The Blue Machine: Intel Corporation

Introduction
Some may have known that I have shared on Intel early in 2010 through email way before I decided to start this blog. Basically I am porting those info over here, updating them slightly with recent turn of events. What I shared at that time still hold true and I stand by my opinions.

• Intel is in a competitive business, it is sustaining itself not a growth company though it is trying to grow.
• Intel's future is uncertain in >3 years time frame as does all tech companies including Intel's competitors.
• Intel's share price is overvalued and overbought by investors.

Company Profile
Technology company and is the world's largest semiconductor chip maker based on revenue figures. It was founded back in 1968 as Integrated Electronics Corporation and is based in Santa Clara, California. The brand name Intel is synonymous with processors but Intel also makes motherboard chipsets, network interface controllers, integrated circuits, flash memory, embedded processors and other devices related to communications and computing. Intel has a long history so I won't bother to continue a grandmother story. 

Financial Charts

• Gross Profit is definitely good, boasting figures within 50% to 60%. With Intel being in a monopoly state for the processor industry this figure is to be expected just like Genting Malaysia.
• Return of Equity trends well with Gross Profit. ROE is the measure of how much shareholders get in return of their investment. It is by no means a measure of what you get in return in hand but at the perspective of the money already invested by owners for Intel to use.
• Revenue Growth Rate. Practically a zigzag over the last 10 years. If I were to compute average 10-year it is at 3.34% growth rate and the average 5-year is only a minuscule 0.90%! Don't believe? Below chart CAGR directly from Intel website from here. This is CAGR (red circle), a slightly different calculation compared to my average formula.

• Earnings Per Share another zigzag trend. Even an entrenched tech company like Intel does not hold a sustaining EPS. This is one reason why I shun away from investing in tech related companies. Again the same data from Intel Investor Relations site (pink circle), you can clearly seen EPS is in a downtrend over the last 5 years.
• Dividend Per Share is on the rising trend but what worries me is how Intel planning to sustain it when their EPS is not growing? Use their cash reserve?
• Data at this point is enough for me to identify a growth company or a sustaining company. I wouldn't want to go into more financial ratios. 

Earnings
Intel's core revenue comes from the sales of microprocessors. As much as 75% from microprocessors, chipsets designed for notebook, netbook and desktop computing market segments. The other ~18% comes from the server market or data centers segment. The remaining ones are from communication products, ultra-mobility segments and digital home.

Intel's Geographic Breakdown of Revenue

As you can see Intel is dependent on two things as their source of income: the continuous sales of their microprocessors in the consumer realm which is majorly in 50% Asia Pacific and 25% America. It doesn't matter what they do on the others (dan lain-lain) as they contribute very little to the overall picture. Intel's share performance will ultimately be determined by investor's sentiment towards their main source of income. 

Competitors
Truth to be told, Intel has many competitors but I am looking at their main rivals, easier. In fact Intel also competes with Texas Instruments and Samsung Electronics if you don't know.

1. AMD-ATI is a solid partnership. They have given up the fight for the halo processor crown but now trying to move the market by promoting a complete set of processing & graphical power. This is an attempt to hit Intel technically where they are weakest. So far it has been quite successful in eating Intel's laptop market share. AMD is doing very well in the graphic segment as well by punching Nvidia right in the face where ATI released new graphics line up 6 months ahead of Nvidia. AMD is playing a different ball game by introducing Fusion lineup in 2011 to OEMs. They call it APU (accelerated processing unit), CPU + iGPU. It could well out-do whatever Intel has in 2011. Intel is infamous for the poor quality of its integrated graphics processors (IGPs). Being a person who customizes PC for people I can testify that.
2. Nvidia. Apart from graphics which they are fighting ATI is NVIDIA's upcoming x86 CPU + GPU combination. That device is still just a secret project which almost nothing is known or publicly announced. The idea is that all you need is a basic x86 processor to make an interface to standard software then push heavy calulations to the GPU. Again this is an area of software and graphics which Intel does not have any advantage.

DCF Valuation

DCF treats a company as a business rather than just a ticker symbol and a stock price which most blind people think that price only matters. It requires you to think through all the factors that will affect the company's performance and gives you an appreciation for what drives stock values. Go to DCF Analysis and spend some time understanding it.

I have estimated that Intel's revenue growth rate is at 1% per annum in the next 5 years, with 75% operating cost margin, 31% US corporate tax, capital expenditure of USD5 billion per year (based on historical figures) for the next 5 years. Having computed all these factor in, Intel is valued at USD18.25 taking into account a 10% discounted rate (safety of margin). Even if Intel has a revenue growth rate of 10% it is valued at only USD22.90. Nevertheless I still hold firm to my valuation that Intel is not worth more than USD20 simply because it is not growing fast enough, look at the data. Then why does Intel trade at over USD20 when times are reasonable good?

This is my theory...

It is quite true at least in the Malaysian market. I have limited know this and that in US market I will admit that. Intel's free float is only 35% and most of the holdings are being held by financial institutions and mutual funds in the United States (65%). These institutions are still clinging on to Intel thus supporting the share price from further weakening or more appropriately trading at its fair value. The only reason why I see them holding is because Intel pays dividends and their payout has been steady throughout the last 10 years. A fund that boast that it has Intel shares that pays reasonable dividend each year will make most people who owns the fund go WOW. And why would they let go if Intel continues to pay decent dividends for a tech company.

Intel Corp Major Holders

Another thing to note, insider transactions reported over the last two years @ Intel Insider Transactions. Look carefully and you can ascertain that officers and directors of Intel Corp are disposing their shares more than exercising them. If Intel is doing as great as reported by them why are they disposing them most of the time? Think about that.

What Do I Think?

No doubt Intel is enjoying a honeymoon & a commanding period now with their Nehalem family of processors but that will not last long. Competition will heat up in 2011 when AMD-ATI launches their Fusion lineup (Bulldozer and Bobcat). Graphics has been an important component in the PC industry and one that Intel in my opinion is underestimating it severely. Intel knows that graphic performance is their Achilles heel but they do not seem to invest much in that realm even though they have such a strong balance sheet.

Gods know what they are thinking. Back during AMD Athlon years early 2000s, AMD was pursuing throughput performance while Intel was still advocating the Gigahertz factor. In the end, AMD was proven right as their lower freq processors consistently outperformed Intel's red hot high frequency processors and thus gained more market share from Intel. Is Intel making another mistake by overlooking this new fusion innovation by AMD?

It could also very well be Deja Vu. Back in the early 2000s when then-CEO Craig Barrett attempted to diversify Intel beyond semiconductors but proved ultimately unsuccessful. CEO Paul then reorganized the company to refocus its core processor and chipset business on platforms but right now we see the same thing happening again, an attempt to diversify beyond just a chip maker. Will it work? Intel seems to know nuts about software division but is extremely good at hardware and manufacturing.

Intel's Diversification Business Model

The recent announcement to buy McAfee at USD7.68 billion, a 60% premium to the share was chosen on the expensive side. Buying at USD44 per McAfee share is outrageous! That share price hasn't approached that level except during the tech bubble in 1999. Intel has about $18 billion in cash and short-term investments but to waste it on a business that has no synergy with Intel baffles investors. As mentioned before, investors will punish Intel share and they did. Makes me wonder whether buying McAfee will benefit Intel in the long run. A company like Microsoft, IBM or Oracle would be a better choice for McAfee.

Intel Share Price Historical Performance, Year 2000 tech bubble burst

Other Fun Facts

1. Headcount at 80,000 (55% employed in the US). Intel has reduced it from a high of 100,000 five years ago. Intel is improving efficiency and productivity to improve their margins.
2. HP and Dell are Intel's biggest customers accounting a combined 30% of yearly revenue. If you see them reporting sluggish sales expect Intel to be in the same condition.
3. Apple will not drive Intel's sales by a big portion as it only accounts 5% of world PC market share.
4. Intel's likes to show off their high gross profit margin >50% but their net profit is below <20% thanks to big budgets in R&D and sales & marketing.
5. Intel spends as much in R&D as with sales & marketing except in 2009 where R&D is $5.6 billion while marketing is $7.9 billion.
6. Intel admits that they operate in intensely competitive industries, and failure to respond quickly to technological developments and incorporate new features into their products could harm our ability to compete (from 2009 annual report pg22).

 

The PE is low at 11 but I do not value Intel solely on this valuation. I will continuously sell off INTC shares and put the capital in other stakes which generate better returns and more predictable business model. My previous sell offs were at USD20.70 and USD24.15.

 

The blue machine is no longer a mean one but still is a force to be reckon with for their size and monopolization of the chip business. It has the financial strength and resources to turn things around if only they use it wisely.