Intel Corp. (INTC - Free Intel Stock Report), the dominant manufacturer of microchips for personal computers, has reported strong operating results in recent quarters, but its stock, at a recent quotation of around $20, is cheaper than it was a decade ago. The current price to earnings valuation of around 10 is at a historic low for the stock and is a fraction of the market’s current multiple, despite the company’s $20 billion cash position and commanding market position.
This seemingly anomalous valuation is the product of a market consensus that demand for personal computers, the market in which Intel first rose to prominence, has plateaued, and that the future of computing is in newer mobile devices like tablet computers and smartphones. Indeed, smartphone unit sales outpaced personal computer sales for the first time during the fourth quarter of 2010, according to market researcher IDC. Tablets are taking off as well; Apple (AAPL) recently introduced the second generation of its pathbreaking iPad product, and competitors are lining up to enter that market, expected to expand to hundreds of millions of units per year within the decade.
These newer, portable products require specialized chips that consume less energy than chips made for traditional computers. In the past, Intel has struggled to gain traction with its chip designs for this market, which has favored chips using architechture developed by UK-based ARM Holdings (ARMH), and designed by competitors, such as Nvidia (NVDA) and Qualcomm (QCOM).
Intel’s failure to capitalize on its earlier success may be the result of an inability to master the necessary engineering challenges, or a simple lack of commitment - an unwillingness to devote its best technology and engineering resources to what is still, for now, a smaller market (in dollars) with lower margins.
Nonetheless, Intel is taking discrete action to penetrate the mobile computing market, and we believe that its forthcoming Medfield chips - a new generation of low-power chips based on Intel’s Atom platform expected to be released over the next few months - will enable it to gain traction with smartphone manufacturers.
That said, Intel must also ensure that its chips are interoperable with mobile operating systems. Ironically, Intel faces a dilemma similar to the one faced by its PC competitors in decades past: the leading operating systems for mobile devices – Apple’s iOS, Google’s (GOOG) Android, even Research in Motion’s (RIMM) Blackberry OS – currently are designed to work best with chips built using ARM’s architecture. Intel has partnered with Nokia (NOK) to develop an alternative operating system, MeeGO. Even so, Nokia has not announced its concrete intention to build phones on this platform, focusing instead on Microsoft’s (MSFT - Free Microsoft Stock Report) Windows Mobile operating system. Further, Google is seeking greater standardization of the “open” Android operating system, which may hinder Intel’s ability to convince smartphone manufacturers to use its chips.
Even so, long-term trends in the mobile computing market may favor Intel. As smartphones and tablets begin to displace PC demand and become the primary devices for many users, these devices will require more processing power for the applications they run, such as voice recognition and video processing. This shift would play to Intel’s strength in developing high-performance chips.
We also expect Intel to see gains from the proliferation of data centers to support cloud computing and other network services. As wired and wireless broadband penetration increases, more data is likely to be created and consumed. In addition, as more applications move to the “cloud” – stored in the network rather than on personal devices – already strong demand from large customers such as Amazon (AMZN) and Google should see continued growth.
Finally, even the PC business may not have exhausted Intel’s avenues for growth. Prospects for global growth are still compelling, and the company is rolling out new products that may improve demand and profit margins. The company recently introduced its Thunderbolt technology for high-speed data transfers, and excitement is building around its “WiDi” wireless display product, enabling users to view laptop content on larger screens.
In sum, while the market seems to see Intel as an aging giant, we view it as a vigorous company with room to run in its core PC chip market, as well as strong future growth story across a variety of new markets.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.