INTC Research Notes

Topics: INTC, Layoffs, Chip Manufacturing, Inventory Glut, Competitive Advantages, "Voluntary Unpaid Leave"

What's The Dealio Here?

Team, I haven't been able to get my mind off of Intel for the last week and, after digging into the nitty gritty details, I can now share why (don't worry all my banker friends, I didn't boil the ocean here - IFYKY lol).

Intel has several business segments, here's the DL on each of them:

• Client Computing - "CCG" (51%): This is Intel's bread and butter and is their largest revenue generator, including computer processors and related components for notebooks, desktops, and other personal devices; yes, this includes the little sticker thingy on the edge of computers when you first buy them. Unfortunately, fewer stickers are being sent out this year, as the sales from this group are taking a big fat L (operating income decreased by 53% YoY YTD). Yikers. Fewer notebooks and desktops are being sold, and INTC is also ramping down its 5G smartphone modem business. On the bright side, at least this segment is profitable...

• Datacenter and AI - "DCAI" (30%): As INTC eloquently states in its 10-Q, "DCAI delivers workload-optimized platforms to empower datacenter and hyperscale solutions for diverse computing needs" (p. 26). In English, this group supports high-performance computing from a software and hardware perspective. Server volume decreased 29% over the most recent quarter; Server volume and average selling prices both decreased 6% YoY, causing quarterly operating income to be $0. This decrease was largely influenced by enterprise "customers tempering purchases to reduce existing inventories in a softening datacenter market" (10-Q, p. 26). This group is one bad quarter away from negative profitability, but we'll get into that momentarily.

• Network and Edge - "NEX" (14%): NEX gives companies open software for access to all network control points. Not that I know much about this, but the agility of the platform seems like it gives developers a lot of flexibility. Anyone have thoughts here? Based on the segment's financial results (up $900M YoY YTD), it seems like people are a fan of these projects. Unfortunately, the segment barely had positive operating income. Yes, I also thought that this segment would have a happy ending... Maybe next year.

• Accelerated Computing Systems and Graphics - "AXG" (1%): Feels like the name is largely self-explanatory here, but for safe measure, this group develops accelerated computing systems and graphics processing units designed for gamers, content creators, and the users of supercomputers. The group is going through a reorg, which is probably good considering Intel's best GPU is playing 96th fiddle to dozens of GPUs from AMD and Nvidia. Oh, revenue's slightly up YoY relative to 2021 YTD, but the segment's lost $1.3B YTD. Now the reorganization of the group is starting to make sense...

• Mobileye (3%): This is (was) a special part of Intel, as it is seen as the leader in self-driving technology (sorry Elon) and had growing revenue and operating income. Well, in an attempt to capitalize on the only thing going well for Intel this year, they decided to IPO the segment in October; Intel still owns ~99% of the voting shares of MBLY, but was able to generate $861M in an otherwise oof of a year. This shows their commitment to their IDM 2.0 initiative (more on that shortly). As Michael Scott once said, "You miss 100% of the shots you don't take". But, as I like to say, "Sometimes you miss 100% of the shots you do take". But you know what a basketball is really good at? Bouncing back.

• Intel Foundry Services - "IFS" (1%): Intel launched the Foundry to help companies without manufacturing capacity to develop their products. They offer silicon, packaging, software, and chiplets instead of just supplying wafers (no, not the cookie).

For a breakdown of revenue and operating income, see the charts below (they are busy, IK, not my fault Intel has so many segments. Sry, but plz fx your attitude. Thx).

Supply Chain Shortages, but The Opposite

In 2021, Intel announced the introduction of IDM 2.0. The goal of this initiative is to further expand their manufacturing capacity, increase outsourced manufacturing of some of their parts, and increase the services of the IFS group, all while reducing dependence on Asian manufacturing. To support this initiative, Intel is making significant capital investments to increase manufacturing capacity and accelerate its process technology roadmap; Intel is also increasing investments in R&D. The goal: 10%-12% YoY growth rate by 2026 and gross margins between 51% and 53% over the next few years before moving upward (for context, revenue growth is negative and gross margins were ~47% during the LTM period).

To see how the IDM 2.0 initiative has impacted Intel's strategy, see the chart below:

*LTM as of 10/1/2022

Long story short, Intel is significantly increasing its manufacturing capacity to reduce dependence on Asian manufacturing in the midst of excessive chip inventory. This is good for the long-term, but has significantly increased Intel's capital requirements and expenses (relative to revenue), which is not good over the short term given its quickly eroding profitability.

Here are several examples of how Intel is implementing their IDM 2.0 strategy:

• Acquisition of Tower Semiconductor - $5.4B acquisition that is expected to close during the first quarter of 2023. The deal requires approval from the US, China, Germany, Israel, Japan, the UK, and Italy.

• Partnership with Brookfield Asset Management - Intel recently reached an agreement with Brookfield Asset Management for $30B of funding for the construction of more manufacturing capacity in Arizona (Arizona Fab LLC).

• $20B semiconductor manufacturing plant in Ohio - This is said to be one of the largest private company investments in the state. Intel has said that there is potential that the region could hold as many as 8 fabs ($100B investment).

• $36B planned investment through the EU - Intel plans on building two factories in Germany in 2023 (production online in 2027), creating an R&D and design hub in France, and investing in R&D, manufacturing, and foundry services in Ireland, Italy, Poland, and Spain. Intel also has plans on investing €12B to double the manufacturing space of a facility in Ireland. 

These investments have increased the number of assets Intel has on its books, which, when paired with falling revenue, has led to lower asset efficiency ratios.

Look, I Think We Should Take A Break...

It's not you, it's me. That's what Intel's leadership team just told several thousand manufacturing workers across the globe. That's also not including the several hundred employees that Intel is breaking things off with at the end of the month. Here's what Andy Burr, Intel's spokeswoman, had to say about it:

This is the professional equivalent of saying, "Hey, you're great and I love spending time with you, but I just need some time to think and figure some things out on my own." Outside of the uncertainty, stress, and anxiety this creates, it almost certainly decreases employee loyalty and trust; plus, how often have things gone well after a couple takes a prolonged "break"? I'd argue that it's not often. I'd know... 😅

The outcome: Intel reduces costs, keeps its manufacturing human capital, and doesn't have to hire new people (which is v expensive), while employees get placed on unpaid leave hoping their jobs will still be there when they get back (which they probably will be given the considerable investments Intel is making across the globe}. It's likely that more layoffs will occur in the not-so-distant future, but it'll likely hit non-manufacturing groups.

I'm partly baffled and partly okay with Intel's voluntary unpaid time-off decision. On the one hand, I think it's great that they are doing what they can to keep employees for the long term given the current economic climate. On the other hand, if you really need to cut costs, why don't you just fire them? Is it really going to benefit the company by not paying several thousand people 3 months of salary (80,000 [estimated annual salary] * 0.25 [period of year that salary isn't paid] * 4,000 [guess at voluntary leave participants] = $80M). Is ~$80M worth it? Plus, there are no significant debt maturities impending in 2023.

What About The Other Major Playas??

Here's a pretty chart illustrating INTC's disappointing performance...

I'm cringing v hard. This is not good. Intel has taken this big fat L largely because they've been losing market share to AMD and NVDA; as previously discussed, Intel's products are behind those of AMD and NVDA. All companies are aggressively investing in manufacturing, though INTC has clearly lost significant market share over the previous few years. It appears like INTC has made some positive headway over 2022, but future decreases in market share are expected.

What you get with Intel is a cash flow-positive business with deteriorating competitive advantages that is committed to future growth that's trading at a low valuation (price/book value of equity is approaching one).

Summary

The semiconductor industry, specifically Intel, has taken a lot of Ls as of late, though the industry is still relentlessly investing in future manufacturing capabilities and R&D; few have been more active in investing than Intel. Despite falling demand and deteriorating profitability, Intel is relentlessly investing in future projects and is committed to the future of the company. Losing market share, firing employees, and investing in a high cost of capital environment are all tough, but it's made the stock cheap relative to its peers. Considering the capital-intensive nature of Intel's business, they haven't taken on a significant amount of leverage (they aren't financially over-extended right now) and are attempting to position themself for future success. The company's been in rough shape for a few years now, and, despite their attempts at pulling Intel's share price out of the gutter, I'm afraid that the worst for Intel isn't over. I like the amount that Intel is investing, but expect investors to continue punishing Intel because heightened construction material costs, continued construction worker shortages, and the lengthened duration of cash flow their investments will result in are all headwinds in this economic environment. Earnings incoming on 1/26/2023.

For me, determining whether to buy, hold, or sell will come down to our ability to discern Intel's ability to re-establish its long-term competitive advantages through this IDM 2.0 initiative. If Intel is unable to catch up and pass its competitors in terms of technological sophistication, then it's probable that Intel will continue sputtering out; a resurgence of technological dominance, however, would do wonders for the company (and its stock price). Unfortunately, I am not an expert on semiconductor specifications, so I'm afraid I can't make a great determination regarding this, but I do plan on dabbling in some semiconductor ETFs, such as SMH, SOXQ, or SOXL (SOXL is triple leveraged if you really want to show the world you're bullish) in the not-so-distant future.

In Conclusion...

• Almost all of Intel's business segments have struggled throughout 2022. Mobileye was the only one to do well, though it IPO'd in October.

• Intel has taken a lot of Ls because they are falling behind their competition.

• Intel's IDM 2.0 initiative requires a significant amount of investment into manufacturing, infrastructure, and R&D. This may help Intel gain market share and compete better with competitors, though it will be a costly endeavor to get there.

• Joining in on the layoffs, Intel decided to spice things up by asking employees to take "voluntary unpaid time-off".

• Despite their commitment to becoming the best semiconductor manufacturer, the impending economic recession (featuring slowing consumer and business spending) will give Intel a few more Ls to hold before they start taking some dubs.

• If you're like me and aren't a semiconductor expert, then an ETF on the sector may be your best bet to get exposure to the industry.