Intel Is Progressing a Little Bit More on Its Road to Recovery; $40 Fair Value Estimate

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Brian Colello

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We expect Intel should remain the market share leader in central processing units, or CPUs, in PCs and servers for years to come. However, Intel’s best days are likely behind it, as it is at a chip manufacturing disadvantage against Taiwan Semiconductor, or TSMC, and its processor partners, such as AMD, Nvidia, and Apple. We think Intel’s aspirations to regain parity with TSMC is the right path forward but faces significant execution risk. Even if successful, Intel’s competitors will be stronger than when the firm was dominant a decade ago. In turn, we assign Intel a no-moat rating, a disappointing erosion from previous narrow- and wide-moat ratings.

We view Intel’s former dominance as stemming from two areas. First, its execution of Moore’s Law, which predicts transistor density on integrated circuits will double about every two years, meaning subsequent chips have substantial power, cost, and size improvements. In recent years, however, Intel was unable to keep pace. Intel’s second advantage comes from its control of x86, the instruction set for virtually the entire history of the PC. Microsoft’s Windows, Apple’s Mac operating system, and the software running on both platforms, was written with x86 processors in mind, which virtually guaranteed that all PC hardware would run on x86 processors. AMD was granted an x86 license but was a subpar second source for decades, and Intel thrived. Lately, however, AMD has forged a tight partnership with TSMC, and the duo has emerged as a credible second source to Intel, allowing AMD to gain market share in both PC and server CPUs. Even if Intel revives its manufacturing roadmap, we don’t foresee AMD recoiling from the market.

Demand for Intel’s CPUs will likely bottom out in 2023, but we don’t foresee a sharp recovery, either. Intel’s plans for five manufacturing nodes in four years (2022 to 2025) are aggressive and might not be achieved on time. Even if they are, there is no guarantee of a booming market for PC or server CPUs. Meanwhile, the market for artificial intelligence accelerators, such as Intel’s Gaudi products, should skyrocket, but we view Nvidia, and even AMD, as better positioned in the AI market.

Business Strategy & Outlook

We assign Intel a no-moat rating. The company’s returns on invested capital have fallen in recent years, and the firm did not earn excess returns on capital in 2022, nor do we expect it will do so in 2023. The deterioration stems from the firm’s manufacturing struggles and hefty investment phase in new manufacturing processes. We don’t believe the company will generate excess returns on capital in the next three to five years (even when considering government subsidies and other incentives). We are also not entirely confident in excess returns on capital looking five to 10 years out if its research and development (R&D) efforts are not successful, again given the capital-intensive nature of cutting-edge chip manufacturing. We acknowledge that, if Intel were to perfectly execute on its aggressive technological roadmap, it may warrant an economic moat rating in the future. Intel’s roadmap is on track currently, but the company has stumbled before, and we would like to see further progress before we award Intel with a narrow moat rating once again.

Intel’s chip design team has decades of experience in processor designs, mostly around central processing units, or CPUs, that, in our opinion, would likely warrant a narrow moat rating in isolation. However, we view the chip manufacturing business as being at a cost and technological disadvantage today, as the firm has stumbled and lost its lead to Taiwan Semiconductor, or TSMC, the world’s largest foundry. In our view, Intel’s manufacturing headwinds more than offset any competitive advantages that its chip design expertise may warrant.

Intel is perhaps best known for its CPUs for PC desktops and notebooks within its Client Computing Group (CCG) business segment. We think that Intel has a competitive advantage in PC CPU chip designs, not only because of chip design expertise honed over decades, but also because Intel is one of two prominent firms (along with AMD) to hold an x86 instruction set architecture license. 

Intel initially developed x86 in the 1970s and emerged as the instruction set required for IBM PCs and, later, Microsoft’s operating systems. Intel and AMD are the primary licensees of x86 and owners of x86 intellectual property, as they have a cross-licensing agreement that covers the x86 patent portfolio and would be terminated if either firm was acquired or had a change of control. The exclusivity of the x86 license serves as a significant barrier to entry for other chipmakers (such as Qualcomm, Apple, or others) that cannot make an x86 processor without a license.

For many years, effectively all PC software (including Microsoft’s Windows, Apple’s Mac operating systems, and any desktop software applications running on both operating systems) was designed for the x86 architecture. Software makers could not easily deviate from building x86-optimized applications, while Microsoft and Apple would have a heavy lift to convert their operating systems to alternate instruction sets (such as those by ARM, which is the dominant instruction set for mobile devices, used in processors from Qualcomm, Samsung, Apple’s iPhones, and others). In turn, Apple (for the Mac) and PC vendors (for Windows machines) had little choice than to buy x86 processors from (mostly) Intel or (on occasion) AMD to run their PCs.

Today, however, Apple has already done the heavy lifting of converting its Mac software to ARM and has now built excellent in-house processors for its Mac lineup. Further, an increasing portion of software is hosted in the cloud and can run on multiple operating systems and isn’t tied to only x86 devices. Microsoft has dabbled in ARM-based versions of Windows and may increase these investments over time. We still think it would be a heavy lift for any on-device software makers to port their software to be compatible with ARM-based PCs, but we think the writing is on the wall here to move such software to the cloud or on to ARM-based devices like the Mac. Thus, we don’t think the x86 architecture is as moaty as it once was, although we still foresee x86-based processors from Intel and AMD as making up a significant portion of the PC market for the next several years.

Intel also had a historical cost advantage in the PC processor market because of its manufacturing leadership along Moore’s Law, which was coined by one of Intel's chief founders, Gordon Moore, and suggests that the number of transistors per unit area doubles approximately every two years. For decades, Intel held a manufacturing advantage that drove PC hardware makers to buy Intel chips, which gave Intel a bigger R&D budget to invest in the next wave of chip innovations, thus coming out with even better processors and keeping the positive flywheel going. 

These dynamics have flipped in recent years, however, as Intel has stumbled in internal manufacturing and could no longer keep up with Moore’s Law. Meanwhile, AMD has partnered closely with TSMC, the world’s largest outsourced chip manufacturer or foundry. TSMC now has a market lead in making cutting edge chips, and AMD is bringing more competitive products to the PC market. Further, AMD has focused on a chiplet strategy with TSMC that is improving yields and flexibility, boosting AMD’s portfolio even further. In turn, AMD has gained market share over Intel in PCs in recent years. 

We view Intel’s cost disadvantage as the primary reason for our moat downgrades for Intel from wide to narrow and now to none. If Intel did not own fabs and instead outsourced production to a foundry like TSMC, it likely would have been far more profitable in 2022 and 2023 during the slowdown in PC demand. Some investors have called for Intel to go fabless, likely to break out the crown jewel chip design team. However, we consider this narrow moat design team as buried within a much larger, struggling, non-moaty manufacturing business. 

Intel is investing heavily in new process nodes to strive for manufacturing parity, if not leadership, with TSMC. If Intel is successful, it could regain some lost x86 PC market share. However, we no longer view AMD as an also-ran in PC CPUs, and even if Intel were to improve, we still think AMD could retain enough customers to maintain a healthy PC business. Further, the rise of ARM processor vendors represents an emerging threat that Intel did not face in its heyday a decade ago and earlier. 

In server CPUs within Intel’s Data Center and AI, or DCAI, segment, we see similar dynamics. Intel captured a dominant market position thanks to both x86 know-how and leading-edge manufacturing, but lost its edge on the latter front, allowing the AMD/TSMC partnership to gain credibility and market share in server CPUs. 

We also think that any cloud-based software vendors face high switching costs to move their software from x86 servers and on to ARM-based servers, although the switching costs are likely far lower between hosting software on an Intel x86 server versus an AMD one. Still, like the PC market, we see ARM-based processors as a threat, as Amazon, Nvidia, and others are developing ARM-based processors to run traditional server workloads as well as AI applications. Optimizing data center architectures and workloads for ARM-based servers, rather than x86 ones, is again a heavy lift, from what we can gather. Still, we recognize that mega-cap tech firms and cloud leaders (Microsoft, Apple, Amazon) may have the incentive to do so if they can use ARM-based processors to elevate their data centers and devices. Ultimately, we don’t foresee a mass exodus away from x86 architectures in the data center for the next several years.

Intel owns some other businesses and segments that hold valuable intangible assets around design expertise. Both Altera and Mobileye were narrow-moat companies when independent. However, 80% of Intel’s revenue comes from CCG and DCAI, and we foresee the PC and server CPU markets as driving Intel’s fate for the next few years. We view Intel’s current cost disadvantage as offsetting any chip design competitive advantages the firm may have in areas like Altera’s field programmable gate arrays, or FPGAs, Mobileye’s automotive products, or any semis developed for the communications infrastructure or networking end markets.

Longer term, Intel is building its foundry services business (IFS) from the ground up. Intel could conceivably carve out a moat here in the long run if it can again attain manufacturing process leadership, but it will be a highly capital-intensive initiative, so we’re not holding out hope for a moat in IFS just yet.

None

Economic Moat

Intel

Intel Corp. engages in the design, manufacture, and sale of computer products and technologies. It delivers computer, networking, data storage, and communications platforms. The firm operates through the following segments: Client Computing Group (CCG), Data Center Group (DCG), Internet of Things Group (IOTG), Non-Volatile Memory Solutions Group (NSG), Programmable Solutions (PSG), and All Other. The CCG segment consists of platforms designed for notebooks, 2-in-1 systems, desktops, tablets, phones, wireless and wired connectivity products, and mobile communication components. The DCG segment includes workload-optimized platforms and related products designed for enterprise, cloud, and communication infrastructure market. The IOTG segment offers compute solutions for targeted verticals and embedded applications for the retail, manufacturing, health care, energy, automotive, and government market segments. The NSG segment is composed of NAND flash memory products primarily used in solid-state drives. The PSG segment contains programmable semiconductors and related products for a broad range of markets, including communications, data center, industrial, military, and automotive. The All Other segment consists of results from other non-reportable segments and corporate-related charges. The company was founded by Robert Norton Noyce and Gordon Earle Moore on July 18, 1968, and is headquartered in Santa Clara, CA.

Earnings data Q1 2024

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Intel Corp. engages in the design, manufacture, and sale of computer products and technologies. It delivers computer, networking, data storage, and communications platforms. The firm operates through the following segments: Client Computing Group (CCG), Data Center and AI (DCAI), Network and Edge (NEX), Mobileye, Accelerated Computing Systems and Graphics (AXG), Intel Foundry Services (IFS), and All Other. The CCG segment consists of platforms designed for notebooks, 2-in-1 systems, desktops, tablets, phones, wireless and wired connectivity products, and mobile communication components. The DCAI segment delivers solutions to cloud service providers and enterprise customers, along with silicon devices for communications service providers and high-performance computing customers. The NEX segment offers computing system solutions from inflexible fixed-function hardware to general-purpose compute, acceleration, and networking devices running cloud native software on programmable hardware. The Mobileye segment develops driving assistance and self-driving solutions. The AXG segment provides products and technologies designed to help customers solve the toughest computational problems. Its products include CPUs for high-performance computing and GPUs targeted for a range of workloads and platforms, from gaming and content creation on client devices to delivering media and gaming in the cloud, and the most demanding high-performance computing and AI workloads on supercomputers. The IFS segment refers to full stack solutions created from the foundry industry ecosystem. The All Other segment represents results from other non-reportable segments and corporate-related charges. The company was founded by Robert Norton Noyce and Gordon Earle Moore on July 18, 1968, and is headquartered in Santa Clara, CA.

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Intel Corp. INTC, +4.18% has struck an agreement with Tower Semiconductor TSEM, +0.86% through which Intel will provide foundry services and 300-millimeter manufacturing capacity, the companies said Tuesday. Tower plans to invest up to $300 million to acquire and own equipment and other assets that will be installed in Intel's New Mexico manufacturing facility.

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Intel Corporation (INTC) Deutsche Bank's 2023 Technology Conference (Transcript)

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