Seth Klarman (Trades, Portfolio)'s Baupost Group filed its fourth-quarter 13-F document with the SEC on Feb. 12, revealing a new stake of 18.18 million shares in semiconductor giant Intel Corporation (INTC, Financial).
Intel is among the largest chip makers in the world, but it has lagged its peers in the recent past, partially because of the production delays faced by the company. Intel's focus on the personal computer market, which was facing challenges until the virus-induced recession triggered a massive work-from-home movement, was another factor that was considered as an obstacle to the company's growth.
The next few months will be exciting for Intel as Pat Gelsinger, the current CEO of VMware, Inc. (VMW, Financial), will join Intel to lead the management team beginning Feb. 15. He is expected to turn things around for Intel.
I think Seth Klarman (Trades, Portfolio)'s recent investment could be an early indication of his belief that the leadership change will steer Intel in the right direction.
The macroeconomic outlook is favorable
Intel is benefiting from the secular growth of the work-from-home trend as many companies and professionals are upgrading their laptops and desktop computers to improve their efficiency. In the fourth quarter, PC shipments grew 26.1% year over year, confirming the strong momentum behind this industry.
Source: IDC
The exponential growth expected in cloud computing and other internet-oriented concepts is also a very promising sign for Intel as the success of these movements depends entirely on the availability of powerful processors to facilitate the transfer of data at high speeds.
The company has opened doors for competitors to take market share
Until very recently, it seemed impossible that Intel would be challenged by its peers for the leading spot in the microprocessor manufacturing industry. To secure its dominant position, Intel continued to spend billions of dollars on research and development costs every year.
Today, however, Intel is playing catch-up following the production delays with its 10-nanometer processor, and the significant delays in the production of the 7-nm processor. Many Wall Street analysts believe Intel should have ideally outsourced the production of some chips to international giants such as Taiwan Semiconductor Manufacturing (TSM), which was a strategy successfully executed by two of Intel's rivals: Advanced Micro Devices (AMD, Financial) and Nvidia Corporation (NVDA, Financial). Both these companies are now believed to be ahead of Intel in the production curve, and failure to gain some ground in the next few quarters could permanently deteriorate the company's earnings power.
Last November, Apple, Inc. (AAPL, Financial) decided to use its own chips in future MacBook devices, which will be a massive blow not only to Intel's earnings but also to its reputation as a trusted provider of high-end microprocessors. The production delays in advanced chips had a lot to do with Apple's decision to ditch Intel as the preferred supplier of processors to its laptop devices.
When it comes to semiconductor companies, the size of transistor processors plays an important role in securing new business. Chip manufacturers have invested billions of dollars to produce smaller yet powerful chips, and the below data confirms Intel is no longer the leader from this front.
| Company | Chip size | Comments |
| Intel | 10nm | The production of 7nm chips has been delayed until late-2022. |
| Taiwan Semiconductor | 5nm | The company has already begun to manufacture 3nm chips and expects to bring these new designs to the market by 2022. |
| AMD | 7nm | The company is likely to bring 3nm chips to the market in the next few years because of the business relationship it has with Taiwan Semiconductor and Samsung Electronics. |
Source: Company filings
The new CEO has pledged to keep most of the production in-house for the moment, so it would be highly unlikely that Intel will manufacture better chips than its rivals in the next few years.
Valuation is cheap
Being a value investor is not easy. In addition to finding companies that are trading at cheap or fair earnings multiples, a value investor needs to ensure that value traps will be avoided at any cost.
Intel is currently trading at a forward earnings multiple of 13.75, in comparison to the sector average of 33.35. To add some more perspective, all of its closest competitors are trading at much higher multiples.
| Company | Forward earnings multiple |
| Intel | 13.75 |
| Broadcom Inc. (AVGO, Financial) | 41.59 |
| Qualcomm Incorporated (QCOM, Financial) | 22.50 |
| Texas Instruments Incorporated (TXN) | 26.91 |
| NVIDIA | 90.32 |
| Advanced Micro Devices | 56.47 |
Source: Eikon
Intel is the cheapest chip maker in the market today, but the real question is whether it can make a strong comeback by addressing all the problems it is faced with. The appointment of the new CEO is a good starting point as he brings expertise in the cloud computing industry to the table, and he served at Intel before joining VMware so it would be reasonable to assume that he has a deep understanding of Intel's business model and target markets.
Some Wall Street experts are bullish on Intel's prospects and believe the company will quickly come back on track. In an interview with Barron's, the founder of Moor Insights & Strategy Patrick Moorhead said:
"I think they are going to bounce back. I don't think it is game over for Intel right now. They have two major issues. The first is manufacturing, and I don't think that's a lifetime problem. The second is they need to field very quickly a machine-learning training piece of silicon to compete with Nvidia for machine learning."
Value investors who wish to follow Seth Klarman (Trades, Portfolio) into Intel should ideally allocate a small portion of their portfolios to Intel because of the mixed outlook for the company.
Takeaway
Seth Klarman (Trades, Portfolio), who is renowned for his value investing principles, has taken a new position in Intel during the fourth quarter of 2020. The company is facing significant challenges from its peer group, and the incoming CEO is expected to turn things in favor of Intel by revisiting the capital allocation policy of the company.
More importantly, the new CEO will be tasked with deciding on the best course of the production schedule for Intel, and to assess whether it would be a prudent decision to outsource some of the production to a well-established tech giant in a bid to close in on the gap with its peers such as Advanced Micro Devices and NVIDIA. If these issues are not addressed in the coming months, Intel might find it difficult to retain its market leadership position. The collapse of Nokia Corporation (NOK, Financial) is a classic example of a company that failed as a result of a lack of innovation, and Intel might follow the same path if it does not make changes to its business model.
Contrarian investors and value investors have an opportunity with Intel because of the very cheap valuation multiples at which the stock is currently trading, but the best course of action would be to use an appropriate position size that would not jeopardize the health of the portfolio even if Intel performs poorly in the coming years.
Disclosure: The author does not own any shares mentioned in this article.
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