Will Intel’s restructuring lead it to a fabless future?
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After trading north of $40 earlier in 2024 Intel Corporation (NASDAQ:INTC) has been on a downslide, dropping to the twenties after reporting its second quarter 2024 results, and even going into the teens. On September 25, the semiconductor chip manufacturer closed at above $23. The seesawing stock price reflects the firm’s bad financial results for the second quarter, and Intel’s plan to cut costs and become more efficient.
There has also been some positive news, including the awarding of an Amazon contract for semiconductor manufacture to Intel’s foundry business as well as Intel’s receiving up to $3 billion in funding from the CHIPS and Science Act to manufacture chips for the U.S government. The impact of rumors about a potential Qualcomm acquisition and a $5 billion investment from Apollo Global Management has also had a positive impact.
On the negative side, there has also been some speculation that Intel might be pushed out of the Dow Jones Industrial Average stock index. That’s a sorry state of affairs for the historic company that prides itself on being the steward of Moore’s Law, enunciated by Intel co-founder Gordon Moore. According to the revised Moore’s Law, the number of transistors on a semiconductor chip will double every two years (initially, in 1965, Moore stated that this would double every year). Moore founded the companyin 1968, together with another Fairchild Semiconductor co-founder Robert Noyce. One more Fairchild Semiconductor alum Andy Grove, soon joined them to lead the company.
Will management’s plans to restructure the company pay off or should investors see this company as past its glory days and avoid it?
Restructuring efforts
For the second quarter of 2024, the company reported revenue of $12.8 billion, down 1% over the year. It also saw a loss per share of $0.38, compared to earnings of $0.35 per share for the 2023 second quarter. For the third quarter of 2024, the company is forecasting revenue in the $12.5 billion to $13.5 billion range, with a loss per share of $0.24.
In the company’s second quarter earnings release, David Zinsner, Intel’s Chief Financial Officer, said, “Second-quarter results were impacted by gross margin headwinds from the accelerated ramp of our AI PC product, higher than typical charges related to non-core businesses and the impact from unused capacity. By implementing our spending reductions, we are taking proactive steps to improve our profits and strengthen our balance sheet. We expect these actions to meaningfully improve liquidity and reduce our debt balance while enabling us to make the right investments to drive long-term value for shareholders.”
Zinsner attributes the third quarter outlook to “weaker spending across consumer and enterprise markets, especially in China.” It seems “continued focus on AI server investments in the cloud” have reduced Intel’s expectations for total market opportunity in 2024, with customer inventory levels being high. “These market dynamics should result in below seasonal revenue growth in Q3, with the client business flat-to-down and modest growth in data center and edge markets. With an expectation of healthier inventory positions exiting the quarter, and the continuation of an enterprise refresh cycle, we should see revenue growth at the high end of seasonal in the fourth quarter,” he noted.
To position itself better for the future, the company is looking to lay off more than 15% of its workforce, or more than 15,000 employees. It’s also cutting down on its R&D efforts as well as marketing and administrative costs by about $20 billion in 2024 and $17.5 billion in 2025, with plans for more cost-cutting in 2026.
Intel is also reducing gross capital expenditures more than 20% down from previous projections for 2024, bringing them down to a range of $25 billion to $27 billion. Intel expects that payments related to the restructuring charges will cause its adjusted free cash flow to be “modestly negative” for the third quarter.
It expects to bring down this spending to between $20 billion to $23 billion for 2025. And it is aiming to bring down its cost of sales by $1 billion for 2025. The company expects such measures to yield over $10 billion in “direct savings” for 2025, making for a sustainable business model to sustain its long-term business strategy. The company is also suspending its dividend, starting in the 2024 fourth quarter.
The company has also played around with depreciation accounting to boost its results. In 2023, it raised the useful life of some of its production machinery and equipment from five years to eight years, bringing down its annual depreciation expense by $4.2 billion for that year and raising its gross margin by $2.5 billion.
Its restructuring includes making its Intel Foundry an independent subsidiary within Intel. This will help establish that there is no conflict of interest between external chip customers and Intel’s internal chip requirements. The foundry has been racking up losses with its investments in new factories and technology such as extreme ultraviolet (EUV) lithography (which is expected to provide better margins on its chip manufacturing in future). For 2023, the company reported its foundry business’ operating loss was $7 billion, up from $5.2 billion for 2022, and for the second quarter of 2024, it reported an operating loss of $2.8 billion. Intel’s core product divisions (including its client computing group; data center and AI; and network and edge) reported total revenues of about $11.8 billion for the second quarter.
On management’s second quarter earnings call with analysts, Pat Gelsinger, Intel CEO, noted, “Having separate financial reporting for Intel Products and Intel Foundry clarifies and focuses roles and responsibilities across the company. It also enables us to eliminate complexity and maximize the impact of our resources.”
Catching up on AI opportunity
While other chip manufacturing companies such as Nvidia and AMD are thriving, having cashed in on AI opportunity, Intel hasn’t quite grasped that opportunity, much as it did not cash in on the mobile phone market. And Apple has been replacing Intel chips on its computers with its M1 series ARM chips that offer a better battery life than Intel chips. Qualcomm has also been making ARM chips for PCs. And Intel’s AI processor hasn’t found favor with Microsoft, Amazon or Google either considering that it came on the scene after they began working on their own AI chips.
According to Gelsinger, in second quarter earnings comments, “We previously signaled that our investments to define and drive the AI PC category would pressure margins in the near-term. We believe the trade-offs are worth it. The AI PC will grow from less than 10% of the market today to greater than 50% in 2026. We know today’s investments will accelerate and extend our leadership and drive significant benefits in the years that come.”
He noted that Intel has shipped more than 15 million AI PCs since December and is on track to ship more than 40 million by the end of the year, and a cumulative total of 100 million by the end of 2025.
Zinsner noted that while the company’s so-called “Lunar Lake” chips use wafers from Taiwan Semiconductor Manufacturing company and also rely on external memory, the upcoming “Panther Lake” chip is “internally sourced” and “has a much-improved cost structure.”
According to him, “As the momentum of AI PCs drives Panther Lake demand, together with the improvements from our new operating model and the cost savings from lower capital spending, we will be in a great position to see meaningful gross margin expansion in subsequent years.” Zinszer expects that with reduced expenses, operating efficiencies and competitive products, the company will be able to get to a gross margin of 60% by the end of the decade. (For the second quarter, the company’s gross margin was about 35% on its products sales.)
On the company’s second quarter earnings call with analysts, Gelsinger noted, “We're building two world-class companies. The forensics that we've done this year, this clean sheet exercise as we could describe it, is building a world-class Intel foundry and building a world-class Intel products group. These efforts, we believe, have identified many opportunities for us to have financial savings. We've launched those aggressive steps today.”
Will Intel go fabless?
According to Gelsinger, Intel is scrutinizing its foundry business for inefficiencies related to aspects such as maintenance, chemicals procurement, shuttle lots, wafer procurement, and production. Gelsinger noted, “We also realized that as an IDM (integrated device manufacturer) 1.0, we were never built for efficiency. We were built for leadership. And now, as we add this focus on efficiency, we see a lot of opportunities.” Going beyond next year, Intel expects to move back some of the chip manufacturing it had outsourced back in-house, thereby improving its costs.
Chip manufacturing is a cost-intensive and risky business, and there is some speculation about whether Intel will divest itself of its foundry business and go fabless (semiconductor chip companies that outsource their chip manufacturing are fabless). A potential Qualcomm acquisition (if it materializes and passes regulatory scrutiny) would likely mean a sale of the foundry business. Apollo Global Management, the other company rumored to be interested in Intel, already holds a $11 billion stake in Intel’s Ireland manufacturing facility.
Zinsner said the company expects operating losses “to continue at approximately the same rate in the third quarter, with more than 85% of wafer volume still coming from pre-EUV nodes with an uncompetitive cost structure and power performance and area deficits reflected in market-based pricing. “
He expects “The continued ramp of our Intel 4 and 3 Ireland facility, and elevated R&D and start-up costs to support the rapid progression of our leading edge technology development will also weigh on profitability.” The Ireland plant will remain Intel’s lead European facility for the near future, while it is pausing on projects in Germany and Poland. The firm will complete the construction of an “advanced packaging” factory in Malaysia though, and will move ahead with plans for manufacturing projects in Arizona, Oregon, New Mexico and Ohio.
Multiple risks
Intel faces multiple other risks. For one, there’s competition from, among others, Nvidia, AMD and Qualcomm, which offer GPUs and custom chips. For the foundry business, it faces competition from Asian foundries such as Taiwan Semiconductor Manufacturing Company and Samsung.
And there’s risk from ongoing litigation in Europe with the European Commission imposing a more than $1 billion fine for engaging in anticompetitive behavior, which Intel is still contesting.
And then Intel, as do other semiconductor companies, operates in a volatile industry which has seen its share of booms and busts. It is also subject to various government regulations relating to AI, data privacy and security, as well as environmental laws relating to disposal of chemicals. It could also be subject to cyberattacks, compromising its products.
Does Intel’s decline present a buying opportunity?
For the second quarter, Intel’s current ratio of 1.58 indicates that its current assets more than cover its current liabilities, giving it an acceptable liquidity position. And its debt-to-equity ratio is more than 40% which also is not out of line. The company’s gross profit margin has been steadily declining, from about 55% for 2021 to 40% for 2023. This compares with the semiconductor industry average of about 60% for the last year.
One favorable factor is that it is trading at less than its book value of about $28. However, its price-to-earnings is lofty, at more than 90, based on the last 12 months, compared to the industry average of about 50. While it has $7.2 billion available for share repurchases, it did not engage in repurchases for the second quarter and doesn’t seem likely to do so until it is in better financial shape.
Intel is looking to raise money through an initial public offering of its Altera unit. It expects that this, together with the suspension of its dividend, and “positive adjusted free cash flow should significantly improve our liquidity in 2025” and allow it to bring down its debt. And it anticipates that it will resume paying a dividend as its cash flow improves in a sustainable manner. On the whole, it expects its business to look up after 2026.
However, it is going to take a while for Intel to improve its financial situation. While an acquisition by Qualcomm or investment from Apollo Global Management could boost its stock, an acquisition would have to pass government scrutiny. With the company’s future prospects unclear in a very competitive industry, it seems prospective buyers could wait and watch to see how the company’s restructuring shapes up, while current shareholders could hold on.
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Note: I do not own any individual Intel stock and I do not intend to take a position in the stock within five days of publication of this article. This write up is my unbiased opinion and not intended as financial advice. All investments carry risks and you should talk to a financial advisor to learn about the suitability of an investment for your portfolio. I did not receive any compensation for this piece that influenced my views.