Having recently sold the majority of my Intel stake, I feel the need to justify myself. So folks, let me present the bearish case for Intel. As you know, I've been bullish on Intel for a while, and I'm making these points for educational purposes and (hopefully) to stimulate discussion.
1. Valuation: Intel is trading higher now than before the earnings warning. This incorporates a change for expected FY97 earnings of $4 rather than $4.25-4.50. The price also incorporates a lot of favorable market conditions, including bond yields, but its explosive run-up after earnings demonstrates that company-specific fundamentals are foremost, as they should be. Perhaps it's vertigo on my part, but Intel seems richly priced. Intel also has a record PSR. I know the common rejoinder is that Microsoft or Coke or Dell or whatever is even more highly priced, but they aren't nearly so capacity-constrained, capital-intensive, nor have the inventory risk that Intel, a classic manufacturer (i.e. widget-maker), has. Besides, that's really a greater fool argument. A bet on Intel now is really a bet on PE expansion.
2. Changing inventory dynamics: 2/3s of the problem Intel suffered last quarter was related to European slowdown and inventory corrections (mostly abroad). The final 1/3 was product transition, but that has been solved with the termination of classic Pentium production. This lead to quarter-over-quarter revenue reduction, and was confirmed by the HD makers (SEG, WDC, QNTM), who experienced same. This was not confirmed by the leading boxmakers (DELL, CPQ) but their mix is very strongly weighted to the U.S. and they probably stole some share from weaker competitors (AST, Packard, etc.) As the industry moves toward leaner inventories, it's not unreasonable to think that the September order rush for the Christmas season may be pushed back a little bit into Q4.
3. Weak demand abroad: Q3 is historically the weakest quarter for Europe; this year, it is coming on the heels of an abnormally weak Q2. The HD makers also confirmed that the European channel is somewhat stuffed. Intel growth in Japan slowed in Q2. The increase in Japan's national sales tax is also a potential pitfall. Finally, currency devaluations in Asia may potentially make the chips more expensive and less attractive (this is dependent on whether Intel prices at local equivalents to dollars or whether they hedge the currency adjustments...it's probably the latter, so this may be an idle concern)
4. Price cuts: Intel is pricing much more aggressively than last year. Last year, they were even able to skip the November cuts. To grow revenue, all pricing cuts must be countered with either a) increased volume or b) richer mix. In my mind, achieving flat revenue quarter-over-quarter will be quite tough considering historical weakness as well as the special situations this year.
5. Lack of demand creation/Lack of product differentiation: Two years ago it was Windows 95; last year it was the Internet. This year? Maybe DVD, MPEG-2, and television reception. But those will come Q4 at earliest. Intel has successfully convinced everybody to buy MMX, despite there being no software for it (Pod and Adobe Photoshop don't count). Can they also convince people to shell out for a ~$200 200MMX or ~$300 233MMX when a ~$100 166MMX is perfectly adequate? Realistically, there is no difference between any of these processors because of the limits of the bus speed. The slowest component's the hard drive, anyway. (Besides, considering Intel's superior yields, the 166 parts are probably underclocked, a la what Jerry Sanders said about 166 K6's... marked down and sold that way. Thank god nobody knows the difference is only a jumper switch away.)
6. Fickleness: If you held Intel through the last quarter or two, you know Wall Street is completely fickle. Combine that with the historical trend of tech underperformance during the summer, it is quite likely that Intel would lose favor with Wall Street before it has a chance to prove itself with a strong Q4.
Considering all these factors, I am unwilling to hold Intel through a flat quarter at these extremely high valuations. Of course, economic indicators are superb and the market is very bullish, but I might as well be holding Coke if that's my only justification. Finally, I think there may be signicifant opportunities to scoop up shares on the cheap in the not-too-distant future.
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