Intel's Own Investments Are Losing Their Glitter
By MOLLY WILLIAMS
Staff Reporter of THE WALL STREET JOURNAL
Intel is finding that the bag of goodies in its investment portfolio is turning into bigger and bigger lumps of coal.
By now, the impact of slower-than-expected sales of personal computers in the important holiday season is well known. Companies like Advanced Micro Devices, Apple Computer and Gateway -- and now Microsoft, after Thursday's earnings warning -- are all feeling the bite. But just as stinging for Intel has been the continuing slide in its Intel Capital portfolio of investments, something that isn't as widely recognized as it should be, according to some analysts and investors.
Intel's strategy of insisting that analysts include its investment gains in earnings estimates looked like a winning one when such investments were flying high last year and earlier this year. But "the seemingly bottomless kitty of unrealized gains that Intel has used to post positive earnings surprises all year long is virtually wiped out," says Fred Hickey, publisher of the High-Tech Strategist newsletter in a recent report.
By Mr. Hickey's analysis, with the stock market's recent declines, the company is running out of unrealized investment gains to turn into realized investment gains to feed into the bottom line. Over the past three quarters, Intel's investments have contributed as much as $3.3 billion to pretax income along the way -- helping to smooth out the earnings of a company with a historically volatile bottom line, according to Mr. Hickey and other critics. Intel is expected to realize another $675 million in interest and investment income in its fourth-quarter earnings.
Once that $675 million is realized, "we're back to the consistently inconsistent Intel of old," Mr. Hickey says. He notes that the company's stock, pummeled as it has been of late, remains richly valued given the uncertainty that investors now face. In 4 p.m. trading on the Nasdaq Stock Market Thursday, shares were down 38 cents to $35.13, off more than 50% from their late August high of $75.81.
Intel declines to comment on Mr. Hickey's analysis but points out that its investment strategy is not just about posting huge returns -- nor is it about smoothing earnings. "Our investment fund has always been designed as a strategic fund, not a venture-capital fund," says spokesman Chuck Mulloy. "We look for return on investment, but the primary philosophy is what can it do to help the marketplace and help Intel."
Les Vadasz, who runs Intel Capital, adds, "If the market is good, the returns are good. If the market is bad, the returns are not so good. Prudent portfolio management dictates you do what is the right thing to do; you don't just sell to meet expectations."
Last week, Intel braced investors for a disappointing fourth quarter, saying it now expects sales to be unchanged from the $8.7 billion it reported for the third quarter and lower than its previous guidance for sales growth of 4% to 8%. And it noted that it expected lower gains from the sale of its investments because of the stock market's decline. Specifically, it ratcheted down its forecast for interest and investment income to the $675 million figure from $950 million earlier. It says it will offer more detail when it posts its fourth-quarter numbers Jan. 16. In its year-earlier fourth quarter, net income totaled $2.11 billion.
Intel is hardly alone in finding that it is a lot harder to make money on tech investments now that the Nasdaq Composite Index is 46% off its March peak. In the mania that took the tech-heavy index above the 5000 level, any number of companies -- from Microsoft to Cisco Systems to General Electric and Chase Manhattan Bank -- were able to sell their investments for princely profits. Just Thursday, Chase Manhattan announced its fourth-quarter earnings would be lower than expected, partly as a result of declining values of the public securities held by its Chase Capital Partners venture-capital unit.
To be sure, Intel has investments in more than 500 companies, and $1.31 billion of its portfolio is in private companies, which could show dramatic increases in value if the initial public offering market rebounds next year and those firms go public.
But other analysts agree with Mr. Hickey when he says that Intel, the dominant maker of semiconductors for personal computers, will find it hard to meet current expectations for earnings in 2001 and show substantial growth over this year's results, barring an amazing rebound in the stock market.
Portfolio manager Christian Koch of Trusco Capital Management, for one, estimates there is "10% to 15% more downside" to Intel's reported income next year than is reflected in the current consensus estimate, as calculated by First Call, of $1.54 a share. "We are now feeling the downside. They were able to show accelerating earnings, but it was coming from nonoperating income. Now it's coming back to hit them in the head."
"It's going to be a challenging year," adds John Spytek, portfolio manager at Banc One Investment Advisors, which owns Intel shares. "When it was going up, it was, 'Look how smart we were.' With how quickly [the markets] collapsed, they'll go back to reminding us that these were long-term investments."
That may be a tough sell. The impact of the declining portfolio comes as problems mount in the underlying core business of selling the processors that run PCs, and Intel's earnings growth comparisons will get even more challenging as the company is faced with year-over-year comparisons with an unusually strong first half of 2000. Demand for PCs in the first half of 2000 was far more robust than PC makers or chip makers had expected. Now, sales are lackluster and there isn't compelling evidence that demand will rebound significantly in the first half of next year, prompting many analysts to predict price wars and poor earnings for Intel and others.
Mr. Hickey (aka Goutama Tanner)painstakingly attempted to reconstruct the public portion of Intel Capital by combing through Intel's federal filings and scouring its Web site. His analysis shows a decline "far worse" than the steep one of the Nasdaq index since Sept. 30. Intel Capital's portfolio had a $5.86 billion value as of Sept. 30, of which $2.9 billion reflected unrealized appreciation of the publicly traded stocks.
"Through November, the Nasdaq has continued to tank," he notes, and the portfolio's decline "is far worse than the Nasdaq's" because many of Intel's positions are in the hard-hit Internet and communications areas. The unrealized gains stood as high as $7.8 billion at the end of first quarter.
Among the 75 holdings -- including Internet incubator CMGI, networking firms Copper Mountain Networks and Covad Communications -- whose value was calculated by Mr. Hickey, the four million shares of CMGI held by Intel had declined in value 64%, to about $41 million, as of Dec. 1, from $112.6 million as of Sept. 30. Covad was off 84% and eToys 71% during the period. Overall, Mr. Hickey estimates the value of the publicly traded investments fell more than 50%.
All this will weigh heavily on the company's stock, Mr. Hickey says, because the stock trades at a rich 30 times its earnings, excluding those gains, while it hasn't traded at such a high multiple since 1983. His conclusion: "You have a disaster in the making at Intel."
The sales of investments allowed Intel to beat earnings estimates in at least two of the past four quarters, says analyst Drew Peck of SG Cowen Securities. Indeed, Intel has on occasion beaten its own estimate for how much it expected from the investment and other income line. In the fourth quarter of last year, the company projected $280 million in such income and actually posted $508 million. In the first quarter, it forecast $500 million and posted $640 million, and in the third quarter it projected $800 million and posted $966 million. The biggest windfall was in the second quarter, when it had $2.3 billion in investments and other income, more than triple what it originally forecast.
"It's been a very frustrating four quarters trying to estimate what that line item would be," says Trusco's Mr. Koch.
Write to Molly Williams at molly.williams@wsj.com |
