Article from Smart Money 5-28-98
DOES INTEL FIGHT DIRTY?
REMEMBER THE Pentium Bug? You may dimly recall how, in late 1994, Intel (INTC) released a flawed version of its brand-new Pentium processor -- and abruptly denied any problems, only later to relent and confess its error. Intel's good name, and its quick response to negative criticism, saved the day and helped the company get past all the bad press.
That style of learning from mistakes and quickly conceding errors is one reason many industry observers believe that today's reports of impending antitrust charges by the Federal Trade Commission against the chipmaker may not go very far. Not only are the stakes in the case far less sweeping than those in the suit pending against Microsoft (MSFT), but Intel is being credited with having the good sense to wrap things up neatly.
The exact nature of the FTC's charges are unclear, but analysts say that unlike trying to pry the browser loose from Microsoft's operating system, the government seems more interested in how Intel uses its monopoly in PC chips to enforce its business dealings with PC vendors and other chip companies. The FTC charges aren't that surprising: Earlier this year, computer maker Intergraph (INGR) sued Intel, charging that the semiconductor king withheld samples of its chips from Intergraph in retaliation for a dispute over intellectual property.
Two issues are likely to be addressed if the FTC sues. First, has Intel bullied its customers into not doing business with competitors such as Advanced Micro Devices (AMD)? And second, has Intel held back on fairly licensing its chip technology to AMD and others? Intel produces about 80% to 85% of the chips that drive desktop PCs, so its product constitutes an "essential facility," in the eyes of some, meaning a common resource that falls under antitrust regulations.
"The competition has really never brought out a product to compete with Intel at the mid- or high-end," says Erika Klauer, who tracks Intel for BT Alex. Brown & Sons. Klauer attributes Intel's dominance not to foul play, but rather to the fact that AMD and National Semiconductor's (NSM) Cyrix unit simply haven't been doing a very good job. "Both have failed to introduce products in a timely fashion," she adds. Don't blame Intel, in other words, if PC buyers continue to choose its products.
That, however, begs the question of whether Intel has unfairly withheld technical information from competitors, thereby hampering their efforts to compete. As the company integrates more and more parts of the personal computer into its microprocessors -- custom-designed graphics capabilities, for example -- it gains a greater stranglehold on the design of the PC, making AMD and others more dependent on its intellectual property.
"There's no question there is an unfair monopoly here," says Carl Johnson, head of chip equipment consulting firm Infrastructure. Johnson says Intel's apparently good-faith effort to license its technology to National and others is a kind of smoke screen meant to disguise its increasing dominance of everything inside the PC.
A technology called Slot One, which controls how the Pentium chip connects to the PC's motherboard, has only been licensed to PC OEMs, such as Compaq (CPQ) and Dell (DELL), but not to other makers of chipsets, although rumors have it that chipmaker Standard Microsystems (SMSC) has been granted a license.
The issue of intellectual property will be a thorny one for any justice suit. As analyst Ashok Kumar points out, the government must respect Intel's right to dispense with its core technology as it sees fit. "Intel has invested a tremendous amount of R&D and manufacturing dollars on [Slot One], and just because they are in a monopoly position doesn't mean they should have to give it away for free."
The question of what's fair licensing and what's not will no doubt blur the whole matter of whether Intel has abused its position.
Sure the issues are complex. But Intel is nothing if not pragmatic. Earlier this year the company settled what promised to be a messy patent infringement suit with Digital Equipment (DEC). So the company should be able to resolve both questions about its business dealings far easier than Microsoft can in the battle over the fate of its operating system.
The one monkey wrench in a neat settlement is the sorry state of the PC market. The sub-$1,000 PC category is forcing Intel to get tough in its dealings with PC makers -- and with the competition. Intel is expected to bring in $3.15 per share in profits this year, down from $3.87 last year, so it's clear that troubles among PC makers such as Hewlett-Packard (HWP) and slowing growth at Dell -- and a general malaise in the PC world -- are taking their toll on the chipmaker.
However, the exact nature of the sub-$1,000's effect is in dispute. Klauer, with Alex. Brown, argues that the cheaper PCs still have to prove themselves among larger buyers, and she says Intel's troubles relate to a short-term slowdown in PC sales volumes that could pick up later this year, bringing potential upside. Intel's margins will probably shift downward, Klauer concedes, from 65% to 75% on average to more like 55% to 60%, but Intel can hold revenue and earnings in line by increasingly becoming a supplier of components that go into the PC besides just the microprocessor. "Intel is able to increase its dollar content per PC from, say, $200 to $275," says Klauer.
But the "Intel Bear," Tom Kurlach of Merrill Lynch, disagrees that the shifting component mix will mean any kind of revenue stability for Intel. "You've run into a limit as to how much more out of the box Intel can take for itself," he says. "Their prices are following the box prices down now."
Kurlach believes pricing compression is definitely happening across the board, with the sub-$1,000 PC coming on especially strong and he sees both factors only aggravating the problem with unit sales. "The overall unit growth has slowed and ASPs [or average selling prices] are declining," he says.
"This is a change that Intel has not experienced in the past, because for 10 or 12 years, their ASPs only went up." Kurlach says he sees no end in sight to the declining prices, and he is anticipating earnings of $2.95 a share this year, way below consensus estimates.
That will only contribute to the sense that Intel is fighting aggressively with all the weapons at its disposal. And that, some say, could lead the government to dig further into how Intel sustains its monopoly on the desktop. "Intel has used some practices to push PC vendors to use their processors, away from the offerings of AMD," says Johnson.
Mike Slater, director of market research firm MicroDesign Resources, says there's good reason for the Justice Department to look deeper. "Intel does have the ability to cripple a PC maker's ability to compete, if [they] just say, 'We're no longer going to brief you on our forthcoming products.'" At the same time, he thinks the licensing of Slot One may need to be expanded.
"Intel should certainly be required to license [the chipset architecture] on some fair and open basis that realistically allows their competitors to be in business," says Slater. "If it's a $3-a-chipset royalty, that's probably acceptable."
Bottom line, few are expecting much to come of any litigation, mostly because the issues are focused on business practices, not core product design, as in the Microsoft case, and because Intel is shrewd enough to come to the bargaining table to reach a settlement.
"The suit will not produce an outcome that will have a meaningful impact on Intel's business," say Klauer.
"I believe it's very likely Intel will reach a negotiated settlement here," says Slater. "I don't think it makes any sense for them to follow this all the way into litigation."
-- By Tiernan Ray
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