It's taken me a little time to go over Intel's finances in detail. However, far from being the glowing outlook that nearly everyone is saying, Intel's financial position is much more precarious. The good third quarter results were actually only a temporary fix created by slashing stock buyback. Unfortunately, even following the buyback patterns from two years ago, this will still leave Intel about $2.5 Billion short at the end of the year. The best that Intel can hope for is that it has a much better fourth quarter than even their best projections.
The overly positive outlook for Intel seems to be based on three assumptions:
- Intel is regaining share.
- Intel is making more money.
- Intel is back to playing its own game.
I've seen some very poor attempts to give Intel credit for a supposed increase in volume share by using a bit of statistical sleight of hand. The statistics for the last three quarters for microprocessor volume are:
Intel - 74.3%, 72.9%, 76%
AMD - 21.1%, 21.6%, 23%
VIA - 4.6%, 5.5%, 1%
Based on these percentages, the naiive claim is that Intel gained 3.1% in the third quarter while AMD only gained 1.4%. This would seem to suggest that Intel gained twice as fast as AMD in the third quarter and, presumably, this would be an indication that Intel is taking back share. Unfortuately, this distorted view is caused by the interference from VIA. VIA only sells at the very low end of the X86 market. Adding their share in with AMD's and Intel's is a bit like adding bicycles to motorcycle sales. We can get a clearer picture by removing VIA from the volume statistics and just showing the volume share between AMD and Intel:
Intel - 77.9%, 77.1%, 76.8%
AMD - 22.1%, 22.9%, 23.2%
The undistorted statistics tell a very different story. We can see that Intel has been slowly losing share to AMD for the last three quarters; quarter three was no exception. Microprocessor revenue share is similar:
Intel - 82.8%, 81.9%, 81.7%
AMD - 17.2%, 18.1%, 18.3%
Clearly, Intel is not regaining share in either microprocessor revenue or volume. Similar distorted claims are based on operating income and cash:
Q2 - Revenue - 8009, Op. Inc. - 1072, 13.4%
Q3 - Revenue - 8739, Op. Inc. - 1374, 15.7%
The operating income as a percentage of revenue appears to be up and Intel boosted its cash by nearly $700 Million in the third quarter. This looks very positive for Intel. However, there is a problem. People who buy Intel stock rely on Intel's stock buybacks to increase demand. In 2004 Intel spent $7.5 Billion on stock buyback and spent $10.6 Billion in 2005. Based on the lower 2004 pattern Intel should spend $7.7 Billion this year. However, Intel has only spent $4.4 Billion so far and should have spent about $1.9 Billion in the third quarter. Instead, Intel only spent $500 Million.
It is clear then that Intel boosted its third quarter numbers by slashing its stock buyback. This makes the third quarter numbers look good but puts Intel $1.4 Billion behind in addition to the $1.9 Billion it would need to spend in the fourth quarter. However, if Intel spends the same as it did this quarter it will end up $2.5 Billion short which will cause its stock to plunge. If it pulls the cash back out that it just put in this would end up only $1.2 Billion short. This is a tough position for Intel. If it doesn't spend any cash then its stock buyback will drop below the 2004 levels and will only be a little ahead of the 2003 levels. This would be a 50% reduction from the 2005 levels and something the stock market surely would not overlook. This could easily cause Intel's stock to slump when the end of year results are released(which will be sharply down from last year). Unfortunately, Intel will not have the money to spend so it will have to choose between spending cash and risking a drop in stock price. From this we can see that Intel's money position is currently worse than it was even in 2004. Intel has not yet recovered in terms of money.
The final assumption is that Intel had to play AMD's game while AMD was ahead in processor performance and now that Core 2 Duo is ahead Intel can play its own game. Well, let's assume for a moment that this is true, that C2D's superior performance is creating lots of demand for Intel and eroding AMD's demand. This could cause AMD to drop its prices even lower to avoid losing too much volume share and this would hurt AMD's margins even more.
The problem is that AMD hasn't lost in volume share; Intel actually lost a little. If the assumption about demand were true then this wouldn't fit with the facts at all.We know that AMD was capacity limited in the third quarter. If demand were strong then Intel should have had no trouble picking up customers beyond what AMD was able to supply. But, this didn't happen. Secondly, the fact that Intel's margins were lower than AMD's and will stay lower in the fourth quarter disproves the notion that AMD has to compete by dropping prices. A similar idea was that Intel was going to get rid of its overstock by selling it at reduced prices and this was supposed to undercut AMD and cause further loss of margin. However, AMD's margins didn't drop all that much and Intel ended up having to take a loss on $100 Million worth of overstock. Apparently, this was only part of the overstock and Intel may have additional losses in the fourth quarter.
The fact that Intel was unable to gain volume share while AMD was capacity limited disproves the idea of extra demand for Intel chips. The fact that Intel didn't gain at all in terms of revenue share also disproves the idea that Intel's chips are more valued. Intel finds itself faced with a competitor who is serious about growing capacity. The only way of stopping this would be to somehow reduce demand for AMD chips and this hasn't happened. Intel seems to be overlooking the fact that having two FABs plus second sourcing from Chartered makes AMD a very reliable supplier; Intel has lost this advantage. Intel has been the strongest player by far in terms of integrated graphics for both desktops and mobile. However, now that AMD has ATI Intel faces a whole new level of competition in these markets.
AMD is currently taking mobile share from Intel. Many have assumed that Merom, the mobile version of Conroe would easily hold this market for Intel. However the fact that Intel will keep making the lower performing Yonah until the end of 2007 suggests otherwise. It appears that Merom is having more difficulty with power consumption than the older Core Duo. AMD's Turion should compete with this very well as it moves to 65nm. This seems to have been a strategic mistake for Intel and not one that it can fix soon. Faced with an inability to manage multiple processor projects, Intel lumped everything together with Core 2 Duo. This chip tries to do the job of server, desktop, and mobile. Apparently, it isn't doing mobile as well as it was expected. This unfortunately occurred at the same time that AMD decided to split mobile off into a separate family. This seems to be what will give AMD the ability to take share in mobile away from Intel. Intel surely realizes its mistake and is probably frantically trying to reform another all mobile team as it had with Pentium M. However, this is likely to set Intel back into 2008 and it can lose a lot of share during that time.
The one size fits all strategy with C2D is also not working as well as it could with servers. Woodcrest doesn't do 4-way and Intel won't have a 4-way until Q3 07. This means that during this time Intel has to compete with the outdated Cedar Mill based Xeons. The result has been that Intel has not been able to take back any of the 4-way and higher share that it lost to AMD both from Xeon and Itanium. Given AMD's recent wins in supercomputers with Opteron it seems that AMD will remain strong in the top end of servers well into 2009. Although Intel has made some gains in 2-way servers it will soon be faced with both lower power 65nm based Opterons and a native quad core design with K8L. This is a fairly grim prospect for Intel as it won't give them much time to gain any share and even then only at the bottom. Further, Intel appears to be behind in base architecture and it doesn't appear that they will catch AMD until 2009. AMD has a good chance of reversing any server losses during that time and taking additional server share.
The sole bright spot for Intel is the desktop. Or maybe it isn't. This depends on how much of Intel's third quarter volume came from moving lower priced P4 stock. It could be the case that Intel's rise in desktop volume share was only a one quarter bump and will drop again in the fourth quarter or even the first quarter of next year after it moves more overstock in the fourth quarter. At this point though there isn't any way to tell. It seems reasonable though that, with increasing pressure from AMD within the corporate market with its Stable Image Platform and integrated graphics from ATI, AMD is not likely to lose very much share. Its deals with the two highest retailers in China and its deal with Dell also suggest that any volume loss on the desktop will be limited. Some have tried to argue that Dell is rapidly losing ground and therefore won't help AMD. However, this seems to be more of a sour grapes argument than anything else. Looking over Dell's financials I was unable to see more than a drop of about 4% and this is hardly proof of any downhill slide for Dell. Intel dropped much more than this during 2006.
Although it has been suggested that AMD's current capacity constraints will cause it to lose customers this logic too does not appear very sound. AMD's capacity will increase rapidly next year so Intel can't count on capacity constraints for AMD unless the market grows much more rapidly than it has. Then too, Intel still would have to turn these limitations into demand for its own products as it was unable to do in the third quarter.
Intel is also unlikely to improve its popularity with vendors. Even though AMD now has ATI it is quite willing to let its customers use other brands of chipsets if they prefer. Intel in contrast, is much more insistent about pushing its own products as it has with its exclusive chipset policy for Centrino.
I have been unable to find any evidence in the third quarter reports that Intel's prospects are better than AMD's. Intel has been unable to create demand or decrease demand for AMD. Intel will find itself in a defensive position trying not to lose share in mobile and corporate accounts while trying to push a single chip design that is not fully adequate for either server or mobile use. It has to do this against a tough competitor who is putting huge amounts of its earnings into capital expenditures to grow its capacity. On top of this, Intel will find itself with a very disappointing 2006 earnings report and enormous pressure on stock buyback with money that it won't have. It is likely to be faced with the prospect of either spending down its cash even more or watching its stock price plunge. From all of these disadvantages it is clear that Intel is not playing its own game.