In recent years, Intel Corp. (INTC, Financial) faced stiff competition from companies such as Nvidia Corp. (NVDA, Financial), Samsung Electronics Co (SSNLF, Financial) and Taiwan Semiconductor Manufacturing Co. Ltd. (TSM, Financial). With domestic chip production in the U.S. dwindling amid heavy reliance on imports, the situation for Intel did not seem promising until the Biden administration stepped in with a mega funding plan.
Intel has secured an impressive $20 billion in financial backing from Washington. This includes $8.50 billion worth of direct funding from the U.S. Department of Commerce and the eligibility for federal loans up to $11 billion. These funds will fuel the company's pioneering IDM 2.0 project by enabling it to construct and expand chip manufacturing facilities in the U.S., develop next-generation manufacturing processes and create tens of thousands of direct jobs with the addition of an even greater number of indirect jobs.
This analysis aims to discuss how securing funds will impact the company's long-term financial performance.
Regaining market leadership through IDM 2.0
Intel announced its ambitious IDM 2.0 project back in March 2021. With this strategy, the company is continuing its traditional mode of operation as an integrated design manufacturer, which involves designing and producing its own central processing units and other variants of chips for PCs and servers. The major evolution of the IDM 2.0 strategy will be Intel's significant manufacturing expansions, which are focused on building large-scale foundry capacity in the U.S. and Europe to serve customers globally.
This strategic narrative puts Intel in direct competition with Taiwan Semiconductor, the current leader in the foundry service market and semiconductor industry as a whole. Intel believes that by opening up its foundry facilities to other companies' designs, it may catch up on the lost market share. It has already entered partnerships with companies like United Microelectronics Corp. (UMC, Financial) and Tower Semiconductors Ltd. (TSEM, Financial), hoping to gain access to the customers of these well-established players in the foundry market.
IDM 2.0's success is dependent on Intel's ability to produce more compact, nimble and power-efficient chips, which it failed to deliver in the past and lost out to its competitors with delays in launching 10 nanometer chips. The company's delays have caused a serious loss of customer confidence in its ability to deliver. Delivering these advanced technologies also requires greater capital expenditures, another area where it falls behind. Taiwan Semiconductor has the upper hand on this front as it has effectively reduced the cost of production, whereas Intel has a long way to go to catch up with peers. The acquisition and retention of talented engineers is highly crucial to delivering consistent new-age technology as well, and Intel has to get this right for it to regain its status quo as the market leader.
Despite all these disadvantages, there are reasons for investors to be enthusiastic about the IDM 2.0 project. Within less than three years, the initiative has delivered some considerable results.
To start, Intel has become the world's first high-volume manufacturer of extreme ultraviolet logic devices. This extremely high-precision EUV lithography is crucial for the development of advanced semiconductors. ASML Holding (ASML, Financial), the world's leading supplier of semiconductor equipment systems, is delivering the first extreme ultraviolet lithography tool with a 0.55 numerical aperture to Intel. This will give its future processors in the post-18A era - especially 20A - a competitive edge in the market.
The government is getting behind the semiconductor sector
On March 20, President Joe Biden announced that the Department of Commerce has signed a non-binding preliminary memorandum of terms with Intel to provide up to $8.50 billion in direct funding along with $11 billion in loans under the CHIPS and Science Act. This move is part of Washington's continuous effort to boost domestic semiconductor production and to reduce the nation's dependency on foreign suppliers with the idea of strengthening U.S. supply chains and protecting national security. This announcement is the fourth and largest that has been issued under the CHIPS and Science Act.
Currently, the U.S. is heavily reliant on Asian manufacturers for chips, and Taiwan Semiconductors has been one of the largest exporters of chips to the U.S. in recent years. The ongoing tensions between China and Taiwan and global supply chain vulnerabilities, however, have caused the U.S. to call for more reliable domestically produced semiconductors to avoid supply chain disruptions. Moreover, on a national security level, importing chips that are used almost in everything from military equipment to medical devices does not seem a strategically sound move. Therefore, boosting domestic semiconductor production seems no longer to be a choice, but an obligation to the government, and Intel is likely to become a big winner as a result.
The direct funding from the Department of Commerce will be streamlined into Intel's four major silicon sites in Arizona, New Mexico, Ohio and Oregon.
In Arizona, Intel is planning to kick off two new leading-edge fabrication facilities and modernize a pre-existing facility. In Ohio, Intel is planning to establish two new facilities. These investments are among the largest in both states' history and will create 3,000 manufacturing jobs and 7,000 construction jobs in each state.
Meanwhile, in the state of New Mexico, Intel will turn its two fabrication locations into advanced packaging facilities. Advanced packaging has an important role to play in chip development as it improves a chip's protection, interconnectivity and performance, while enabling form factor flexibility and integration of heterogeneous technologies.
Finally, in Oregon, the funding will be deployed to expand and modernize facilities to increase clean-room capacity and utilize advanced lithography equipment, which will enable Intel to break into next-generation chip production. During the current financial year, Intel is expecting the net capital expenditure intensity to be in the mid-30% range of revenue. After an aggressive investment phase, the company expects to lower capex to a range of around 20% to 25% of revenue. The funding from the government will help Intel to reach this goal more smoothly.
The proposed funding from the CHIPS Act and Intel's previously announced plans to invest more than $100 billion in the U.S. over five years makes it one of the largest public-private investments ever made in the U.S. semiconductor industry. To strengthen Intel's ambitious capacity expansion plan, the government has also given it the eligibility to receive up to 25% of investment tax credits on more than $100 billion worth of qualified investments. This move will make the company's efforts in domestic chip production more financially feasible over the next several years. By offering these tax credits, the government is trying to reduce the overall tax burden on Intel to promote more domestic investments. This tax break is likely to incentivize the company to reinvest its profits back into the business, enabling it to achieve the goals of the IDM 2.0 strategy.
In the greater economic picture, Intel is already contributing more than $102 billion annually to U.S. gross domestic product. With the recent funding, this share is going to expand even more. According to Intel, these investments are expected to create more than 10,000 company jobs and nearly 20,000 construction jobs, and will also support more than 50,000 indirect jobs among suppliers and related industries.
To complement government funding, Intel has already announced a $100 million investment to expand semiconductor education, research and workforce training opportunities across the nation, with a partnership valued at $50 million with the National Science Foundation and another $50 million to fund the Semiconductor Education and Research Program for Ohio.
The impact of funding on Intel's business
The $20 billion funding package will benefit three main segments of Intel's business: Client Computing Group, Data Center Group and Intel Foundry Services.
With the new fabs coupled with advanced packaging facilities and cleanroom capacity to utilize lithography equipment, Intel's chip production is expected to increase notably in the coming years. This will allow the Client Computing Group segment to meet the growing demand for personal computers, especially with artificial intelligence integration. Intel is betting big on AI, and it believes it will be the next major technological breakthrough. With the newfound interest in AI, the company can utilize the funding to design AI-integrated personal computers by incorporating accelerators or optimizing chip architectures for machine learning tasks.
On the data center front, Intel can leverage the funding for investments in server chip development. The funding provides Intel with the capital to boost its research and development budget in the server chip segment to produce energy-efficient output using the latest lithography technology. More efficient server chips would mean improved cloud computing capabilities, which will enable the DCAI business to offer competitive cloud service options to clients. These steps may create an opportunity for Intel to regain market share in the data center space where companies such as Advance Micro Divces have made big strides in the last several years.
The Intel Foundry Services division will be the biggest beneficiary of the government funding. Since a significant portion of the funding is planned to be deployed for the construction and modernization of facilities that are specifically catered to provide foundry services, a notable increase in production capacity is on the cards. This will enable the company to provide services to a larger customer base. Additionally, the fact the U.S. government is funding the business may give customers a greater sense of confidence. As a relatively new player in the foundry business, such a confidence booster will be an encouraging development for Intel.
There are a couple of key concerns that need to be addressed from both cost competitiveness and managing customer expectations perspectives. Foundry customers are typically cost-sensitive, making cost optimization a major task for Intel. With its IDM 2.0 project, the company could create specific niche products with a slightly higher cost than trying to compete in the general categories, at least in the initial stages. Optimizing the manufacturing yield is also key to being successful in the foundry business. On this front, Intel has an experience advantage as it is known for its high-volume production capabilities. However, adopting these skills for the foundry business may become an uphill battle. Sticking to a strict timeline is non-negotiable in the foundry business, which is an area where it has a lot to prove.
With the newfound interest in the foundry business, Intel is planning to employ a margin-stacking strategy on IFS operations. With this strategy, Intel will use IFS foundries for its products, which would enhance overall profitability. In other words, when the company uses its foundry services to manufacture its chips, it can potentially benefit by capturing profit margins from both the foundry service and the final product sale. Furthermore, Intel could also provide its IFS customers with margin stacking benefits in the form of offering full-suite services, expertise from its heavily invested advanced packaging services and possible integration with its technologies.
The path ahead: Opportunities and challenges
The path ahead for Intel has a few broader challenges that have to be maneuvered around with great caution.
Advanced Micro Devices (AMD, Financial) has gained market share at the expense of Intel in laptops, PCs and server CPUs. Emerging players in this space such as Nvidia and ARM Holdings (ARM, Financial) are also making strides in the chip market with AI-specialized production. Taiwan Semiconductor is standing tall in the foundry business. As a result, Intel has to play its cards carefully to regain its position as the market leader in this heavily competitive sector at a time when all of its businesses are threatened.
Another major challenge for Intel is the deteriorating relationship between the U.S. and China. On March 24, China blocked the use of Intel and AMD chips in government computers, which could be an early indication of more trouble ahead.
Despite the challenges, there seems to be one area where Intel could carve out a position for itself: the growing AI chip sector. Management remains committed to investing in AI as this would boost the company's financial performance at a time when the demand for AI chips is accelerating and help it regain market leadership. Intel believes AI demand will accelerate CPU upgrades as well. Currently, the company has a promising $2 billion potential revenue pipeline for AI products. Intel is also integrating AI on an organizational level and is currently exploring the technology for optimizing manufacturing processes, improving decision-making and automating programming tasks.
Takeaway
Intel is set to benefit from a government funding package that will see the company receive $8.50 billion in direct funding. This will help the company's efforts to aggressively invest in expanding its production capacity to regain its dominance in the chip sector.
At a forward price-earnings ratio of 31, Intel is not as expensively valued as peers Nvidia and AMD, which are valued at forward ratios of 38 and 49. This relatively cheap valuation makes the stock an attractive bet in the semiconductor sector amid the company's comeback story that is gaining traction.
