of the identity of sizzling fast new machines.
Now, those little labels are a liability. They’re a reminder that Intel built its fortunes on the PC, increasingly a dinosaur in a phone-and-tablet computing world. Slow to serve mobile devices, Intel is at risk of dying along with the PC.
That’s the sentiment, at least, of a number of investors. Despite a nearly 15 per cent gain this year (slightly below the overall U.S. market), Intel’s valuation remains below historic levels. Analysts are unenthusiastic, at least by Wall Street standards. Fewer than half rate the shares a “buy,” according to Bloomberg; fully 15 per cent have slapped the rare “sell” rating on them.
There is a compelling bull case, however, based on Intel’s legacy of quality, innovation and adaptation. New, non-PC opportunities are available, some analysts say, and Intel has the skills and track record to take advantage of them. Investors who have a suitably long-term view – enough to weather the ups and downs of the next couple of years – may find Intel shares as rewarding in the future as in years past.
“There seems to be a lot of hesitation about Intel because it’s so tied to PCs, and it’s absolutely true – the PC market is declining compared to last year, and in the next quarter or two, it’s absolutely going to matter,” says Morningstar analyst Andy Ng. “But if you’re willing to look a few years out, to when they manage the transition to the cloud computing era and lower their exposure to the PC by investing more in tablets and smartphones, strategically, they’re making those moves.”
First, however, let’s review the arguments against Intel. While semiconductor stocks have historically been cyclical, trading along with economic cycles, there are fundamental changes in computing.
PCs, plugged into the wall for their power, need high-performing processors, with energy use a secondary consideration. Mobile devices place a premium on efficiency; the chips they use also happen to be cheaper than the ones Intel makes for PCs.
It is the U.K. company ARM Holdings that designed the processors now used in most mobile phones and tablets, and is perceived by many as winning the chip war. (See the companies’ price-to-earnings ratios as evidence: While Intel trades for about 12 times forward earnings, ARM trades for 42 times.)
“The issue for Intel is of a structural nature given that demand trends are increasingly shifting towards energy efficiency in computing platforms, which are dominated by lower-priced ARM-centric offerings,” says analyst Hans Mosesmann, who downgraded Intel to “underperform” in December. “The next 10 years will be vastly different for Intel than the last 10.”
Auguste (Gus) Richard Sr. of Piper Jaffray, who cut Intel to “underperform” in June, says chips are becoming a commodity, and with PC sales declining, he sees little room for sales growth. “In the heyday of muscle cars, everyone knew what engine was under the hood. Horsepower sold a car. Today no one even looks under the hood. Electronics are undergoing a similar shift in focus.”
There are many, though, who still believe Intel’s name and quality will translate to new uses, and new revenue, even if lower sales prices compress the company’s margins.
Mr. Ng, who has a “fair value” estimate of $26 (U.S.) on Intel shares, a couple dollars above current prices, notes that computer functions are increasingly divided into two buckets: ones that are home on mobile devices and those that are part of the server-based “cloud” they rely on. “The server portion of the business is going to be the fastest-growing part of Intel in coming years,” he says, noting his forecast of annual server-chip revenue growth in the low-to-mid-teens is slightly below Intel’s forecast of 15 per cent gains. “As smartphones and tablets proliferate you have to build out the servers in the cloud. They all require server chips and Intel can benefit.”
Meanwhile, Christopher Rolland of FBR Capital Markets & Co., who upgraded Intel to “outperform” in July with a $28 target price, says the company’s work on chips for the mobile devices themselves will pay off in 2014 or later. Intel is the company, he says, that proved Moore’s Law, the theory that processing power would double every 18 months and will continue to lead change in the industry.
“We argue that Intel’s business plan is not based on PC or server, but rather on executing according to Moore’s Law,” Mr. Rolland says. The new products represent a potential market of $200-billion, he says, versus $70-billion of PC and server microprocessors. He believes the flexibility provided by “the best silicon manufacturing operations in the world” will allow Intel to successfully replace lost PC business.
Which vision of Intel best represents the future? Perhaps a bit of both. Analyst Stacy Rasgon of Bernstein Research says Intel’s cash-flow story – it currently pays a 3.8 per cent dividend – is dented by the billions of dollars of capital expenditures Intel is saying it will spend in its transition. Still, she says, “this is how a company should be run – for the long term.”
“We believe that one could look back (say, in five years) and greatly compliment the path Intel chose,” she says. “Future Intel (and future Intel stock) could be phenomenal at that point … However, the journey to nirvana is likely to be fraught with potholes. From the perspective of the stock today, we don’t want to be along for the ride.”
Investors with that long-term perspective, however, may find that today’s price is but one of a few buying opportunities before the company demonstrates that “Intel inside” signifies a whole new generation of value.