Intel Corporation (INTC, Financial) is a technology company that belongs to the industry of broad line semiconductors. The company designs, manufactures and markets technology platforms including microprocessors and chipsets. Intel’s computing platforms power desktops, notebooks, servers and, to a lesser extent, tablets and smartphones.
The company primarily sells its products to original equipment manufacturers, or OEMs, and original design manufacturers, or ODMs. Intel has always been at the cutting edge of technology. It is already marketing 14nm products while Advanced Micro Devices Inc. (AMD, Financial) struggles to move past 28nm in CPU. Intel’s reportable segments include PC Client Group, Data Center Group, IoT Group, Mobile and Communication Group, Software and Services and All Other.
Revenue insights
Net sales of Intel totaled $55.9 billion during 2014, up 6% on a year-on-year basis. The company generates most of its revenue from PC Client Group, which contributed $34.7 billion, or 62%, towards the total revenue during 2014. Data Center revenue was $14.4 billion, or 25.8% of the total revenue. Intel is also picking up pace on the IoT front with $2 billion in revenue during 2014, a 19% year-over-year increase. Regarding customers, Hewlett Packard (HPQ, Financial), Dell and Lenovo accounted for 18%, 16% and 12% of the company’s revenue respectively during 2014. Intel Corporation was founded in 1968 and is headquartered in Santa Clara, Calif.
Thesis
Intel holds a monopolistic position in the microprocessor market. It holds the leading market share in PC and servers. Advanced Micro Devices is the only competitor on the PC side, and it is lagging behind in terms of node technology and is also financially distressed to some extent. Intel’s lead in node technology allows it to maintain a leading market share along with charging high premium for its products. In the PC group, the company will continue to dominate the high-end market for ultra-books, convertibles and slim notebooks. Productivity related issues of tablets and smartphones will keep portable computers alive going forward. PCs are being replaced by ultrabooks, not by tablets and smartphones, for productivity. That’s why Intel is going to remain relevant in the PC market especially on the enterprise front. PC is not dying. Desktop is.
Intel has yet to show dominance in the smartphone and tablet market but it's positively affected by the growth of these markets indirectly. IP traffic is expected to witness double-digit growth during the next five years, according to Cisco. Data storage needs are growing. The point is that Intel’s data center business will benefit from these trends amid adoption of Cloud, increased computing demand for servers and the rise of IoT. It is worth mentioning that Intel’s recent acquisition of Altera expands the company’s data center TAM due to FGPA offerings of Altera; FGPAs enable efficient compute deployment in data centers.
Most importantly, Intel generates a lot of cash flow; its OCF inflow was $20.4 billion in 2014. Due to cash-cow nature of the company’s business, it is able to spend generously in R&D. Research and Development expenditures of the company totaled $11.5 billion in 2014, more than any other technology company in North America. These expenditures are the very reason Intel maintains a leading technology position in its industry. Further, the company can leverage its PC and resulting cash flow, strength to move into IoT and mobile. Intel surpassed its 40 million tablet shipment target in 2014, thanks to contra revenues. All in all, Intel can steal market share from competitors given its cash-rich position.
Risks
The PC market has been shrinking for the past few years; it will continue to do so in coming years. Intel generates most of its profits from this market. Intel has to transition towards mobile, Cloud and IoT in order to sustain or grow its revenues. The company is spending a large sum to remain relevant in the mobile market. Being late to the market, it is quite difficult for the company to play catch up with players like Qualcomm (QCOM, Financial). The company recently launched its first integrated SoC solution, SOFIA, for mobiles. Qualcomm and others have been doing that for several years now. High-end market is out of the question for Intel’s SoCs for now as the company’s 4G integrated SoC is yet to be rolled out. Moreover, the mobile side favors ARM and, therefore, it would be quite difficult for Intel to become relevant in this market. In the process, the company will lose a lot of money.
IoT is touted as one of the potential growth businesses for Intel. But, the company is not performing well in small form factors. x86 is not a favorable proposition in terms of power consumption. Intel has been trying to address that by moving to a smaller node, which is, in fact, an expensive venture. Intel’s IoT potential lies on the data center side rather than the IoT product side.
Advanced Micro Devices has been a resilient competitor. The company competes on pricing and will give Intel a run for its money on the lower end of the PC and notebook markets. Further, Advanced Micro Devices has a superior GPU technology, which serves a selling point for casual laptop gamers. Advanced Micro Devices is also planning to use Samsung’s 14nm process for its next generation products. Removal of technology gap can have a material impact on the sales of Intel’s processors going forward.
Accounting for value
From a valuation perspective, Intel seems fairly priced. Our EVA model reveals a price target of $32 for Intel. Assumptions include 5% P.A. earnings growth during the next five years. No growth is assumed for perpetuity. CAPM is used to calculate the cost of equity while NASDAQ returns are used as a proxy for market return. See the valuation sheet below:
Focus Equity Estimates
Prudena's Monte Carlo reveals a similar valuation. Assuming an 8% cost of equity, the stock seems adequately priced. See below:
Prudena, Soid's Model
The model indicates that Intel's stock can reach as high as $40, but the probalility is quite low. However, analysts are projecting a growth rate of just 5% P.A. for Intel going forward, which is quite low given Intel's exposure to IoT, Cloud computing and data center market. These markets will allow the company to achieve higher growth in coming years. Therefore, the aforementioned valuation should only be viewed as a base case.
Bottom line
Whatever the future may holds, Intel currently holds a dominating position in the PC market. It is also using its cash rich-position to challenge competitors in the mobile space along with improving its technology. Notebooks are staying amid productivity concerns tablets entail. Intel’s resources and technological lead forces us to believe that the company will be able to benefit from IoT, adoption of Cloud and the data center market. Given Intel’s lead in the process technology, decent operation cash flows, aggressive R&D spend and a forward PE of just above 12, it seems like an attractive buy in the technology sector.
