PAUL , JOHN , Ibexx - INTERESTING ANALYSIS No Change in Outlook From Intel Analyst Meeting
11:09am EST 10-Nov-97
Following the Intel analyst meeting, there is no change to the outlook for a slight increase in revenues this quarter and essentially flat earnings. Analysts expect that Intel will have two more quarters of mixed performance before the benefits of the Pentium II begin to accelerate top and bottom line once again.
Nevertheless, analysts are increasingly confident that Intel can sharply cut production costs in the next year to maintain its long-term operating model, even in the face of a market shifting rapidly to the low end. Given this, analysts' recent earnings cuts may be the last. If so, this should eventually be good for the stock.
Reducing costs on Deschutes
Probably the most important piece of information analysts picked up all day was Intel manufacturing management's claim that they can reduce the die size of Deschutes (ex-cache and module) down to and even below Tillamook's die size. Deschutes is the 0.25-micron version of the Pentium II, and Tillamook is the 0.25 version of the PentiumMMX. This is critical because in 1998 Intel will forcibly convert the personal computer market from PentiumMMX to Pentium II, even in the $1,000 Basic PC segment. That means Intel should be able to reduce manufacturing costs on the Junior Pentium II to about $25-30, or less. This would allow for an $80 unit price, shipping into an $800 PC, and gross margins of about 70%, its current microprocessor average. Indeed, one slide showed that Intel's defect densities are almost as low on the new 0.25-micron process as the 0.35-micron process, suggesting that yields are probably running well above 70% on Deschutes.
Pentium II sluggishness not a show stopper
Although Intel officially holds to its claim that Pentium II is on track for the quarter, analysts' many inputs suggest that it is running slightly below plan, probably due to softness in the mid-section of Intel's product line -- the $1,500-2,500 consumer market. The low-end PentiumMMX market (currently, 166MHz parts are selling at a premium in the gray market) and the high-end Pentium II markets appear strong. However, this is largely a matter of pricing and demand creation. Both the 486 and the Pentium hit similar slow spots 6-9 months into their ramp. The company claims that two of its top six accounts now have about 40% of their sales in Pentium II. Worst-case scenario, Intel would be forced to cut Pentium II prices more sharply than expected in February and May; analysts believe that current revenue and earnings estimates are sufficiently conservative to incorporate these price cuts.
Will the real sub-$1,000 PC please stand up?
On the one hand, Intel made a fairly plausible claim that the sub-$1,000 PC phenomenon was a figment of some market researcher's imagination. Home computer prices have dropped in the past year from about $1,851 to $1,525. But, in 1993 and 1994 they were averaging around $1,450, slightly below the current level. On the other hand, if the Basic PC is not a real market issue, why is Intel talking so much about it? Because Intel is smart and aggressive and recognizes it must go wherever the market goes. Indeed, Intel is already there. The company claims it owns 90% of the sub-$1,000 PC market and 65% of the sub-$1,500 PC market. And, that is why, as investors, it is critical they understand that Intel is addressing this market not just by cutting prices, but by slashing manufacturing costs as well.
Inventory correction over, hopefully
Intel believes at least 3% of sales, or up to $750 million in 1997, were lost due to an inventory correction at its top OEMS. These companies have aggressively reduced in-house inventories by 35-50% to 1-1.5 weeks and channel inventories to 2.5-4.0 weeks, in the past year. This is the first time analysts recall Intel talking about that issue. At any rate, the correction analysts did not know about is almost completed, the company says. With that, revenues should return to average PC growth trends. Analysts believe recently cutting revenue growth assumptions for 1998 from 23% growth to 18% growth was prudent.
Addressing weaker regional markets, segmentation
The company remains concerned about Asian markets (including Japan), which in the third quarter amounted to about 28% of sales. Within Asia, only China, which analysts figure is slightly more than 5% of sales, remains strong, while S.E. Asia and Japan are weak. The company expects a seasonal rebound in Europe this quarter, and the U.S. should be in line. Increasingly, Intel is pushing into other emerging markets like South America and Eastern Europe to generate new sales growth. In addition, the company is further segmenting markets from the four traditional markets -- server, business, mobile and consumer -- to high-end, performance, basic business, lean client (replacing dumb terminals), set-top box, performance consumer and basic consumer. Clearly, Intel will go where it needs to address the market, a market that appears to be increasingly complex as it grows.
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