Introduction
- Over the last few years Intel has faced setback after setback in their R&D, causing them to fall behind their competitors.
- TSMC is now manufacturing at the 5nm node while Intel has just released their 10nm chips. This technological disadvantage has caused them to lose market share, as fabless chipmakers like AMD and even former Intel customers like Apple are leveraging TSMC’s advanced foundry capabilities to produce superior processors.
- With Intel’s 7nm chips set to release in 2023 (while TSMC expects to be at the 3nm node by that time) the technological gap is not expected to be bridged in the near-term.
- The erosion of Intel’s formerly quasi-monopoly dynamics has caused their valuation to sink to a mere 11.7x 2020 earnings, compared with ~23x forward earnings for the S&P 500.
- Clearly the market is pessimistic on Intel, indeed it is difficult to find people that have good things to say about Intel. Analysts frequently invoke struggling technology conglomerate of yester-year, IBM when speaking of Intel’s future, while rival AMD with its explosive growth is a Wall Street darling.
- These factors have caused Intel’s stock to lag the S&P significantly over the last several years: ~11% return for the 3 years 5/1/18 – 5/1/21 vs ~58% for the S&P 500. Meanwhile, INTC’s peers have soared.
- This investment thesis rests on three main points:
- Intel should reclaim a leadership position in the chipmaking industry.
- The semiconductor industry faces both short-term and long-term tailwinds.
- Intel’s valuation implies no growth.
Reclaiming a Leadership Position
- Not terribly long ago Intel held a near monopoly on the semiconductor market, with 80%+ of desktop market share. Perhaps it was that cozy monopoly position that allowed them to fall asleep at the wheel and let competitors gain an advantage over them.
- Their desktop market share in particular has given up considerable ground to AMD. Indeed, all of the best-selling desktop processors on Newegg are AMDs.
- However, most of the CPU market is data-centric, a trend that will likely only continue.
- In server-based applications, most platforms use Intel, and the best-selling server CPUs on Newegg are still Intel.
- However, Intel’s new offerings still trail AMD in performance. Intel’s newly released 10nm Xeon processor, Ice Lake is perhaps roughly comparable to AMD’s 7nm EPYC Rome, but against AMD’s newly debuted 5nm Milan it is no match.
- Intel must improve their product quality if they are to have any hope at competing.
- Of course, there are not yet any concrete signs of a turnaround, but if there were then the stock would not be so cheap. However, there are a few things that lead me to believe Intel should reclaim the top spot in the semiconductor industry over the longer-term.
- First, Intel is still much larger than its competitors with revenues more than TSMC and AMD combined, affording them more resources to invest into R&D and to attract the best talent.
- Second, management has expressed that regaining their position as the leader in the product categories in which they compete is paramount. To this end they recently brought on a new CEO, industry veteran Pat Gelsinger.
- Gelsinger worked at Intel for 30 years under founders Moore, Noyce, and Grove before going on to become CEO of VMWare.
- Gelsinger seems like a solid choice, and perhaps with his technological knowhow and leadership skill could be the one to put Intel’s execution woes behind it and right the ship.
- Gelsinger also does not seem afraid to shake things up, which leads me to my third point. Gelsinger announced his “IDM 2.0” strategy which involves using TSMC to produce some of Intel’s chips, while simultaneously expanding into the foundry business.
- Despite being a competitor, using TSMC could be a good temporary solution until they get their development issues fixed.
Industry Tailwinds
- Currently there is a chip shortage, which has spurred many chipmakers, including Intel to invest heavily in capex.
- The shortage should, in the short-term, support demand and prices.
- The shortage has also raised awareness about the fact that a robust domestic capacity for semiconductor production is a national security concern, as most semiconductors are currently produced in geo-politically unstable East Asia.
- Intel has been working with the Biden administration, and will likely be a beneficiary of his infrastructure program, as they seek to add many high-skill jobs.
- Over the longer-term, the increased development and proliferation of technologies like AI, cloud, 5G, and edge computing should continue to drive the demand for computing power.
Valuation
- Intel trades at 11.7x 2021 guidance, compared to 23x 2021 forward earnings for the S&P, implying that INTC’s long-term earnings growth should trail the S&P by roughly 4%
- TSM and AMD trade at more than 30x TTM earnings while NVDA trades at nearly 100x earnings
- Even over the last 5 years, as they have begun to lose ground to competitors, revenues have increased by 7% compounded annually. This is not a dying company despite what many people think and what the valuation implies.
- If Intel can get their mojo back and ride the semiconductor wave the stock should rise considerably given the very low valuation.
Conclusion
- INTC has caught the eye of other notable investors. It is Seth Klarman’s 3rd largest position and activist investor Dan Loeb recently built a large stake.
- It seems like Loeb does not intend to let management rest on their laurels; in December of 2020 he wrote a letter to the board shaming the company for its poor performance over the last few years. Shortly afterwards the board brought on new CEO Pat Gelsinger.
- Given how far behind Intel is right now, it is not surprising that many consider them to be down and out, but the trend of a few years should not be extrapolated out forever.
- Intel still has considerable resources at its disposal and winds at its back while the valuation provides a margin of safety.