Intel's Foundry Spinoff: A Turning Point or Continued Struggle?

Intel Stock: Turning Bullish For The First Time In Years (NASDAQ:INTC)

The output of a conservatively-built DCF model suggests Intel's current valuation fails to reflect the company's turnaround potential accurately, creating a window of opportunity for contrarian investors. Intel Corporation (NASDAQ:INTC) is a company that I have closely followed for many years because of the strategic importance of the company as a U.S. chipmaker. It would not be true if I were to claim that I was not waiting for an opportune time to invest in the company, too because turnaround opportunities often deliver lucrative returns when projections go according to plans. When it appointed Pat Gelsinger as CEO more than three years ago, Intel had a difficult task ahead of itself, as competitors such as Advanced Micro Devices (AMD) and Nvidia Corporation (NVDA) were aggressively taking market share from the company. Back in January 2021, when the CEO transition announcement was made, I thought this was a prudent move but decided to stay on the sidelines as I wanted to see some tangible progress before betting on a turnaround. The execution of Intel's turnaround plan may not have been perfect, and the market performance speaks volumes. INTC is down more than 60% YTD and at a stock price of close to $19, the recent highs of around $70 registered in 2021 seem a country mile away. Under CEO Pat Gelsinger's management, Intel is undergoing significant restructuring amid intense competition and continued financial struggles. Some of these measures include extreme cost-cutting and reorganization of capital expenditure as the company tries to restructure its business to make the most of the booming semiconductor market. According to Reuters, the management team is preparing to present a new plan to the board of directors later this month to get the approval for a major business reorganization, which includes a potential spin-off of key assets and business units. A closer look at the proposed actions and other recent developments suggests Intel is entering a new business phase that would determine its long-term financial future. After updating my discounted cash flow model for Intel, I finally feel there is a sufficient margin of safety to bet on Intel's turnaround potential, at least based on my risk tolerance. Before diving deep into the latest reorganization strategy, Intel is rumored to pitch to its director board, it's important to understand some of the other recent measures Intel has taken to improve its financial performance. Although these strategies signal progress toward recovery, Intel has yet to see a meaningful recovery in its financial performance. As illustrated below, Intel's revenue growth has failed to pick up meaningfully despite several promising initiatives introduced by the company. It is important to note that most of the new strategies embraced by CEO Pat Gelsinger are long-term initiatives that would take years to play out successfully. For example, the goal to take process leadership in the advanced chip manufacturing market would take at least three years from now, given the head start of its competitors. Against this backdrop, Intel is reportedly preparing to pitch a few other strategies to its board of directors to accelerate the business transformation. The details of Pat Gelsinger's financial roadmap are to be released during the board meeting scheduled for mid-September. The main goal is to rationalize the business and focus on the semiconductor and integrated circuit business. To achieve this, Intel may divest some of its non-strategic assets, slash the capital investment budget, and commit to even more workforce reductions if needed. As reported by Reuters, Morgan Stanley (MS) and Goldman Sachs (GS) have been called in by Intel to assist with asset disposals and restructuring efforts. The company targets to cut down capital expenditures to $21.5 billion in 2025, which is 17% lower than the level of 2024, which confirms that the company is planning to be conservative on the deployment of capital in the future. Additionally, according to Reuters, Intel may close down the Ignite accelerator program while simplifying its global partner organization, SMG, to become a leaner and more agile company. Reuters also suggests that Intel may consider divesting Altera, the company's programmable chip unit, which it acquired for almost $17 billion in 2015. Intel's recent divestiture of its investment in Arm Holdings, Astera Labs (ALAB), and Joby Aviation (JOBY) confirms that the company is trying to focus on its core business and is planning to raise cash to support investments in technology. The restructuring is fueled by the transformation of the company into an AI powerhouse and the need to overcome the worsening financial position. Intel posted a worse-than-expected loss for the second quarter of 2024 on the back of revenue of $12.8 billion, down 1% year-over-year. The company's overall profitability has deteriorated dramatically in the last five years, with net income declining from $21.05 billion in 2019 to just $1.67 billion in 2023. In addition, Intel had to suspend the quarterly dividend last month on the back of dwindling profits and free cash flow. To revive growth, therefore, the company has to take aggressive, bold actions. Pat Gelsinger is determined to meet the most ambitious objectives, including transforming Intel into the number one foundry in the world, dethroning Taiwan Semiconductor Manufacturing (TSM). However, these plans have met substantial execution barriers in the real world. For instance, investments in the foundry business have not delivered the desired results so far, with the business unit losing nearly $10 billion annually and only projected to break even by 2027 in the best-case scenario. The company's other long-term goals such as delivering five upgrades to its advanced chips within just four years and aggressively expanding manufacturing capacity in the U.S. with the help of funds it has secured from the CHIPS Act seem to be taking a toll on the company's liquidity profile, evident from the substantial cost-cutting measures Intel has been looking at to bridge the funding gap. Bernstein analyst Stacy Rasgon, commenting on these liquidity issues, said: The problem is the business itself is not really supportive of those plans. The issue is the revenue assumptions he (Pat Gelsinger) had while they were making these investments. Some analysts are already questioning the rationale behind a strategic split of the foundry business, which is rumored to be on the cards when Pat Gelsinger presents his new reorganization measures to the board in a few weeks. Moor Insights & Strategy CEO Patrick Moorhead said: I believe any split before the design and foundry side get healthy is a horrible move. Look at the AMD-GlobalFoundries split. Both companies almost failed. Overall, Intel seems to be backed into a corner today due to liquidity issues stemming from the undesirable returns from its aggressive turnaround investments in the last three years. Although there is potential for a turnaround in prospects in the long term, the company may have to make bold, unpopular decisions to survive the short-term financial struggles. Although the semiconductor sector is thriving due to the AI boom, Intel has not been successful in making the most of it. The company's technology, particularly related to high-end processing chips, is lagging behind those of Nvidia and Advanced Micro Devices. Cost-cutting measures undertaken by Intel to outsource certain processors to TSMC have incurred sizable losses to the company as well, with gross margins continuing to decline since 2021. In light of these challenges, Intel stock has declined to lows that have not been seen in more than a decade, resulting in a market capitalization of just over $80 billion, a fraction of Nvidia's market value of close to $3 trillion. Exhibit 2: Market capitalization of Intel and Nvidia The rise of Nvidia since 2021 is one for the history books, and Intel may never replicate them. However, as discussed in the following segment, all hope is not lost. Intel may very well regain some of its lost mojo, leading to a reversal in stock prices. Despite being positioned unfavorably to benefit from the expected growth of the chip sector, there are some positive developments that suggest Intel may see light at the end of the tunnel if it sorts out the funding issues. For example, the new 18A chip, which is expected to go into mass production in 2025, holds the potential to recapture some lost market share in the advanced chip sector. According to Intel, 18A will be its biggest technological innovation since the launch of FinFETs in 2011. This technology, due to its advanced capabilities, has already won the interest of many clients, which could help boost Intel's revenues and improve its market competitiveness. Furthermore, Intel is likely to benefit from the ongoing improvement in global personal computer market trends. In the second quarter, PC shipments grew 3.1% YoY to reach 62.5 million units, and Counterpoint Research projects this positive momentum to continue through the end of this year, aided by the growing demand for AI-powered PCs. This would mark a remarkable comeback following a few years of shipment declines. Last year, PC shipments declined almost 15% to 241.89 million units. Lunar Lake and Arrow Lake, Intel's next-gen chips for mobile devices and PCs, will be released this month, and these new chips should position Intel to gain some ground in the PC market. The CPU business segment at Intel could see some recovery owing to the increasing renewability in certain niches due to the PC base overhauls to AI content. Given that the client computing group segment, which records revenue from desktop and notebook chip sales, still accounts for the bulk of company revenue (57% of revenue in Q2 2024), a growth revival in this segment should bode well for the overall financial performance of the company. Intel's new Gaudi 2 and the upcoming Gaudi 3 accelerators are promising technologies as well. Even though Nvidia is the current market leader in the AI space, Intel is devising a low-pricing strategy and broadening its AI computing range that would come in handy for customers who are looking for Nvidia alternatives because of the sky-high prices of Nvidia chips. Intel hopes to rake in over $4 billion in sales of AI chips in 2024 and there is potential for Intel to shift the narrative around its AI ambitions by emerging as a competitor to Nvidia. This should help the company regain investor trust as well. When investing in a turnaround opportunity, it is imperative to do so at the right valuation that offers an attractive risk-reward profile for investors. With Intel expected to announce a new reorganization strategy that focuses on its core business and substantially reduces its cost base while continuing to invest in technology advancements, the company seems to be in a much better position to see revenue and earnings growth compared to the last few years. Intel is currently valued at a forward price-to-sales multiple of just 1.8 compared to 23.35 for Nvidia and 9.39 for AMD, which suggests the market has already punished Intel for its past financial struggles. Any improvement in the financial performance from here on is likely to attract handsome rewards from Mr. Market, which tilts the odds in favor of long-term-oriented investors today. I updated my DCF model for Intel to assess whether there is any margin of safety to invest in Intel. Note that I have used very conservative assumptions for growth to make sure my model captures the expected volatility in revenue in the foreseeable future as Intel devises a new reorganization strategy to address growth challenges head-on. Below are the revenue growth assumptions used in my model. Source: Author's projections Below are some of the other key assumptions used in my model. Based on these assumptions, Intel's fair value comes to $30.30 per share, which implies an upside of close to 60% from the current market price. Given my risk tolerance and the conservative assumptions used in the model, I feel comfortable allocating approximately 5% of my portfolio to Intel in the hopes of a major turnaround in the next five years. Intel faces many execution risks, which is evident from the company's failure to gain traction in the last few years despite the surging demand for advanced chips. The company also faces the risk of continued erosion in PC market share if its latest chips fail to attract PC manufacturers. In that case, product development investments are likely to yield disappointing returns in the foreseeable future, potentially leading to a further deterioration in profitability. Investors need to also monitor the risks associated with the new reorganization plan the company may reveal in the coming weeks. If asset sales are part of the plan, Intel will be tasked with attracting potential buyers for these assets, which may take more time than expected or even end up attracting a lower-than-expected value. The September board meeting is highly important for Intel and will potentially mark the beginning of a new business phase for the company. The potential split of Intel's product design and foundry businesses has raised questions about the effectiveness of Pat Gelsinger's strategies in addressing the company's challenges. Furthermore, as the 18A process node comes closer, it will be important for Intel to attract new clients to the manufacturing business, and the board meeting is likely to include a discussion of Intel's strategy to do this. Intel seems cheaply valued at a time when major changes are coming, presenting an opportunity for long-term investors. However, investors will have to keep a close eye on the macroeconomic outlook for the chip sector, especially for chips used in personal computers and AI, to monitor the success of Intel's turnaround strategy.

Intel: Stay Away From Falling Knives (NASDAQ:INTC)

My previous bearish thesis about Intel Corporation (NASDAQ:INTC) aged well, as the stock lost around 37% of its value since mid-June. Despite such a massive drop over the relatively short timeframe, I do not recommend buying the dip. The stock is still significantly overvalued, and the company's capital-intensive business model appears to be not efficient in competing with fabless players like NVIDIA Corporation (NVDA) and Advanced Micro Devices, Inc. (AMD). Intel is much weaker positioned to compete with more flexible and aggressive rivals. I also see apparent flaws in strategic decision-making. All in all, I reiterate my "Strong Sell" rating for INTC. INTC released its latest quarterly earnings on August 1, underperforming against consensus estimates. This was the second consecutive quarter of missing quarterly revenue forecasts. Revenue declined by 1% YoY, and the adjusted EPS deteriorated from $0.13 to $0.02. The company's balance sheet is still highly leveraged in absolute terms. Total outstanding debt as of the latest reporting date was $53 billion, which is more than $20 billion higher compared to outstanding cash. INTC bulls might say that the total debt is still lower than the company's market cap. This is true, but I want to emphasize that Intel's balance sheet is much weaker compared to its closest rivals. NVDA has a massive net cash position, and AMD's balance sheet is also much cleaner compared to Intel's. Therefore, Intel is in a very weak position to compete with rivals, if we speak from the perspective of financial position. Another big red flag is that even the AI-driven boom in the industry did not help Intel to capitalize on it. Intel's operating margin and EBITDA margin are still significantly lower compared to historical levels, and the late 2023 rebound was insignificant. A weaker balance sheet compared to rivals together with stagnating profitability is a very weak blend, meaning that INTC is not ready to compete. Intel's business approach itself appears to be obsolete. Of course, fabless players like AMD and Nvidia face significant geopolitical risks when they outsource production to Taiwan Semiconductor Manufacturing Company Limited (TSM). On the other hand, without spending resources on maintaining and expanding their production facilities, these companies are free to focus all their resources on innovation. When we look at how these three companies' revenues behaved over the last decade, we can see that five years ago, Nvidia's revenue was nowhere near Intel's. As of the latest reportable quarter, Nvidia's TTM revenue is almost two times higher than Intel's. The gap between INTC and AMD in terms of revenue is much narrower today than it was before the pandemic. Therefore, it appears that the fabless business model is likely more efficient in driving growth and innovation. Analysts from Citi agree with me, as they recently shared their opinion that Intel should exit the foundry business. Prominent Wall Street names agree with my overall bearish stance on INTC. Banking giants like JPMorgan Chase & Co. (JPM), The Goldman Sachs Group, Inc. (GS), and Bank of America Corporation (BAC) have downgraded INTC to "Sell" after the company released its latest earnings report. My pessimism is also backed by the sentiment around the next quarterly earnings release, which is scheduled for October 31. There were 32 downward EPS revisions over the last 90 days, which is another red flag. Quarterly revenue is expected to be $13.06 billion, almost 8% lower compared to a YoY basis. The adjusted EPS is expected to plunge from $0.41 to -$0.03. Strategic decision-making at Intel is also questionable. The company acquired Mobileye Global Inc. (MBLY) for a massive $15.3 billion not so long ago, but it appears that the management already decided that this investment is not paying off. Intel started selling its stake in MBLY last summer when the stock traded at around $40. MBLY has lost around 70% of its value since then, but INTC is considering selling more shares. With all these developments around MBLY, it is highly likely that the quality of due diligence made before the deal lacked quality. MBLY currently has a "Strong Sell" rating from Seeking Alpha Quant. If Mobileye's shares continue falling down, this will further diminish Intel's shareholders' wealth. INTC declined by more than 60% YTD, a significantly weaker performance compared to the broader U.S. market and the iShares Semiconductor ETF (SOXX). Intel has a very low "D+" valuation grade from Seeking Alpha Quant, meaning that the stock is overvalued. Indeed, a 73-forward non-GAAP P/E ratio is ridiculous for a fundamentally weak company like INTC. To figure out Intel's fair share price, will simulate the discounted cash flow [DCF] model. I need to figure out the cost of equity using the CAPM approach. All assumptions for the cost of equity calculation are publicly available. The risk-free rate is the current 10-year Treasury bonds' yield. Now I can proceed with other assumptions for my DCF model. Intel's consensus revenue estimates are available up to FY 2028. I will rely on consensus for FY 2024-2028. However, since INTC's revenue has been stagnating over the past decade, I cannot give it a revenue growth rate above the 2% inflation for the years beyond FY 2029. For the base year, I use a 2.7% FCF margin, which is INTC's last five years' average. I incorporate a 50 basis points yearly FCF margin expansion. As we see, the business's fair value is still below its market capitalization, even after a recent sharp dip in the share price. Moreover, please pay attention that I incorporated FCF margin expansion in my DCF model. I did that on purpose, to demonstrate to readers that INTC is still around 30% overvalued even with unrealistic FCF assumptions. I call them unrealistic because, over the last decade, INTC's FCF has been demonstrating a weaker dynamic than the company's top line. INTC's seasonality trends suggest that the stock's historically the weakest months are behind us. INTC usually performs better closer to the year-end, which means that the stock might show a short-term rally over the next few months. The stock dipped by around 62% YTD, which also might be tempting for some investors to buy the dip, further fueling some near-term rally. In 2023 Intel had the same fundamental weaknesses, but nevertheless, the stock rallied by 90% in 2023. The AI boom in the stock market fueled lots of semiconductor stocks, while not all of them have strong AI exposure. Intel is a widely known company with a vibrant brand, and this might be misleading for some investors who think that buying INTC will give them strong AI exposure. Despite all fundamental flaws, INTC is still a giant company with the capacity to invest billions in R&D. This means that there is always a possibility that the company can present a disruptive product to the market. Given all the fundamental flaws, I think that the probability of such a scenario is extremely low, but the positive magnitude might be significant. To conclude, INTC is still a "Strong Sell". The stock is still significantly overvalued, even if I incorporate the highly unlikely FCF margin expansion trajectory. The balance sheet is much weaker compared to the closest rivals, and profitability is deteriorating. The CAPEX-heavy business model highly likely does not allow the company to concentrate most of its resources to drive growth and innovation.

Intel: Foundry Spinoff Won't Stop Sell Pressure (NASDAQ:INTC)

Looking for more investing ideas like this one? Get them exclusively at Envision Early Retirement. Learn More " My last article on Intel Corporation (NASDAQ:INTC) was titled "Intel's Q2 Earnings Release Taught Me 3 Lessons About Its Turnaround." As seen from the screenshot below, it was published on August 7. As the title suggests, the focus was on its Q2 earnings report and how it has influenced my assessment of its turnaround plan. Quote: Intel Corporation's Q2 earnings report has led me to reassess the odds of the success of its turnaround plan. A successful turnaround requires sound fundamental economics and financial resources. Intel's Q2 results and, more importantly, FWD guidance have led me to question both. Credit downgrades can further increase its future borrowing costs and limit its financial resources. Since that writing, there have been a few new developments surrounding the company. The most important one on my list is the possibility for the company to spin off its foundry division. Given the pivotal role of the foundry dividing in its turnaround plan, this possibility merits a closer look and motivated this follow-up article. For readers unfamiliar with the background, recently, INTC has been reported to be in talks with investment banks to spin off its foundry business. Leading analysts also argued for such a spin-off as you can see from the quotes below. Tech PowerUp (August 30, 2024): According to a recent report from Bloomberg, Intel is in talks with investment banks about a possible spin-out of its foundry business, as well as scraping some existing expansion plans to cut losses. As the report highlights, sources close to Intel noted that the company is exploring various ways to deal with the recent Q2 2024 earnings report... CEO Pat Gelsinger is now exploring various ways to control these losses and make the 56-year-old giant profitable again. Goldman Sachs and Morgan Stanley are reportedly advising Intel about its future moves regarding the foundry business and overall operations. Seeking Alpha news (Sept 5, 2024): While management has bet the company's future on its foundry business, Citi believes it should get out while it still can. "While in our view Intel manufacturing for CPUs is on track, we continue to believe it should exit the foundry business in the best interest of shareholders," Citi analyst Christopher Danely said in a note to clients. In the remainder of this article, I will explain why A) I consider it unlikely that INTC can find a suitable buyer for its foundry business under current conditions (at a reasonable price anyway), and B) thus I consequently expect the ongoing selling pressure to persist. INTC's foundry initiative and the support provided by the US government for this initiative were key factors in my earlier bullish thesis on the stock. As an example, the chart below shows the preliminary awards the US has made under the CHIPS Act. The total amount allocated is $39 billion and is distributed across a handful of companies. Intel has secured the largest share of the funding as seen, with a preliminary award of $8.5 billion. Following closely are TSMC and Samsung, each receiving $6.6 billion and $6.4 billion, respectively. With the setbacks the company suffered, I had to reassess my thinking and have to admit that I misjudged the impact of the US support, badly. The challenges faced by INTC (and other recipients of the CHIPS awards too) are far beyond financial. Almost all the recipients listed on the chart above, both domestic and foreign, face various substantial challenges in building manufacturing facilities in the United States, despite the incentives provided by the CHIPS Act. These challenges include difficulties in adapting to the local environment, labor issues, high operational costs, etc. Even sector leader Taiwan Semiconductor Manufacturing Company Limited (TSM) is experiencing difficulties and delays with its Arizona factory. TSM announced plans in 2020 to build a chip manufacturing facility near Phoenix. Four years have passed and TSM has yet to start selling semiconductors made in Arizona. Out of the many issues, the top one - an almost insurmountable issue in my mind - is the issue of skilled technicians and engineers. TSMC is successful for its hiring standards and rigorous work pace, which is what the precision of chip manufacturing requires and the crucial ingredients in its success in my view. TSM can send highly skilled and experienced local (i.e., Taiwanese) engineers to Arizona (at the cost of higher operating expenses) and yet still cannot overcome the issue entirely due to a range of reasons (cultural, language, etc.). INTC does not have a reservoir of experienced engineers like TSM to start with and is probably facing more restrictions in terms of hiring as it is more limited to local talents (and the US unions could further add to the limitations). Given these issues and the current limbo status of INTC's many foundry projects, I think it is very unlikely for INTC to find a buyer. Even if it does, I don't think the price would be in favor of shareholders. As a reflection of my above pessimism, the stock continued to face selling pressure shortly after the news of the spinoff possibility. As you can see from the chart below, the stock price enjoyed a sizable rebound immediately after the news of a potential spinoff broke. However, the selling pressure shortly took over and pulled the stock prices to be even lower than before the news. Judging by the technical trading pattern, I think the selling pressure facing INTC stock is likely to persist. More specifically, the top panel of the chart below describes the price-volume trading information of INTC with its 20-day moving average. As seen, INTC stock prices have now declined to be well below its 20-day moving average of $20.22. This negative divergence is a classical sign that selling pressure outweighs buying interest. Also, note that the trading range (around $19 to $21) highlighted by the green box represents the range with the largest cumulated volume in the past 6 months. Given the high volume, I consider this to be a key support range. INTC prices currently are near the bottom of this range and are likely to fall through. On the upward direction, the closest resistant level is around $30 as highlighted by the yellow box judging by the sizable volume in this range. The current price is too far away from this level and I do not expect it to challenge it anytime soon given the negative fundamentals. Lastly, the Relative Strength Index (RSI) furthers the bearish outlook. The RSI currently sits around 36, borderline the oversold regime (30 is typically considered the threshold). In terms of upside risks, a strong PC market recovery or update cycle could help INTC. The company has been losing its PC market share (and lagging competitors on the AI front) in the past few years. However, in recent quarters, the company's PC market share seems to be stabilizing or even slightly improving as you can see from the chart below. This chart provides a comparison of INTC and AMD's market share in the x86 computer CPU market from 2012 to 2024. Intel has maintained a dominant position in the market before 2017~2018, with its market share peaking above 80%. The market share quickly dropped since then due to competition from AMD. Its market share dropped to as low as ~60% recently and has recovered slightly to the current level of 63.5% as of the latest quarter. To sum up, I see an overall bearish picture surrounding the stock. Fundamentally, I do not see INTC having the resources - both in terms of talent and money - to simultaneously compete on both the chip and manufacturing fronts. On the foundry front, pure-play rivals such as TSM are too far ahead. Thus, I do consider the spinoff of its foundry division as a viable option. Although it is only an option to cut losses in my view. In the case the spinoff indeed materializes (and I have my doubts as argued), I expect INTC to still be in a tough position to compete with fabless chip rivals such as AMD and NVDA.