Robert and All, Kurlak on Intel (from SmartMoney)
February 20, 1998
5:30 P.M. EST
THE INTEL BEAR SPEAKS
FEW PEOPLE can claim to have had as dramatic an influence on the price of Intel's (INTC) shares as Merrill Lynch & Co.'s semiconductor analyst, Thomas Kurlak. When he cut his rating on the chip bellwether late last August to Hold from Buy, the stock plummeted 7%. But Intel has managed to turn things around with a stellar fourth-quarter report that crushed consensus estimates. Result? Intel shares have spiked 19.5% since Jan. 13, the date of the earnings report.
Naturally, given Kurlak's reputation as the last word on Intel stock, you'd have expected the analyst to have just as suddenly turned bullish. Not so. As a matter of fact, the analyst is as negative as ever. Here's why: First off, Kurlak believes that Wall Street is putting too positive a spin on the company's fourth-quarter results. Strip away the company's tax-rate reduction and higher nonoperating income, and you're left with a company with flat earnings and declining gross margins. So how does he explain Intel's stunning rise? "There is a reluctance by the market to accept the reality that this company is no longer growing," says Kurlak. "People have been buying because of the absence of bad news."
What the market isn't taking into account, he says, is the fact that prices for Intel products are falling -- and fast. Even growth in the overall number of chips sold can't make up the difference, he says. "For 12 years, average selling prices were up 8% every year; now they are falling," he says. So, even with its much-ballyhooed introduction of the Pentium II processor, Intel hasn't been able to drive revenues higher thanks to price cuts across its product line.
What's more, the popularity of the sub-$1,000 computer promises to pressure Intel margins further. For PC makers to make money on cheap computers, the microprocessor -- the most expensive part of the PC -- has to cost around $80, far below the $200 that Intel currently gets on average for its chips. Asks Kurlak, "As the sub-$1,000 computer becomes a bigger part of the PC market, the question you have to ask yourself is how long until Intel's average selling price is $80."
And, while Intel bulls like to point out that improved manufacturing processes are making it possible for Intel and others to produce more chips from ever-smaller silicon wafers, Kurlak says that will only make the chip oversupply problem worse and push prices lower.
At the heart of Kurlak's worry about Intel is the idea that consumers and businesses have fewer reasons to upgrade their computers these days with the kinds of powerful and expensive chips that Intel likes to produce. In the past, Intel was able to come up with new chips that were needed for high-speed applications like Windows 95 and computers games, but these days there aren't as many new processing-hungry applications that people are demanding. "Once you have a 100-megabyte ethernet on the desktop, or cable modems or desktop video conferencing, you will need more processing power, but that's down the road," he says. "Until we have a demand driver for processing speed, people are looking for an improvement in cost per bit and cost per unit of processing power, which translates to lower prices in the near term."
He sees many similarities between the current state of the PC business and the VCR market in the 1970s. Prices for both boxes stayed high for a number of years. But after the VCR reached a level of function that consumers were satisfied with, they balked at paying for incremental improvements in performance. "After a while, VCR makers couldn't add bells and whistles that people would pay for, so prices went down," explains Kurlak. In other words, people didn't want more programmability with their VCRs, they just wanted to buy one cheaply. Similarly, in PCs, a 300-MHz Pentium II chip doesn't offer a whole lot more to most users than a 233-MHz Pentium II processor.
This isn't to say that Intel isn't a great company. Instead, it's an indictment on high expectations amidst a minefield of potential problems. Kurlak will be the first to tell you that. "There will be plenty of times when a stock will rally, and we won't be part of that," he says. "We are trying to play the major fundamental moves in a company's fortunes, where we can make a lot of money on the upside, and protect ourselves on the downside."
-- By Pablo Galarza |
