On October 26, 1999, Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC) were added to the Dow Jones Industrial Average as component stocks. In retrospect, this move signaled the pinnacle of the personal computer revolution. Intel shares, at the time, traded for a split-adjusted $27.28. More than 14 years later, on January 28, 2014, Intel closed out the trading session at $24.90.
Quite frankly, Intel is dead money. Investors who were fortunate enough to buy in near the 52-week ground floor of $20.10 should immediately sell their positions and take profits. Ironically, mobile has been the real albatross at Intel in recent years. Conservative, long-term investors should avoid Intel stock until managers agree to shut down the mobile division and concentrate efforts on minting cash out of the personal computer and server markets. Alternatively, traders may consider re-entering the stock to turn a quick profit if shares were to fall through support levels at $20.
Former Intel boss Paul S. Otellini boasted of Intel’s “mobile edge“ in his 2012 annual letter to shareholders. A confident Intel was then attempting to leverage aggressive research and development spending to tap into smartphone and tablet growth. At that time, Intel was banking on the emergence of mobile sales to help carry it through a personal computer market down cycle until support for Microsoft Windows 8 gained traction. Otellini also touched upon Intel’s manufacturing prowess in his letter to shareholders.
Intel then projected that it would be upgrading its foundries to 14nm process technologies by the end of 2014. At that time, Intel claimed that its chips had been installed within six separate smartphones. That number has since been expanded to eight and now includes the bargain bin Acer Liquid C1, Motorola RAZR I, and Safaricom Yolo handsets sold in Thailand, Mexico, and Kenya.
On May 2, Brian Krzanich was named Intel CEO after the resignation of Otellini. Despite the management change and high hopes for its Atom line of mobile chips, Intel has remained without a major design win over the past year. If anything, Intel has walked back its “mobile edge” commentary. As somewhat of a first, operations man Krzanich has also made Intel foundries available to the competition. In November, Chairman Andy Bryan admitted to being “embarrassed” that Intel had “lost its way.”
Intel was to promptly follow up this declaration by issuing pink slips to 5,000 employees, or 5 percent of its workforce. Going forward, it may be both inevitable and prudent for Intel managers to focus upon the build-out core PC and server businesses, rather than to fight a losing war against the likes of mobile stalwarts Taiwan Semiconductor (NYSE:TSM), Qualcomm (NASDAQ:QCOM), and ARM Holdings (NASDAQ:ARMH).
Intel built for power
In football parlance, Intel may be described as an old school ballclub. The Intel organization — featuring hulking lineman, two tight end sets, and workhorse running backs — has suffered from an identity crisis. Intel was built for a power attack. Today, the game has shifted to better accommodate read-option quarterbacks, five wide receiver sets, and speed, above all else. Intel shareholders, however, would have been better served had this company stayed the course with its own basic blocking and tackling. The Intel business model has suffered through an identity crisis chasing after the latest gimmicks.
Silicon Valley technocrats and Wall Street analysts, of course, may recognize the idea that personal computers and servers are driven by raw processing power. Alternatively, mobile consumers are more so concerned with lightweight chip technologies that remain cool and preserve battery life. In effect, Intel is expecting its roster of 250-pound bruising backs to catch swing passes out in the flat, juke tacklers, and tip-toe the sidelines into the end zone. The results have been embarrassing, as was to have been expected. Again, Intel should quietly scrap the mobile playbook, get back to basics, and play its power game.
For the sake of making apples-to-apples comparisons, please be advised that Intel fiscal years coincide directly with calendar time. Intel has classified its businesses according to PC Client, Data Center, Software and Services, and Other Intel Architecture operating segments. Other Intel Architecture has been designated as the umbrella category largely above mobile chip sales. The PC Client Group has historically generated two-thirds of total net sales at Intel. Last year, The PC Client Group accounted for $33 billion of the $52.7 billion in 2013 Intel net revenue.
The Data Center Group of server technologies was the only Intel operating segment to bank year-over-year revenue (+6.9 percent to $11.2 billion) and operating income growth (+2.9 percent to $5.2 billion). In all, Intel revenue and operating income declined by 1.2 percent and 16 percent, respectively, between 2012 and 2013. The somewhat shocking acceleration in Other Intel Architecture operating losses may define Intel’s latest fiscal year results.
Intel has aggressively ramped up its research and development spending from less than 10 percent of revenue to more than 20 percent of total net sales within the course of 15 relatively short years. Intel has dumped $29.1 billion into R&D spending within the past 36 months. Certainly, Intel executives and shareholders expected these initial upfront investments to have already paid off in the form of advancing mobile chip sales and bottom-line growth.
Instead, Intel shareholders have been left with little to nothing to show for the massive capital-spending program. Other Intel Architecture closed out the 2013 year having racked up $2.4 billion in operating losses off $4.1 billion in segment revenue. In 2012, the Other Intel Architecture division reported $1.4 billion in operating losses off $4.4 billion in revenue.
The mobile duopoly
Information out of independent researchers comScore and the International Data Corp. will confirm the presence of a dominant Apple (NASDAQ:AAPL) iOS and Google (NASDAQ:GOOG) Android duopoly above the mobile space. On January 6, research firm comScore released its report for November 2013 U.S. smartphone subscriber market share. The comScore report actually presented averages for data taken from the quarterly period spanning August and November 2013.
Taken together, Google Android and Apple iOS operating systems claimed 93.1 percent of the fall quarter U.S. smartphone subscriber market. IDC estimates have confirmed a similar tablet market structure, where Android and iOS systems have also run away from the competition. Meanwhile, BlackBerry (NASDAQ:BBRY) and Microsoft Windows operating systems have been fighting simply to maintain relevance at the bottom of the heap.
Technocrats and Wall Street analysts alike will immediately recognize that Intel has been completely shut out as a real player within the mobile market. The ARM Holdings Company Overview now boasts that ARM-based technologies have already been installed within more than 95 percent of the world’s mobile phones. ARM, of course, collects royalties off Apple A-Series and Qualcomm Snapdragon chips designed around its architecture.
Again, in football parlance, the Qualcomm Snapdragon line has emerged as the go-to receiver for all serious mobile organizations beyond Apple. Even Microsoft and Nokia were to have recruited Qualcomm Snapdragon chips to power premium Windows Surface tablets and Lumia smartphones. Microsoft has subtly rejected its historical running partner by omission and rendered Intel somewhat powerless in mobile. Windows, of course, may be described as a third wheel in mobile, at best.
Intel executives have responded to the mobile shutout by announcing vague plans to build out foundry business during each quarterly earnings call. Intel, of course, must fill large orders in order to budge the needle at the bottom line. Qualcomm is not likely to sign a manufacturing contract to do business with its own fierce rival in Intel.
By default, Apple would remain the sole king maker to grant Intel rights to manufacture millions of A-Series chips. Instead, Apple has enlisted the help of Taiwan Semiconductor in order to shift away from unlikely bedfellow Samsung (SSNLF.PK). Apple did award its chip manufacturing business to Samsung before the Korean consumer electronics firm emerged as Cupertino’s most formidable smartphone competition. In any event, the sputtering Intel mobile machine will continue to run into roadblocks in all directions through 2014.
The bottom line
Intel stock closed the January 24 trading session at $24.81 per share. At this level, Wall Street traders have effectively applied a $125 billion market capitalization price tag onto the Intel business model. For 2013, Intel posted $9.6 billion in net income and $52.7 billion in revenue. Intel now trades for 13 times current earnings. On paper, this valuation may appear cheap. Intel revenue and net income, however, have declined significantly since 2011, when the company generated $12.9 billion in net income off $54 billion in revenue.
The stock market, of course, is a pricing mechanism that discounts future growth. Legendary Peter Lynch opines that Intel must achieve consistent 13 percent annual growth in order to justify current stock market valuations. According to Lynch, stocks carrying price to earnings to growth ratios of one may be described as fairly valued.
Interestingly, Intel would unlock shareholder value if it were to shut down its mobile business and slash capital spending. Intel may then be taking a page out of the Big Oil playbook. In recent years, ExxonMobil (NYSE:XOM), Chevron (NYSE:CVX), and Conoco Phillips (NYSE:COP) have largely divested themselves away from low-margin downstream retail gasoline operations. In 2012, Conoco Phillips actually spun off its entire Phillips 66 (NYSE:PSX) refining operation in order to focus resources upon the more profitable exploration and production side of the business.
Intel would refashion itself more so as a long-term holding attractive to conservative investors if it were to also strictly drill the personal computer and server markets for big profits. For Q4 2013, the Intel PC Client Group rang up $3.4 billion in operating income off $8.6 billion in revenue. Year-over-year quarterly PC Client Group income increased from $2.8 billion to $3.4 billion despite the fact that operating segment revenue remained flat at $8.6 billion during the same time frame.
Intel also listed $2.9 billion in capital spending within its Q4 2013 statement of cash flows. A move to quietly shut down mobile would leave more cash available to return capital to shareholders through stock buybacks and dividends. Intel spent a mere $528 million in cash upon stock buybacks through this latest quarter, which was down from the $1 billion spent in Q4 2012 ($2.5 billion in Q4 2012 capital spending). Intel literally shifted $500 million away from buybacks and toward capital spending over the past year.
For now, prospective investors should avoid Intel stock until the company gets back to playing its power game. Mobile has been the albatross weighing down Intel shareholder value. Mostly likely, management will come to its senses by the end of 2014 and quietly abandon mobile operations.
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