Thursday, October 18, 2012

Why I Own Intel (INTC)

Intel (INTC) is the most profitable chip maker in the world. I bought Intel last year when it hit $20 a share. Intel dominates the x86 processor market with a 80% plus market share. x86 processors go on all PCs running Windows and Macs. So, these processors are everywhere, in the majority of homes and offices in the world.

Intel has established a wide moat around its business. And this is not typical for technology companies. It has a wide moat because of a number of barriers to entry. This technology has been refined for over 30 years and key aspects are patent protected, only AMD and Intel have the patent rights. Intel has unmatched name recognition and marketing clout. And most of all, Intel is the leader in chip manufacturing technology. For these reasons, we have seen the x86 architecture and Intel thrive for 30 years. Very few other technology companies have had that much staying power.

But Intel is a very cheap stock right now because of a perception that the chip processors of the future will be mobile, which are smaller and less power hungry than Intel's chips. The best selling design right now is by ARM. But ARM's product is an Intellectual Property (IP); i.e., code. ARM gets royalty from this code inside billions of mobile phones and tablets. But code, especially less complex code, can easily be copied or replaced. So there is no guarantee that ARM processors or some derivation will be in our mobile devices 10 years from now. And Intel has mobile offerings that are getting more power efficient. It is conceivable to me that, given enough time, Intel's x86 code can evolve to be as efficient as ARM.

But Intel's biggest technological advantage lies in Intel's fabrication (manufacturing) capabilities. They have their own exclusive in-house fabrication that is the most advanced in the world. Their fabrication is one full generation ahead of the rest. Intel's competitors using ARM and Advanced Micro Devices (AMD) all must use third party fabs. Fabrication of the coming generation has simply gotten so expensive that only Intel can do it on its own. Intel being one generation ahead means their chips have transistors - transistors are the most basic building blocks of a processor - that are cheaper, less power hungry and faster.

The fab advantage is most evident on the other extreme: in server processors. Intel has a 90% plus market share. AMD, Intel's only competitor in servers, is trading at 3 year lows due to poor sales and execution. This removes pressure from Intel to reduce server margins, which are the biggest in the processor space.

As for the Intel financials, they are similar to Cisco and Microsoft. Intel earns $2.40 a share. Its free cash flow is about $2.00 a share. Its dividends are $0.90 a share per year. All this on a stock price of less than $22! Their balance sheet has plenty of cash and they are buying back stock.

The recent headline news is depressing Intel share price because 2012 is clearly a bad year for computer sales. And a bad year simply means an earnings drop of less than 10%. But I don't think of a short term problem as a big deal. I've read some analysts project a long-term 6-8% growth. That's fine by me. Intel is a net-net company. This means their financial assets exceed all their debt. Intel has equity of $10 a share. This is the value of all their fixed assets and intangibles. Intel can easily issue bonds at interest rates below 3% but buyback Intel shares that yield 10%. Intel has bought back significant stock and continues to do so. I hope it does so before the stock gets much higher than $20.

Disclosure: I also own Cisco and Microsoft. I also own a negligible amount of AMD.

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