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Announcement on 23 September, 2024
Intel’s New Processor Launch Could Be The First Step To Restoring Investor Confidence
There’s been a lot of news flow concerning Intel over the last few months. It’s been mostly negative, but there have been a few positive developments more recently. I’ll start with the bad news, including Q2 results.
Q2 Results
- Revenue fell 0.9% compared to Q2 2023. The net loss of $1.6 billion, compared to a $1.4 billion profit a year ago and a $380 million loss in Q1.
- The client computing group reported a 9.5% increase in revenue over 12 months. To give this context, AMD’s client computing group reported a 49% increase in revenue.
- The datacenter segment reported a 3.5% decline in revenue. Again, for context, AMD’s data center group reported a 114% increase in revenue.
- The smaller segments reported lower revenue, while the foundry reported a slight increase in revenue.
- Most of the operating loss can be attributed to the foundry where the operating loss widened to $2.8 billion.
- The company also reported further cost-cutting initiatives.
I wasn’t expecting Intel to be reporting massive profits by now, but such a wide loss was very disappointing. The datacenter business is most concerning given the current investments being made by datacenter owners. Even more concerning, Intel seems to have excess inventory in this segment.
The PC segment is lagging, but customers may have been waiting for the new CPUs that have just been shipped. It’s also likely that the issues with CPUs crashing played a role too.
To me, the foundry segment’s loss does make sense as it’s expanding, and losses are likely to widen until more chips start coming off the production line.
High End 13th and 14th Gen CPUs Stability Problems
Gamers and users of other high-performance CPUs have reported processors crashing under certain conditions.
Intel has released a patch that seems to be working. It has also stated that this issue won’t occur in the new chips as they use a completely different architecture.
Loss of Investor Confidence
For many investors, the Q2 results, and the stability problems with some chips, were the final straw. Investors were already growing skeptical after the foundry business began reporting separately. It seems that some of the financials over the last 18 months have been structured to obscure the true state of the business and the amount the turnaround will end up costing.
And now onto a few positive developments. The true test of Intel’s new products was always going to begin in H2 2024. That seems to have begun with the release of the Lunar Lake chips, but there have also been a few surprises.
Qualcomm is reportedly interested in acquiring Intel:
- The ‘hot take’ is that regulators would block this deal. I actually think they may turn a blind eye in the interest of developing US chip manufacturing capacity.
- A merger/acquisition would create a semiconductor powerhouse with a significant share of the PC, datacenter and smartphone markets.
- A combined company would be selling X86 and ARM chips. This would allow the company to hedge its bets. However, it could also result in a lack of focus and difficulty in making decisions about priorities.
- For now, I’m not going to assume this deal will happen, but will monitor developments.
Amazon Partnership
Amazon AWS has contracted Intel to manufacture custom AI chips using Intel’s 18A process technology. Intel will also be manufacturing custom Xeon 6 chips as an extension of a current agreement. This is a huge sign of confidence for the foundry business and will give Intel better exposure to the datacenter and AI market.
Lunar Lake Release
Intel’s Lunar Lake CPUs, now called Series 2 Core Ultra, were released on 3 September. These processors are designed for ultra-thin notebooks and mobile devices. Most of the leading notebook manufacturers have already announced new products with the processor. In fact Microsoft has confirmed that its Copilot+ will run on 80 new notebook designs powered by these chips.
Early reviews have been very positive, particularly regarding power efficiency. The release has also generated excitement about the upcoming Arrow Lake chip which will be used in high-performance and general-purpose PCs.
The Lunar Lake chips are being manufactured by TSMC using its 3-nanometer process. They were originally supposed to be manufactured in house using Intel’s own 18A process, but this does at least bring Intel into line with its competitors. I believe the market’s reception to these chips over the next few months will be pivotal to Intel’s future. Restoring customer confidence in the company would be a great first step to restoring investor confidence.
Foundry Spinoff
Intel has finally announced that IFS will become an independent subsidiary. This will avoid the current conflict of interest between Intel and its competitors, which are also potential customers. Investors have demanded this for a long time - but I’m not so sure it will make a big difference to Intel’s finances unless a substantial stake in IFS is sold. So far, Intel has only indicated that IFS will be an independent subsidiary.
What does this mean for my narrative?
My thesis for investing in Intel was always asymmetrical in that I believed there would be about 30% of downside risk vs 100%+ of upside potential. The biggest risk was execution on the new product roadmap. There has been a lot of bad news, but most of it hasn’t concerned the launch of the new chips, which seem to be largely on track.
I actually think the investments Intel is making will eventually pay off. However, any delays will make a substantial dent in my forecast for net income. In particular, Intel could miss out on the current PC cycle, and further delays in cash flow generation would change the funding picture. The foundry business wasn’t part of my narrative, but ongoing and increasing losses for this unit will be.
I’ll need to adjust my fair value estimate, but I’m going to wait a few weeks. The new Lunar Lake CPUs (and the PCs that contain them) will be more widely available later this week, so I’d like to see more reviews and initial sales numbers. I’ll also be looking for further comment on the acquisition bid from Qualcomm.
Key Takeaways
- Market has low expectations for Intel due to a series of strategic errors in recent years.
- Market is underestimating Intel’s aggressive strategy to regain product leadership.
- Intel’s new processors will offer significant improvements in performance, efficiency and flexibility.
- These new product releases will coincide with an inevitable recovery in demand for CPUs.
- EPS will double in five years due to incremental improvements in demand, market share and margins.
Catalysts
Company Catalysts
Intel is back on the offensive
Intel lost its edge during the years prior to 2020 by playing defensively. This was a strategic error and the company is now going all out to correct it and reclaim product leadership.
Recent capital allocation decisions prove just how much Intel’s priorities have changed: Stock buybacks have been suspended and the dividend has been cut by 60%. Instead, Intel has spent $32 billion on R&D during 2021 and 2022. For context that compares to $5 billion at AMD and $7.4 billion at Nvidia during the same period.
The market is still focussed on how Intel’s current product lineup compares to AMD, and on Intel’s historic first quarter loss. Two years ago when CEO Pat Gelsinger took over he said the turnaround would take five years. Anecdotal evidence suggests that most of the key timelines are still in place and guidance for 23Q2 was recently raised.
A roadmap to reclaim product leadership and market share
Intel’s roadmap to 2026 will not only make it competitive with AMD, but offer customers more choice and flexibility. As Intel progresses through 5 process nodes it will also be introducing an entirely new, flexible and efficient architecture.
Source: Electronics Weekly
PC and Mobile Processors
Raptor Lake (in production since late 2022) is the latest core CPU using Intel’s 7nm process. Though the architecture is similar to the Alder Lake CPU, increased core counts have resulted in improved performance.
Meteor Lake (due H2 2023) will be the first core CPU using the Intel 4 process. It will also be the first processor built using Intel’s new tiled architecture which stacks separate components (including components from other manufacturers) to create a single chip.
This modular approach means Intel can mix and match components from different process nodes and manufacturers to create processors for specific market segments. It will also be able to react to changing demand trends relatively quickly.
Arrow Lake (due 2024) will be the first chip from the Intel 20A (~ 2nm) process. With this generation of processors, Intel will be using a new transistor architecture and a new power delivery scheme. The new design and higher density will translate to significantly improved performance and power efficiency.
Arrow Lake will also include a substantially more powerful 3nm iGPU which will make all but the most powerful discrete GPUs unnecessary.
Lunar Lake (due 2024) will be Intel’s first chip from the 18A (~1.8nm) process. These processors will offer ultra low power performance and are being developed in partnership with OEMs specifically for lightweight, ultra-thin devices.
Datacenter Processors
Intel’s XEON datacenter processors will follow a similar series of architecture changes, and include an additional node (3nm). The next four generations of the XEON chip are:
- Intel 7: Emerald Rapids (due Q4 2023)
- Intel 3: Sierra Forest (due H1 2024)
- Intel 3: Granite Rapids (due H2 2024)
- Intel 18A: Clearwater Forest (due 2025)
Complementing the CPUs are Intel’s Gaudi2 processors designed for deep learning and inference, and currently used at Amazon AWS.
The new and improved value proposition
Intel’s x86 product list is going to be completely transformed over the next three years:
- Intel will be able to compete with AMD on performance and efficiency at each price point.
- Intel will then have the flexibility to help OEMs meet end user needs with any combination of price, power efficiency, performance and graphics capabilities.
- The improved GPUs will allow OEMs to remove discrete GPUs on some devices, thereby lowering costs.
- The ultra low power performance chips require smaller batteries, so OEMs will be able to build thinner and/or cheaper devices.
This new proposition will allow Intel to comfortably reclaim 5% market share from AMD by 2027 - and possibly quite a bit more.
The narrative could improve considerably
80% of Intel’s revenue comes from the client (50%) and datacenter (30%) segments. The remaining segments are unlikely to move the needle in the next five years, but could become game changers beyond 2027.
Intel Foundry Services: Intel has an ambitious goal of becoming the world’s second largest foundry by 2030, and manufacture chips for other leading chip companies. To do this it intends to eventually invest up to $100 billion in partnership with the government and other investors. Seven new fabs are currently being built in the US. Germany and Ireland, four of which are dedicated to 18A and 20A processes.
IFS is now on a revenue run rate of ~$500 million which will increase by about $1.5 billion with the recent acquisition of Tower Semiconductor. It’s unlikely to contribute meaningfully to total revenue by 2027, but could contribute very meaningfully to the picture after 2027.
If Intel’s new architecture proves to be successful, it will have a proprietary and flexible process to offer to fabless semiconductor makers, as well as companies like Apple that are developing their own chips. In addition, it will offer chipmakers the opportunity to diversify their production away from TSMC and Samsung.
Mobileye: Intel owns 94% of the autonomous driving and driver-assistance technology company. Mobileye has partnered with many of the leading automakers and is already showing strong growth and has two new level 4 ADAS (advanced driver sssistance systems) products due in the next two years.
Revenue could actually become meaningful for Intel by 2027, but margins would probably be low. Beyond 2027 Mobilye could become a significant growth engine.
GPUs, IoT, FPGAs, networking and edge computing: Intel sells dozens of other products, mostly in growing markets. There are no obvious catalysts likely to lead to standout performance from these products in the short term. But each of these product categories could turn into a major opportunity down the line - ie, they add optionality to the investment case.
Industry Catalysts
A cyclical rebound in CPU demand
PC sales and demand for CPUs in general fell in 2022 and the first half of 2023. This was the result of sales being pulled forward during the pandemic: Companies upgraded PCs to allow employees to work remotely, consumers upgraded their own PCs for gaming, and data centers were expanded to support cloud growth.
Semiconductor inventories also increased as companies over-ordered to counter supply chain bottlenecks.
PCs are typically replaced every 3 to 6 years, so a new replacement cycle will need to occur over the next few years. At the same time, inventories are now being drawn down which will soon lead to accelerating demand. Much of the current focus is on AI investment for data centers - but this will still need to be complemented with CPUs.
Source: Semiconductor Engineering
A cyclical recovery in demand is now inevitable in the next few years, just as Intel rolls out four new generations of processors.
Onshoring and the ‘TSMC risk’
The US and EU are providing funding and incentives to companies building fabs in the US and Europe. This is being done to reduce reliance on ‘geopolitically at risk’ TSMC and bring manufacturing jobs back to the US and Europe. Intel is probably the biggest beneficiary of capitalizing on the opportunity.
Besides the subsidies and incentives, this also makes Intel a compelling partner for OEMs wanting to support these initiatives and secure their own supply chains.
Assumptions
Global CPU sales rebound from 2024 to 2027:
The inevitable rebound in CPU demand will result in industry wide sales increasing at 7% between 2024 and 2027. This compares to forecasts for the 2021 to 2030 period that average around 5%.
Intel wins back 5% market share from AMD:
Intel’s product range will become increasingly more competitive as the Intel 4, 3, 20A and 18A products are released. Customers will also be keen to diversify their supply chains in light of the TSMC risk.
The market will be eagerly anticipating the new product launches, which will serve as a catalyst for accelerating sales volumes. Intel should therefore be able to win back 5% of the market from AMD.
Revenue increases to $91 billion for FY2027:
Intel’s revenue for the datacenter and client segments should comfortably grow at 8.5% a year due to the 7% market growth and 5% market share gains. This will bring revenue for the two segments to $75 billion for 2027. I’m assuming revenue for the remaining segments will increase at 5% a year to reach $16 billion. So Intel’s total revenue for 2027 will be $91 billion.
Net profit margin reaches 22%:
Intel has a long term operating margin goal of 27 to 33%, while its average net margin over the last 10 years was 20.2%. The company is already cutting costs in some areas, and after 2025 will be able to reduce R & D spend relative to revenue. With accelerating revenue growth and cost increases slowing, the net profit margin will be at least 22%.
EPS will reach $4.8 by 2027:
Assuming the share count remains unchanged, $91 billion in revenue and a 22% net profit margin means EPS will be $4.80 in 2027. This will be a 150% increase from the $1.92 Intel earned for FY2022.
Risks
There are several risks that could derail my narrative:
Execution risk
Intel has had numerous production delays in recent years. It does seem that the company is now more focussed and managing to stay on track, but the risk is still real. While I don’t believe these risks are that high, they’re worth keeping mind for an understanding of probabilities, and expectations
The balance sheet, funding and debt:
If Intel's turnaround is delayed, the company’s financial health would become an issue. I’ll be monitoring their project execution timeline, and seeing how the company’s balance sheet and debt affordability travels as things develop.
Industry growth
Forecasts for the growth of the digital economy including cloud software, AI, gaming etc are quite optimistic. If these trends lose momentum, the entire hardware sector will be affected, including Intel.
AI and GPUs
There is some speculation that AI will eventually make CPUs obsolete in data centers as workloads move to GPU powered algorithms. I believe Intel is positioned within the industry to navigate these risks should they become more likely and or more prominent.
How well do narratives help inform your perspective?
