Size Is Not All
Intel is the largest semiconductor company in the world, with a market capitalization of more than $114 billion. Enjoying scale advantages, it has consistently outperformed its closest competitor, Advanced Micro Devices, which is about 40 times smaller in terms of market cap. However, concerns about the competition posed by AMD and ARM Holdings (ARMH) have arisen and the management has responded. Over the past two years, Intel has shifted its focus from rewarding shareholders thorough dividends and stock repurchases, to fueling its R&D activities with plenty of cash. The main reason for this stems on Intel’s desire (or need) to enter the mobile chip market, currently dominated by the ARM-Qualcomm (QCOM) alliance.
Despite applauding the company’s response, I must highlight that R&D expenditures are no guarantee for success, especially in a segment as contested as the mobile market. Even with an unmatched R&D budget, any missteps would hurt Intel’s profits, favoring AMD.
As Intel continues to lose the battle against ARM in the smartphone and tablets segment, its finances are starting to deteriorate. Although its margins and returns are currently above average, and its valuation at 12.3 times its earnings, at almost half the industry average, make it seem like a buy, long-term prospects lead me to differ. Actually, analysts expect Intel to close fiscal 2013 with $8 billion in net income on the books. If this (or something similar) was the case, its forward price-to-earnings ratio would ascend to 14x.
With its valuation becoming less attractive going forward, growth prospects being unclear and most investment gurus (from Jim Simons to Jean-Marie Eveillard and Pioneer Investments) selling their stocks, this is a company to stay away from, at least for now!
The Restructuring Plan Seems on Track
Advanced Micro Devices (AMD)'s stock rose almost 5% during Tuesday, following the announcement of a new chip family designed for non-PC applications and devices. Investors seem quite encouraged by the chip-designer’s shift, away from PC markets and into faster growing segments.
The company’s bet is strong on microservers, an area in which AMD runs ahead of Intel on the back of its new 64 bit chips for data centers. These semiconductors combine ARM Holdings' architecture, usually used in smartphones, with the x86 architecture normally present in servers.
Despite the recent success achieved with its award-winning Embedded G-Series SoC family, investors needed further reassurance, proof that a turnaround is possible. The announcement certainly reinforced my confidence in AMD's restructuring plan.
Shifting away from the PC markets might just be the solution for AMD, which has always been a laggard in relation to Intel. Now solely dedicated to designing chips, while outsourcing the manufacturing to other chipmakers, AMD is gaining an edge over its eternal competitor through differentiation. Cutting-edge technologies and a shift away from the PC market might be just what AMD needs to fix its finances.
Although currently its margins and returns are negative, a turnaround looks more likely now. Trading at only 0.6 times its earnings, at about 1/5 of the industry average, this looks like a stock to buy and hold over the long-term. With Brandes Investment’s, Chales Brandes, Fidelity Management and Research Company, and Citadel Advisors Llc (amongst various other institutional players) betting on AMD’s restructuring. Why shouldn’t you?
Although Intel easily beats AMD in scale, market share and margins, this is just one half of the story. Looking backwards, there's no doubt that Intel has done better. But will it continue to do so going forward?
The current state of affairs leads to believe that AMD could outperform Intel over the next few years, as the PC market declines and a transition towards other segments will determine their success. Although both face strong headwinds, AMD seems to be taking a better way towards a reconversion.
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