When it comes to my investment dollars, if I can't envision a company's future economics and have a reasonable idea of what they'll be producing, I stay away. Intel (NASDAQ:INTC), as you've probably seen, has been beaten down in price to the point it sports a good dividend yield and many wonder whether it's a good value proposition at this point. Since it's in my circle of competence, I thought I'd re-visit my previous research and think about the company and their future prospects and whether I should add it to my portfolio.
Don't hate me, but at this time that answer would be "no."
Let me explain.
When it comes to the microprocessor, Intel (NASDAQ:INTC) has no doubt been extremely successful. With the advent of the mobile phone market, there's change afoot with a lot of discussion on whether INTC can compete against ARM Holdings (ARMH), whose designs are incorporated in the lion's share of smart phones, tablets, etc., and consume considerably less power. There's also plenty of corollary discussion on the future of the PC market--with smart phones and tablets in abundance, many wonder whether the PC is in terminal decline.
Don't get me wrong, this is all good discussion, but I consider it noise compared to two other items on INTC's horizon that cast a cloud of unpredictability on their future.
Let me share them with you.
Business Model Re-Boot:
INTC changed their business model...no longer do they intend to be a pure-play microprocessor producing company like they used to be. It's there in the very first paragraph of their 10-K, the company overview...it says (emphasis mine):
"We are the world’s largest semiconductor chip maker, based on revenue. We develop advanced integrated digital technology, primarily integrated circuits, for industries such as computing and communications. Integrated circuits are semiconductor chips etched with interconnected electronic switches. We also develop computing platforms, which we define as integrated hardware and software computing technologies that are designed to provide an optimized solution. Our goal is to be the preeminent computing solutions company that powers the worldwide digital economy. We are transforming from a company with a primary focus on the design and manufacture of semiconductor chips for PCs and servers to a computing company that delivers complete solutions in the form of hardware and software platforms and supporting services.”Since I hadn't followed INTC for years, I wanted to know when this change in model happened. It seems it began when Mr Otellini became the CEO, circa 2006. In this Business Week article from that period, it says:
"Otellini is tossing out the old model. Instead of remaining focused on PCs, he's pushing Intel to play a key technological role in a half-dozen fields, including consumer electronics, wireless communications, and health care. And rather than just microprocessors, he wants Intel to create all kinds of chips, as well as software, and then meld them together into what he calls "platforms." The idea is to power innovation from the living room to the emergency room. "This is the right thing for our company, and to some extent the industry," he says. "All of us want [technology] to be more powerful and to be simpler, to do stuff for us without us having to think about it."So it appears INTC wants to transform into a cross of business models--something like a hybrid IBM (NYSE:IBM) plus Texas Instruments (NASDAQ:TXN)--providing computing solutions and making all kinds of chips.
From my point of view, with this break from the past, there's no way to know what INTC will look like in 10-20 years, much less know what the economics of their new business model will be. No doubt they'll attempt to be very good at what they do. But, history shows that most times when companies change their business models and expand into things outside of their core competence, if they don't over-pay for the acquisition they usually don't fare well in its operation, only to later divest themselves of the acquisition.
Why change the business model?
According to the Business Week article, it's stark necessity because of the slowing growth of PCs. It says:
"Why the shift? Stark necessity. PC growth is slowing, even as cell phones and handheld devices compete for the numero uno spot in people's lives. Otellini must reinvent Intel -- or face a future of creaky maturity. Revenue growth has averaged 13% for the past three years, but analysts figure Intel will see only 7% growth in 2006, to $42.2 billion. Meantime, profits, which have surged an average 40% annually over the past three years, are expected to rise a measly 5%, to $9.5 billion. "It's a race for Intel and other companies to figure out how fast is revenue going to come from emerging areas before PC margins begin to come down sharply," says Ragu Gurumurthy, head of technology practice for Boston tech consultancy Adventis Corp."Ok, fair point...that article was from 2006 and since then the mobile device market has exploded. Additionally, the larger INTC gets we should expect them to slow down in growth.
But I think the "stark necessity" comes from a different reason.
Unclear Future of Silicon
As you may know, microprocessors are made of millions upon millions of tiny silicon transistors. Ever since their invention, the industry has been able to continue to miniaturize integrated circuits--packing more and more transistors into a given space. With each wave, integrated circuits and processors have not only gotten smaller, but included more functions and became more powerful to the point that we use and depend on them in our everyday lives and commerce. This miniaturization has been governed by "Moore's Law", which basically states that the transistor density on a given wafer will double every two years. Although not a law, per se, it's more of a guide-post and INTC has been able to effectively meet it for the last 40 years.
As with everything in life, there are limits. Due to physics and the size of the silicon atom, there's a certain limit to the miniaturization you can effect with silicon with current fabrication methods. Current estimates indicate there's about another 5-10 generations left--roughly another 10-20 years.
Why is this anything to be concerned about?
Consider the second- and third-order effects. In effect, cutting-edge miniaturization with silicon would slow to a crawl or halt, and processors wouldn't get any smaller. The effective computing horsepower of a given silicon density would plateau. Adding additional functions to create more powerful chips would then require chips to get larger or (as the case with multi-core processors) consume more circuit board real estate, which would then place additional demands on power consumption. And INTC's chips already consume plenty of power.
The good news is research has been underway to find a replacement material for the microprocessor. These developmental technologies include things such as carbon nano-tube and DNA computing.
The bad news, as far as I know, is neither of these are out of the lab or commercially viable. INTC is doing research, as discussed in this article. However, this research appears to be aimed at reducing power consumption and enhancing performance from their existing silicon devices by enhancing current fabrication methods.
What will the replacement microprocessor material be? Who knows?
When will replacement microprocessor materials arrive? Who knows?
Will commercial fabrication be possible and cost effective? Who knows?
Will they be suitable for mobile devices and consume less power? Who knows?
With silicon reaching the end of its useful life for miniaturization and no clear path forward on a replacement material, it seems to me that the "stark necessity" in INTC re-booting their business model is finding a replacement revenue stream(s) in enough time in the event something doesn't materialize to replace silicon as the dominant material in the microprocessor.
My crystal ball is cloudy on this one.
Until they have a significant track record with their new business model, they announce the successor to silicon, or it gets so hammered in price that it'd be a steal, INTC won't find a spot in my portfolio.
No position in INTC.
This analysis is provided for informational and entertainment purposes only and is the opinion of the author. The information and content contained herein should not be construed as a recommendation to invest or trade in any type of security. Neither the information, nor any opinion expressed, constitutes a solicitation of the purchase or sale of any security or investment of any kind. Conduct your own research and due diligence.