A short thesis on Intel

Intel Corp (XNAS: INTC) has experienced several setbacks in recent years due to technological delays and increased competition. Competitor AMD (XNAS: AMD) has taken share with a more competitive chip offering and a lower cost structure. Under its new CEO, INTC has laid out its turnaround plan which involves a $20bn investment plan up until 2024 on top of its historical end of range capex budget. We think the long timeline and massive spending are reasons to avoid INTC for now and given the recent rally on the new CEO announcement (+15% on announcement, and +26% following) we are short INTC. Although INTC has underperformed peers for years, the stock is overextended now given the ‘change of the guard’ with AMD taking the Silicon Valley crown recently.

Background

Intel designs and manufactures microprocessors, chipsets, motherboards, and wireless and wired connectivity products. INTC sells primarily to original equipment manufacturers (OEMs), cloud service providers and original design manufacturers (ODMs) and its three largest customers account for nearly 40% of revenue, with Dell Technologies, more than 15% of sales, and Lenovo Group, more than 10%, and HP Inc., around 10%. Intel derives ~50% of revenue from the consumer PC segment, while 33% is derived from data center servers.

Short Thesis

INTC lost the Silicon Valley crown over a series of missteps. Very simply, AMD has been closing the desktop CPU gap on Intel for years, and now stands at around 50/50 market share. But the damage was self-inflicted within INTC. In 2015, INTC released the ground-breaking line of 14nm chips, a significant improvement from the previous 22nm. Around the same time, INTC was already testing the next line, 10nm chips for release in 2017. But it wasn’t until 2020 that INTC finally released the 10nm chip. Taiwan Semiconductor Manufacturing (TSCM) was way ahead with high volume shipments of the 10nm since early 2017. Yet again, in July 2020 INTC announced its new 7-nanometer chip technology was six months behind schedule. AMD on the other hand, had no issues pumping chips out 24/7 at TSMC foundry, not just the PC -- but next-gen PlayStation 5 and Xbox Series X consoles. 

 With AMD getting 7nm to market before INTC, there has been a change of the guard and AMD for now will dominate. Further, AMD will follow with a 5nm product next year, putting additional pressure on INTC. INTC aims to enter the final design stage for the 7nm chip this year, with chips shipping in 2023.

When it comes to laptops and servers, the story is different. For laptops, Intel dominates AMD four to one, with the gap being far bigger when it comes to the server market. But the pandemic saw a decline in data center growth and a strong acceleration for PC demand over laptops. INTC also missed the surge into smartphones, which is dominated by Qualcomm. But to make the outlook even more dim in where INTC still dominates, its biggest customers Apple, Amazon and Microsoft have begun designing their own chips and outsourcing manufacturers to produce them.

INTC’s solution is... to continue doing what it’s doing. That is, to manufacture the bulk of chips internally rather than shift to fabless (outsourcing its manufacturing completely). INTC has laid out a $20b investment plan into new fabrication facilities (fabs) at its campus in Arizona, expected to be complete by 2024. The new CEO also indicated they would use external foundries more for certain chips. INTC also said that within the year it would detail further expansion plans in the U.S., Europe and elsewhere. In addition to the $20bn fab investment, INTC announced $19-20bn capex for 2021, up from $17bn in 2020. The aggressive capex plan is at the high end of INTCs historical range and R&D expenses will increase as the company will likely need to support parallel design processes, one each for its internal and external design teams.

INTC has also laid out plans to re-enter the foundry game (producing chips for other suppliers), but not only is it going to cost them a lot of money to do so but they are extremely unlikely to get the high-end chip business from AAPL, AMD, QCOM. There are 2 reasons for this:

1. They are direct competitors 
2. They simply don’t have the technology to fabricate chips on 3-5nm, which is the future path.

Any significant turnaround at INTC will be several years away, along with navigating cyclical and in-house issues that may weigh on fundamentals. INTC remains heavily dependent on PCs and the segment may have seen the peak with pull forward demand, just at the time when INTC is ramping investment.

Valuation

INTC is reasonably valued at 12.4-times 2022* earnings and justifiably below the peer average of 23x. But on a free cash flow (FCF) yield of 4.4%, it is more expensive than peers trading at 5.40%, before considering potential headwinds from a slumping PC market and chip supply shortages normalising, before INTC’s turnaround can bear fruit in 2023-24.

Risks to the short call

• PC and Data Center end-market demand improves
• Execution on 10nm / 7nm chip ahead of forecasts

Technical

INTC has been choppy and messy, but despite that, sentiment has been very bullish with a new CEO and investment plan. Nonetheless, the chart is forming a large double top and even if it's not confirmed there is no solid support until $45, from the $56 level currently trading, or 20% lower.