will INTC make tablet/smartphone chips for AAPL?: the INTC view

recent analysts’ reports

A few days ago,Forbes published an article highlighting a report by Glen Yeung, an analyst from Citigroup, saying that AAPL will use INTC as the manufacturer for the advanced tablet and smartphone chips that it’s designing in-house.  Thsee chips will use ARMH designs, but INTC’s fabrication know-how.  Later on, speculates Yeung, AAPL could shut down its own design effort (more likely sell it to INTC, in my opinion) and rely 100% on INTC for both design and fabrication.

Similar reports have been circulating for at least a month.  In  typical Wall Street fashion, they follow a spate of other analysts’ output claiming exactly the opposite!!  –that AAPL, which uses INTC to power all its Macs, will ditch INTC entirely in the next year or two, in favor of its own ARMH-based chips.


I think this issue is interesting for three reasons:

–stuff like this is fun to talk about,

–what APPL decides now may be important to the market share it eventually stakes out in the tablet business, and

–contrary to what you may think, what AAPL decides makes no difference to the positive case for INTC stock.

I’m going to write about this last point today.

my take on INTC

1.  What catches most people’s eye about an advanced semiconductor plant, other than it requires highly specialized craft skills to run, is that it costs at least $3 billion to build.  That’s the wrong thing to focus on.  What’s more important is that to operate the plant effectively, you have to be able to sell the $7 billion+ of output it is capable of churning out annually.  If you figure the selling price of each unit at $100, that means 70+ million units a year.

If you don’t have a market that size, you’re not only pouring $3 billion down the drain by trying to make chips yourself, you’re ensuring a constant flow of red ink until you shut the plant down.

In other words, in today’s world it only makes sense for Intel, Samsung and third-party foundries like TSMC to build and  operate cutting-edge semiconductor plants.  ( In 2Q11, AAPL sold 3.8 million Macs and 4.7 million iPads;  that works out to about a 34 million units a year.)

2.  INTC is the best operator of advanced semiconductor plants in the world.  It has maybe a two-year lead over TSMC in process technology.

3.  The yin of mobile computing–the small size, low power market that INTC has missed up until now–has created a yang of demand for high power corporate servers and cloud computing that plays to INTC’s traditional strengths.

The fast growth of emerging economies over the past decade has created a large market of first-time computer buyers.  Unlike buyers in the US or the EU, who want tablets and smartphones, these customers want the high power laptops INTC has traditionally excelled at.

These businesses combined make up the majority of INTC’s profits today and are growing very rapidly.

4.  INTC’s stock has been such a poor performer recently that it’s now trading at about 9x earnings and yielding a tad below 4%.  If its consumer business in the developed economies were to completely vaporize today (including, of course, its Mac business with AAPL), I think the stock would still be trading at under 15x earnings and yielding more than Treasury bonds–but would be showing growth of 20%+.

5.  INTC had a management change a few years ago.  The new guys have been working very hard on delivering the small size, low power use chips that smartphones and tablets require.  So far, what they’ve done hasn’t been good enough.  But they’re making fast progress.  And who knows?

I think INTC now has a much better management than investors are giving the stock credit for.  But the real point is that at 9x and a 3.9% yield, the stock looks to me to have factored the worst possible outcome for the company’s business–and then some. So downside seems limited to me (remember, I own the stock), and hte upside oculd be large if INTC’s chips in 2012 onward perform as advertised.  Sure, having AAPL use INTC as a foundry would be a plus, but–yes or no–it doesn’t alter the fundamental positive case for the stock by much.


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