Two Factors That Can Alter Intel’s Valuation By More Than 10%

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The persistent decline in PC shipments, its late entry in the mobile market, and increasing investment in building out its technology impacted Intel (NASDAQ:INTC)  in 2012 and 2013, variously constraining revenue growth as well as its bottom line. However, driven by its participation in a broader range of devices and emerging segments, the company closed 2014 on a strong note, reporting revenue, operating income and earnings per share of $55.9 billion (up 6%), $15.3 billion (up 25%) and $2.31 (up 22%), respectively.

Intel strives to use its manufacturing leadership to transform the company by developing leadership products across a broad range of end-markets. Despite a weak Q1 2015 (on account of weakening PC sales), the data center, IoT and NAND businesses accounted for approximately 40% of Intel’s total revenue and two-thirds of its overall operating profit. Innovating in its client business, improving mobile profitability, and investing in and growing profitable adjacent markets remain key focus areas for the company going forward.  In the mobile business alone, Intel plans on improving its profitability by $800 million this year.

Our current price estimate of $35 for Intel is just marginally above the current market price. In this article we list down some factors/ scenarios that can lead to a significant upside/ downside in our valuation for the company.

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See our complete analysis for Intel

Intel currently derives approximately 50% of its valuation from the PC market, as per our estimate. The company has been the dominant leader in the notebook and desktop processor and chipset market for years, and currently accounts for more than 80% of the market. We forecast Intel’s PC market share to decline marginally over our review period as we expect the entry of ARM based  players to intensify competition in the market. However, even if Intel’s market share in PCs declines drastically over our forecast period, it will not have a significant (>5-10%) impact on our valuation for the company. You can alter the forecast in the graph below to see how a drastic decline in Intel’s market share in PCs impacts its stock price.

1. Intel’s Server Processors Market Share Declines To 50% (~10% Downside)

The server processor division accounts for approximately 28% of Intel’s’ valuation, as per our estimate. Intel’s Server Processor market share has increased from 85% in 2007 to 98% at present. Having lost market share to AMD several years back, Intel has steadily regained its share in the server processor market. The success of Intel’s Xeon processors combined with AMD’s execution issues are the key factors responsible for Intel’s success in the server processor market.

Intel’s data center business continues to see robust growth as a result of the build-out of the cloud, data analytics and a strong product portfolio. Towards the end of last year, Intel launched the new Xeon E5 processors (Grantley), which provides features and performance that are optimized for compute, storage and network workloads, respectively. The Grantley Xeon CPU is seeing strong uptake and is already 50% of Intel’s two-socket volume. Approximately 50% of the 19% growth in Intel’s data center business in Q1 2015 was driven by Grantley.

New products like Grantley, along with Intel’s increased support of custom versions of the product, are helping to drive growth in cloud revenue. Intel’s data center team is customizing its Xeon products for specific customers and workloads. Over the last year, volume from custom SKUs has grown at three times the rate of Intel’s off-the-shelf products. Facebook, eBay, Microsoft, and other Web giants have been avid buyers of custom Intel server CPUs. [1]

We currently forecast that  Intel’s server processor market share to decline to 88% by the end of our review period. With new improved servers, industry-leading graphics processing capabilities, and strategy to embrace both the x86 and ARM architectures, AMD remains committed to strengthen its foothold in the server processor market.

In October 2012, AMD announced its collaboration with ARM Holdings to design server processors using the ARM technology in addition to its x86 processors for multiple markets, which makes AMD the only processor provider to bridge the x86 and 64-bit ARM ecosystems. AMD believes that ARM CPUs have the potential to account for 20% of the server market by 2016 or 2017. [2] If AMD manages to accelerate its progress in the server processor market and its collaboration with ARM helps the company increase its market share to historical levels, it can have a considerable impact on Intel’s valuation. If Intel’s market share declines to as low as 50% over our review period, it will lead to an approximate 10% decline in our price estimate for the company.

2. IoT Becomes A Significantly Bigger Part of Intel’s Business (~12% Upside)

Having missed out on the mobile revolution, Intel is determined to be an early entrant in the Internet-of-Things (IoT) market, which is considered to be the next big wave in computing. Last year, the company changed its reporting structure and made IoT a stand-alone segment, underlining its growing focus on the business.

Research firm Gartner expects the installed base of the IoT units to increase from 3 billion in 2013 to 25 billion by 2020. Gartner estimates that IoT will support total services spending of $69.5 billion in 2015 and $263 billion by 2020. [3]

In addition to introducing new platforms, Intel has launched a number of products and initiatives in the past year with different fashion, fitness and lifestyle brands, to accelerate its presence in wearables. These include the acquisition of Basis Science, the partnership with renowned rapper 50 Cent to create fitness-tracking headphones, the collaboration with Opening Ceremony to launch a fashion accessory MICA, as well as the partnership with Fossil, Tag Heuer and Luxottica, among many others.

Intel currently derives less than 10% of its valuation and approximately 5% of its revenue from the IoT segment. We believe that accelerating its entry in IoT augurs well for Intel’s long term growth potential, and estimate the segment will  account for approximately 10% of Intel’s total revenue by the end of our forecast period.

Given the growth potential in IoT, there is a possibility that we are underestimating Intel’s growth potential in the space. For example, despite the vast growth potential in the automotive segment, Intel still has a long way to go to make a mark in this sub-segment of IoT. (Read: Intel Still Has a Long Way To Go To Make a Mark In The Automotive Industry) Given Intel’s technology prowess, it won’t be a big surprise if Intel steps up its effort in the auto segment and becomes one of the key suppliers of In-Car Infotainment and Advanced Driver Assistance Systems. If Intel’s IoT revenue increases to $20 billion by the end of our review period (versus our current estimate of $6 billion), there will be an approximate 12% increase in our valuation for the company.

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Notes:
  1. Intel talks server demand and mobile profits on CC; AMD and MU higher, Seeking Alpha, October 14, 2014 []
  2. AMD reboots server technology strategy with first ARM chips, Tech World, June 18, 2012 []
  3. Gartner Says 4.9 Billion Connected Things Will be in Use in 2015, Gartner Newsroom, November 11, 2014 []