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I. Introduction to Intel Long the dominant player in the market for computer microprocessors (CPUs), Intel currently faces a significant shift in the market for consumer electronics to mobile devices. Founded by Robert Noyce and Gordon Moore in 1968, the company was led for many years by the inimitable Andy Grove. The company is currently run by President/CEO Paul Ottelini, who will be stepping down in May 2013. Intel’s stock has been publicly traded since 1971, when it was listed for the equivalent of 2.0 cents.1 While Intel is decidedly not unknown by any measure due to its Intel Inside promotional campaign, its stock is a fallen angel. The stock did not suffer from a sudden decline but has languished for the past decade. After hitting a high of $70 during the dot-com boom, the stock has mainly traded in a range from $15 to $30 per share since 2001. The company has transparent financials and is not particularly complex to analyze. The potential investment opportunity has arisen as the company has become unloved by the market due to the boom in smartphones and tablets, markets in which Intel has not laid claim. However, the market appears to be overlooking the company’s ability to adapt over time, its history of leadership in technological processes, its leverage to the new world of cloud computing, and the fact that for serious computing, people continue to opt for traditional computers. As a result of the market’s dismissal of its prospects, Intel’s stock appears to be at its cheapest level in decades, with a price/earnings ratio of 10, an EV/EBITDA of 4.5, a price/book ratio of 2, and a PEG ratio below 1. The company continued to perform through the recent recession, unlike peers Micron and AMD, whose currently negative earnings prevent comparison of P/E ratios. Compared to companies with positive earnings, Intel looks inexpensive. For instance, ARM, Qualcomm, and NVIDIA trade at P/Es of 75, 17, and 14, respectively. Given its current valuation and its venerable history replete with competitive advantages, Intel gives every appearance of being a franchise business whose stock is suffering from neglect and mistaken perceptions of obsolescence. We expect the company to be every bit as relevant in 10 or 15 years as it is today and view the stock as a sound purchase at current levels. II. Historical Competitive Advantages and Current Industry Trends a. Personal Computer Processors i. Intel Inside 80% of Laptops and Desktops Intel’s greatest competitive advantages exist in the market for microprocessors for the personal computer market, which it has dominated for decades. According to IDC, Intel held 80% market share at the end of 2012, lower than the 90% that it has traditionally garnered. Thanks to its original connection with IBM, the power of the Wintel platform over the years, and the adoption of Intel chips in Apple computers in 2005, Intel has managed to continuously protect its entrenched position in the personal computer market. Its large market share has
Adjusted for 13 subsequent stock splits
The main risk to Intel’s competitive moat in this segment is the rapid growth of cloud computing. Given the recent emergence and rapid rise of these segments. On the other hand. Although the market to manufacture servers has grown more competitive. and IBM) accounted for 75% of its data center revenue. lighter-weight. a behavior we expect it to continue. Intel’s technological prowess and reputation are essential. Intel’s three top data center customers (Dell. Tablets and Smartphones and Bears…Oh My Despite Intel’s tremendous competitive advantages in the PC and server markets. In fact. Fortunately for Intel. an advantage for Intel is that the declining market should discourage new entrants and also create challenges for the smaller players who attempt to compete with Intel. The drawback to Intel’s competitive strength in this market is that PC sales appear to be destined for decline as consumers shift their personal computing to mobile devices such as tablets and smartphones. Likewise. As a result. it has been unable to crack the new markets for smartphones and tablets.0? The high-powered but still portable option which recently entered the computing market is the Ultrabook. b. In 1998. Intel has made Ultrabooks a key element in its strategic initiatives going forward and is poised to transfer its leadership from the PC market to this new segment. eight server makers account for 75% of its data center revenue. faster-starting device which blends the benefits of a notebook and a tablet. Today. controlling 90% of the server market. The same types of competitive advantages that allowed them to dominate the PC market should allow them to continue to dominate this market. Intel still rules the market for server chips. permitting the company to outspend and stay ahead of or at least even with its rivals. Intel’s competitive advantage from the PC market should transfer directly to this new arena. which should serve to enhance its competitive advantages in this arena. manufacturer’s trust in Intel’s reliability and the scale which allowed it to fend off competitors in the PC market should continue in Ultrabooks. One fact appears certain—the emergence and growth of cloud computing is leading to an arms race for server makers and cloud providers. Data Center (Server) Chips – Dancing in the Clouds Like the PC market. HP. it is effectively the arms dealer of choice for every player. Although portability and energy efficiency are important in this market. Intel has been able to innovate consistently and maintain a technological lead over its competitors. Given the importance of reliability to server manufacturers and users. Given Intel chips’ computing power and the company’s relationships with major PC manufacturers in the Ultrabook market. a smaller-sized. The Ultrabook – Competitive Advantage 2. Intel has dominated the data center market for years. This is one of the key weaknesses upon which the market appears focused. as it could provide challengers the scale required to effectively compete against Intel. This is a viable and expanding business in which Intel is strongly positioned as a result of existing competitive advantages. ten of the top Ultrabook manufacturers already use Intel chips in their products.2 allowed Intel to spread its R&D and other fixed costs over more units than its competitors. ii. Intel’s history of developing powerful chips and its focus on new interfaces should allow it to compete effectively. c. no sustainable competitive advantages appear to have been .
Accordingly. which is where the competitive advantages of Intel’s design experience. we think that while the foundry business could be a potentially useful side activity to take advantage of Intel’s infrastructure and to defray the company’s fixed costs. We do not seek to predict their behavior. management attention is better spent outside this area and focused on those areas in which the firm has durable advantages. The importance of chip efficiency has put Intel in a disadvantageous position in this new market. manufacturers may have learned from the experience of the PC market. Many firms are entering the market and its rapid growth may allow several of them to achieve critical mass. III. A Future as a Foundry? Following Intel’s recent deal with Altera. as in its other endeavors. As a final note. As of mid-2012. As smartphone and tablet usage becomes more demanding and require more computing power. ARM’s architecture could be found in 95% of the mobiles. On the other hand. Going forward. it obviously also makes sense for them to find a chip architecture that works for them and to build multiple technologies around that. and scale are concentrated. However. especially now that the company has focused its attention on efficiency. Intel’s stronger processors will be increasingly well suited to compete.3 cemented. however the company does not hold any durable competitive advantages. d. In fact. We view this as more of a peripheral bonus than a competitive edge for Intel. Foundry partnerships are not based on Intel’s architecture. we expect Intel to innovate and compete but do not expect any company to dominate this segment in the way Intel has the PC and server markets. Intel wishes to accelerate the development of 450 mm silicon wafers . best-inclass processes. Its chips have historically been more powerful but also used more energy. With the advent of smartphones and tablets. However. ARM has not created a competitive moat in the market for mobile chips.e. Rather than face a single powerful supplier. ARM’s research and development have been primarily geared towards low power consumption. Because of ARM’s emphasis on power consumption and its licensee model. Intel has found the technology to compete. ARM’s processor architecture currently dominates the smartphone market. which rose to prominence because of its relationship with Apple. a need long ignored by Intel. Analysis of Strategic Decisions Intel’s acquisition strategy revolves around improving its existing core processor offerings. We simply note that neither case spells success or disaster for Intel. Unlike Intel. ARM does not manufacture its own microprocessors but instead licenses its designs to companies like NVIDIA and Qualcomm. it quickly came to dominate the mobile market. it has been speculated that it may take advantage of excess capacity to produce chips for other companies. the Motorola RAZR i (with Intel’s processor) outlasts the nearly identical RAZR M (with ARM’s processor). MP3 players). The key player in this segment is ARM. ARM originally developed its architecture with small devices in mind (i. despite being in the right place at the right time. As a result. ARM offered an architecture oriented towards significant power efficiency. they may prefer to work with multiple chipmakers. Its most recent investment (a 15% stake in ASML in exchange for ~$4 billion) was consummated to bankroll ASML’s R&D related to 450mm silicon wafers and extremeultraviolet chip-making.
000 people. it completed the purchase of patents and patent applications relating to Wi-fi and LTE from Aware Inc for $75 million. we estimate the asset value of Intel’s equity to be around $90bn (~$18 per share). To represent the value of the company’s R&D. the results do not seem obvious and the reasoning seems speculative. it has turned outward in order to acquire the technology necessary to achieve that goal. After all adjustments.4 due to the large cost savings it would create for the company. we arrive at owner’s earnings of $12. which would be the cost of hiring a workforce of 105. as per Exhibit 6.700 patents and related rights in the 3G. As Intel works towards creation of a winning processor design for mobiles and tablets. 80% of the 2011 figure. In 2011. We estimated 25% of R&D expense and 10% of MG&A expense were used for growth. and eliminated accounting goodwill.68 billion. In June 2012. and amortization of intangibles of $350m. 60% of the 2010 figure. Intel acquired McAfee. The difference between the actual capex and our maintenance capex has been used to fuel the company’s growth. for $7. we capitalized it based on 100% of 2012 R&D expense. Intel argues that creating more effective security requires implementation throughout an ecosystem (software.4 billion. Intel could save $2 billion annually on 450mm processes versus the 300 mm standard. 4G and Wi-fi technology spaces. We also added back depreciation and amortization and subtracted maintenance capex of around one-fourth of net PP&E. At around the same time. hardware. We valued the employee base at 10% of estimated annual salaries. Asset Value and Earnings Power Value of Equity To arrive at a replacement value of Intel’s assets. Intel acquired Infineon’s Wireless Solutions (WLS) business for $1. so we estimated additional brand value by capitalizing advertising expense as we did the R&D expense. adjusted its marketable equity securities to reflect ASML’s current share price. et cetera). leases. we began with a normalized EBIT margin of 27%. we did not want to double count the value of those employees. this deal has destroyed shareholder value which we do not expect it to reproduce in the future. Based on charges for the past six years. given its high price. We added back part of the accumulated depreciation for PP&E. we adjusted the value of several line items and added non-accounting items to the balance sheet to represent the true cost of recreating Intel’s asset base. we estimated additional normalized charges for restructuring. and unfunded pension liability roughly offset its cash and .7bn. While much of Intel’s marketing and brand value is done by sales representatives. As such. This is Intel’s most controversial and outlying acquisition in recent years. After deducting income taxes at a normalized rate. Intel is maintaining WLS as a separate business in order to allow WLS to continue servicing its existing customers in the same manner as before the acquisition. In calculating Intel’s earnings power. IV. adding this back to our sustainable earnings. impairment. While this may be possible. Intel paid InterDigital $375 million for 1. According to analyst estimates. Intel’s debt. The rate of return on these investments is not expected to be quickly observable. In 2011. and so forth. Actual capex has typically ranged between one-third and onefourth of PP&E. synergies could be created through processor/software offerings that are tightly aligned between Intel and McAfee. We estimate a cost of capital for the company of just under 10%. Thus. our team regards these investments as akin to R&D for patents that could create value for future product lines. the computer security software firm. The importance of this acquisition has been mainly to accelerate Intel’s development of baseband processors for 4G LTE to be offered in Intel’s processor architecture for future smartphones. Although the McAfee acquisition appears to have added marginal profits to the loss-making software and services operating segment.
and Margin of Safety Despite the value-destroying McAfee acquisition. our buy recommendation stands on its own. Intel’s stock is currently trading near historically low levels relative to asset value and earnings power value. Intel’s post-tax ROIIC appears to be around 24%. Investment Recommendation Based on our analysis. We consider the $40bn difference between EPV and AV to be justified by the company’s substantial competitive advantages. Positive developments in new markets such as smartphones/tablets could add value but are not essential to our thesis. . Given the company’s competitive advantages.8bn in dividends and $23.6%. there is a net margin of safety of 2.1%. The company has returned $20. With a current earnings yield of 10%. Even factoring in franchise erosion of 2. Intel benefits from the existence of sustainable competitive advantages in several markets. Unlike the PC business. prices falling slightly) and blending Intel’s sales mix with our growth assumptions results in an organic growth rate of -0. As can be seen in Exhibit 1 and 2. reinvested earnings have historically added value. Based on Intel’s historical ability to add value. we assume a conservative 5% growth for this market. versus net earnings of $52m.6%.6%. V. although if Intel makes a large push into smartphones and tablets and if that market is as competitive as we expect. Still. Given current circumstances.6%. and the resulting economies of scale. Accordingly. Value of Growth. We estimate a 3% rate of decline based on recent industry trends and a 30-year erosion period. we estimate a reinvestment return of 3. we consider it to offer a sufficient margin of safety at current levels and recommend it as a sound investment.5 equivalents and we arrive at a market value of equity of around $130bn (~$26. Given its technological process leadership and history of innovation. we seek not to predict the outcome but to remain conservative.5% per year (based on the company’s current 40+ year existence).70 per share). Given its tremendous R&D capabilities. Rate of Return. it also has the potential to create a competitive position in developing markets as new technologies emerge. The main headwind Intel faces is the structural decline of the PC business. we recommend the purchase of Intel stock at current levels.8% and a marginal cost of capital based on recently issued debt below 3%.6bn in net buybacks in the past six years. On the other hand. its hold on customers in certain markets. compared to a market return of 7%. However. VI. these investments will likely earn only their cost of capital. Assuming other segments grow at 2% (units growing with GDP. the data center market is growing. In our calculations. if Intel’s innovation and customer relationships allow it to change the market structure and gain competitive advantages in the smartphone/tablet markets that would be a driver of value creation going forward. This compares to a cost of capital of 9. that equates to a cash return of 8. this provides a margin of safety of 4.
00 5.000 200.00 1990 1995 2000 2005 Market-to-Adj Book 2010 Market-to-Book Ratio .00 7.000 0 1990 1995 Market Value 2000 Adj Book Value 2005 EPV 2010 Exhibit 2: Comparison of market-to-book and market-to-adjusted book values Market-to-Book and Market-to-Adjusted Book Ratios 9.000 50.000 100.00 4.00 0.00 6.00 3.00 8.00 1.000 150.00 2.000 250.6 Exhibit 1: Comparison of Intel market value to AV and EPV Intel Valuation 300.
000 10.0% 35.0% 25.000 40.0% 0.0% 30.000 20.000 30.000 50.7 Exhibit 3: Intel operating data Intel Revenues and Operating Expenses 60.000 0 1990 1995 2000 2005 2010 40.0% 15.0% Revenues R&D (% of Rev) MG&A (% of Rev) Exhibit 4: Intel performance by segment .0% 20.0% 10.0% 5.
00 0.4% 1.00 Dividends Per Share 2004 2006 1990 1992 1994 1996 1998 2000 2002 2008 2010 Exhibit 6: Comparison of PP&E levels vs.20 0.6% 36.40 0.0% 37.2% 37.5% 32.8 Exhibit 5: Intel ROIC and dividend histories Intel Adjusted Pre-tax ROIC 45% 40% 35% 30% 25% 20% 15% 2007 2008 2009 2010 2011 2012 38.80 0. capital expenditures Intel PP&E vs CapEx 35000 30000 25000 20000 15000 10000 5000 0 1990 1995 PP&E.9% 42.60 0. net 2000 CapEx last 4 Yrs 2005 2010 CapEx last 3 Yrs Exhibit 7: PC industry sales statistics (data and forecasts courtesy of Gartner) 2012 .
702 831 1.512 31.336 124.644 12.023 2.396 46.015 1.023 2.983 4.148 831 445 24.235 4. loans.999 5.412 3. assume machinery/equipment halfway through useful life.999 5.734 2.203 312 3.179 5. cost of hiring equivalent workforce Capitalization of R&D spend Capitalization of advertising spend 312 3. construction in progress current Estimate of current value.148 0 0 0 0 52.871 4.117 2. net Other long-term assets Capitalized operating leases Value of employee base Capitalized R&D Additional brand value Total long-term assets Total assets Current liabilities Short-term debt Accounts payable Accrued compensation and benefits Accrued advertising Deferred income Other accrued liabilities Total current liabilities Long-term liabilities Long-term debt Long-term deferred tax liabilities Other long-term liabilities Capitalized operating leases Unfunded pension liability Total long-term liabilities Total liabilities Asset value of equity 2012 Actual 8.136 3.972 1.358 27.351 +/Adjust. based on ASML's current stock price Mostly corporate bonds and govt bonds Eliminate accounting goodwill No adjustment Unadjusted / 992m in equity method investments / 1.117 2.972 1.993 84.9 Exhibit 8: Asset value of Intel’s equity Adjustments to 2012 Balance Sheet Current assets Cash and equivalents Short-term investments Trading assets Accounts receivable. plant and equipment. Multiple Adjust 2012 Adjusted 8.932 3.787 493 0 6.478 3.932 3.644 12.685 3.710 6.015 1.179 5.250 33.424 493 9.685 3.833 4. other Capitalized operating leases 10% of estimated annual salary.148 51.688 93.202m in non-marketable cost method investments / also DTAs.925 23.904 88.530 4.898 13.702 0 20.547 -100% 831 445 24.688 Add back depreciation on land/buildings.235 4.734 2.828 No adjustment No adjustment No adjustment No adjustment No adjustment No adjustment 831 No adjustment No adjustment No adjustment Capitalized operating leases Current plan assets less current pension benefit obligation . net Inventories Deferred tax assets Other current assets Total current assets Long-term assets Property.006 35.136 3.478 3. net Marketable equity securities Other long-term investments Goodwill Identified intangible assets.898 13.412 3.732 Notes No adjustment No adjustment No adjustment Add back allowance for doubtful accounts No adjustment No adjustment No adjustment 38 18.512 31.
955 8.448 831 831 831 831 831 831 522 645 455 668 1. and ST invest.531 32.639 4.751 Investment Decision Tangible Book Value Unadjusted Book Value Asset Value of Equity Earnings Power Value of Equity Implied Franchise Value Current Market Capitalization Implied Discount to Fair Value Implied Return Total investment return Net margin of safety 35.611 12.064 6.343 7.208 98.204 3.258 51.583 131.484 1.363 11.35 17.6% 2.236 16.283 87.616 5.122 1.979 1.357 3.828 131.617 31.10 Exhibit 9: Owner’s earnings.638 14.3% 33.547 8.912 31.778 (350) 2.8% 91.588 11.212 21.129 87.638 4.96 26.230 130.72 21.477 14.216 8.350 10.13 10.221 2.287 2.725 13.7% 3.301 2012 14.711 27.203 88.3% 4.580 (350) 2.115 7. equivalents.402 (350) 3.1% 31.713 9.386 17.522 7.311 11.780 12.206 4.843 13.171 96.162 103.855 6.832 100.976 2.937 43.547 12.1% per share 7.484 (350) (350) (350) 1.925 15. Market value of equity 2007 2008 2009 8.230 8.885 14.331 13.6% 11.904 2011 17.937 2010 15.920 21.616 9.245 119.148 9.68 8.0% 10.846 32.960 125.052 4.07 . EPV.109 104.954 5.466 4.751 11.275 4. and margin of safety Owner's Earnings and EPV Reported operating income Normalized EBIT margin Normalized EBIT +Normalized other items +Growth operating expenses +Depreciation & amortization -Maintenance capex Adjusted EBIT Adjusted EBIT margin Income tax Owner's earnings Cost of capital Earnings power value Less: Book value of debt Less: Capitalization of operating leases Less: Unfunded pension obligations Plus: Cash.0% 26.837 18.798 4.980 2.2% 3.9% 4.392 129.
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