Why We Are Neutral On Intel Despite Decent Q2 Results

by Trefis Team
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We have kept our price estimate for Intel (NASDAQ:INTC) at around $36, despite the strong growth that the company reported in its key segments such as data centers and client computing, which prompted it to raise its full year forecasts. We do acknowledge that the semiconductor giant is holding its ground. It still has a strong position in the  data center market, and has impressively managed to increase average selling prices of its notebook microprocessors this year. Intel’s relentless focus on performance has earned it a loyal client base. However, we believe that its rivals such as AMD (NYSE:AMD) and Nvidia (NASDAQ:NVDA) are closing the gap. The biggest risk for Intel right now is potentially losing its grip on the data center market, which we expect to grow much faster than the traditional personal computing market, thanks to growth of big data analytics and artificial intelligence. Nvidia and AMD are making investments to capture this growth. Our unique interactive platform allows you run scenarios and gauge their impact on Intel’s earnings and valuation. Here is a “bear case” scenario where Intel loses nearly half of its share in the server market in the next five years. Such a scenario would imply nearly a 20% downside to our current $36 price estimate for Intel. Our price estimate is slightly ahead of the current market price.

See our complete analysis for Intel

Uncertainty Around Intel’s Latest Bet On AI Market

To Intel’s credit, it has recognized the need to invest to capture the growing AI (artificial intelligence) market. It expects to close the acquisition of Mobileye, an Israel-based autonomous vehicle technology company, in the third quarter of this year. But considering that Mobileye had revenues of less than $400 million in 2016, a price tag of $15 billion is fairly steep. This clearly suggests that Intel is very bullish on the company’s prospects, as well as the autonomous vehicle market in general. However, with a hefty price tag comes added pressure to make the acquisition work. This increases the company’s overall risk in our perspective. Intel needs this bet to pay off, but on the bright side it estimates a $70 billion market opportunity for autonomous driving systems, data and services.

Data Center Growth Impressive, But What Comes Next?

Intel registered nearly 9% growth in its data centers segment in the second quarter of 2017. This was driven by cloud and communication service providers, which more than offset the decline in the enterprise business. However, it all boils down to Intel’s new Xeon scalable platform for the data center market, which the company touts as the biggest improvement in a decade.

Intel claims that it saw the largest early shipment program in history, when it shipped nearly 500,000 new Xeon processors to clients who wanted to test them out early. However, the number of clients was limited to 30. We believe that it would be premature to draw any concrete conclusions from this effort. There will always be a set of clients who will be loyal to Intel and prefer high computing performance over anything. The risk lies with the rest of the client base, who could start to see that the yield of computing power per dollar spent has started to look impressive for AMD server processors and Nvidia’s GPUs, which are finding strong acceptance in the cloud and AI markets.

With AMD, Qualcomm and Nvidia targeting the data center market, Intel will likely have a hard time maintaining its dominant share. Some of the comparisons that Intel made in its recent product launch did not fully address the section of the market that competitors like AMD are targeting. Even if Intel does maintain its leadership in the high performance segment, it still has some downside risk related to competitive pressure. Some channel checks suggest that Intel could face some competition from AMD’s new EPYC architecture chip. In addition, one of the most significant threats could come from Nvidia, whose GPUs are adept at the parallel processing required by many data centers, especially those powering AI and big data analytics. Overall, Intel is very likely to see some pressure on its server market dominance going forward.

Nevertheless, investors can take comfort in the fact that, unlike the consumer market, the server market is relatively slow to change. Semiconductor research firm Mercury Research notes that product changes only tend to show up in market share data after a lag of 18 to 24 months.

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