The Case Against Intel

Brit Ryle

Posted January 30, 2023

Last week, semiconductor giant Intel (NASDAQ: INTC) reported earnings that were…um…bad. Intel shares closed at $30.03 on Thursday, January 26. The stock opened for trading Friday morning at $27.07, down 10% after a surprise earnings miss.

The stock rebounded a bit during the day, as investors apparently thought maybe it wasn’t as bad as it looked. They shouldn’t have.

Likewise, investors shouldn’t have been surprised by the earnings miss. Intel has been a rolling disaster for the last few years. 

In 2017, Intel posted $61 billion in revenue. Over the last 12 months, Intel’s revenue is $63 billion. And its net profit is down 30%. Stagnant revenue, falling profits – not good. 

How did it all go so badly for Intel? 

Well, in a general sense, it’s because technology is hard. A tech company like Intel has to be able to see the future. You have to be able to see where the market is headed before it gets there. You have to have a handle on what new devices will be all the rage, you have to know what functionality consumers will want, and you have to have tomorrow’s products ready today.

For a chip company like Intel, that means being ready for smartphones. It means ever more powerful processors for laptops. It means shrinking those processors to be more energy efficient to increase battery life. And it means being ready for the rise of the cloud and the datacenter. 

Intel failed at smartphones. Qualcomm (NASDAQ: QCOM) won the smartphone market  because it saw it coming early and had an ironclad patent portfolio that Intel couldn’t compete with. By mid-2019, Intel had abandoned the smartphone market. That was the first time I advised investors to sell Intel stock. Shares were $45-$50 at the time…

One might think that the transition from desktop computing to laptop computing would be a pretty easy thing for Intel. And Intel did make the transition, but it wasn’t exactly smooth. When the semiconductor industry shrank chips and 7 nm became the standard, Intel couldn’t make them at their own foundries.. 

In fact, Intel’s first 7 nm chips will be out this year. And they will be outsourced, made by Taiwan Semiconductor (NYSE: TSM). Sadly, for Intel, anyway, Taiwan Semi is already making 5 nm chips for other companies – like Apple (NASDAQ: AAPL) – and will probably be making 3 nm chips sometime this year. 

Playing catch-up is not easy. A missed cycle in tech can be devastating. The best I can say for Intel regarding its laptop business is that it managed to tread water. The laptop processor market  is pretty much split in three, shared by Intel, Qualcomm and Advanced Micro Devices (NASDAQ: AMD)

Eating Lunch in the Clouds

So Intel failed at mobile and kept its head above water with laptops. That leaves data centers as the one area where Intel enjoyed success. And in fact it was more than success – it was outright dominance. 4 or 5 years ago, Intel commanded an incredible +95% share of the entire data center market. 

Data center chips were much less of a challenge for Intel because they’re much more like desktop chips. Miniaturization isn’t as important for data centers. Power and reliability are the prize functions, and Intel could still make a pretty good chip. 

If you’re familiar with the term “disruption,” then you have an idea what happens when an industry or business sector does things the same way for a period of time. Get too comfortable in your ways, rely on the status quo to carry you and it is inevitable that someone will come along with some kind of innovation and disrupt your cozy business…

So when you see a market share as lopsided as Intel’s +95% share of the data center chip market, well, it’s a pretty good bet that some company is gonna come gunning for it…

That company was Advanced Micro Devices. 

I was a little late to that party. Shares of AMD had already doubled when I recommended them at $10 in 2018. It’s usually a little easier for investors to play catch-up…

In its most recent quarterly report, Intel’s data center revenue was down 27% to $4.2  billion. AMD reported a 45% increase in its data center revenue. That pretty much says it all. AMD is eating Intel’s lunch in the data center server market. From above 95%, Intel’s market share in the data center space is down to 83%.

A Classic Value Trap

As investors, we are taught that low P/E (price-to-earnings) ratios are better because it means that the stock is cheaper. 

I find it helpful to think about P/E ratios in terms of a buyout price. As in, if you were going to get a loan to buy a company, how long would it take you to pay off the loan from the company’s earnings? A company with a Price-to-Earnings ratio of 10 means that it would take 10 years to pay off the loan out of earnings.

Intel currently has a P/E ratio of 9 – if you got a loan to buy Intel, could pay off the loan out of Intel’s earnings in 9 years. Throw in the 5% dividend you’d get from the stock and it might look like a pretty good investment right now…

But sometimes stocks are cheap for a reason. And this is the case with Intel. Earnings are falling, and the forward P/E based on analysts earnings estimates for the next year is 18. So the 9 years to pay off the loan is really more like 18. And if business gets worse for Intel (and in the stock market, bad stories tend to get worse), it might take 20 years or more to pay off that loan.

Intel is a classic value trap. 

Could Intel make a turnaround? Maybe start taking some of that data-center market share back from AMD? Maybe increase its share of laptop processors? Sure, anything’s possible…

But the message in Intel’s valuation numbers are telling you that it’s not likely. 

Briton Ryle
Pro Trader Today