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Intel Is Seeking Safety in Diversity

By Olga Kharif The personal-computer market's doldrums are putting chipmaking giant Intel (INTC) in a pickle -- and not just for the near term. PCs will likely never again sell as well as they did during the Internet boom, when Intel enjoyed 25% annual sales growth. PC shipments are expected to rise by only 2% in 2002 and 6% in 2003, estimates Lehman Brothers analyst Dan Niles. With PC microprocessors accounting for 80% of Intel's sales, the Santa Clara (Calif.) company has figured out that the only way it can grow faster than the PC market is by diversifying.

Yet that strategy has risks, too, given that Intel will face a swarm of competitors. Still, it may have a better chance of succeeding in its core competency of chips than in, say, Web hosting (a unit Intel shuttered on June 18).

The plan is to go after faster-growing markets, such as mobile and communications chips. If done right, these moves should allow for 12% to 15% annual, long-term growth, says Tim Mahon, a CS First Boston analyst, who recommends the stocks of both Intel and rival Advanced Micro Devices (AMD). Growth of this scale would exceed projections for AMD, adds Mahon.

OUT OF THE WOODS? If Intel succeeds, its stock, which closed at $17.75 on July 3, 2002 -- less than half what it was 12 months earlier, and well down from the $28 it attained in June -- should rebound smartly. The short-term future probably won't be that pleasant, however.

Analysts, who are awaiting second-quarter results on July 17, expect earnings of $735 million, or 11 cents per share, on revenues of $6.35 billion, according to a First Call poll. That's down from 12 cents a share (excluding acquisition costs) in the same quarter of 2001, when Intel reported $6.33 billion in sales. Still, what matters in the long run is that Intel could be coming out of the woods.

The diversification effort's success will depend in part on the reception for several key products, such as new chips for servers and networking, due around yearend. Intel's new Itanium 2 processors, expected to be released in the next few months, could give it up to a 30% market share in the high-end server market, where it has so far made barely a dent, says Peter Glaskowsky, an analyst with consultancy MicroDesign Resources. Intel already holds 89% of the overall server-processor market.

WIRELESS LAUNCH. The new processor will be several times cheaper than those of server giant Sun Microsystems (SUNW), says Glaskowsky. A server requiring four Sun chips could operate with only two Itanium 2s, he estimates. "If I were Sun, I'd be worried," adds Glaskowsky. Sun's reaction? Its UltraSPARC chips are widely used and cheaper to operate, says David Yen, a vice-president and manager of Sun's processors product group, which commands 30% share of the high-end server-chip market. Many corporate buyers, adds Yen, wouldn't want to become Itanium 2 "guinea pigs."

Intel is also making inroads into the mobile computing market. Later this year, it should release its first wireless local-area network (LAN) chip for laptops, combining two leading technology standards, 802.11a and 802.11b. And, in 2003, it's scheduled to introduce its new Banias chips, equipped with always-on connectivity and ready for wireless LANs. The market for such chips should grow 37%, from about $270 million in 2002 to $370 million in 2003, according to tech consultancy IDC.

Portable devices are another market Intel is making a major push into. Its XScale chip, already used in pocket PCs made by Toshiba and others, could soon debut in next-generation cell phones capable of streaming video and gaming. "These chips will sell," says an admiring Glaskowsky. The spoiler: Demand for next-generation phones might not ramp up until 2004.

EQUAL FOOTING. Intel also has to consider competition from established players such as Texas Instruments (TXN). TI chips are used in more than 50% of the handheld devices shipped each year, and its OMAP chips for phones have been available for a year, says Danni Gladden-Green, Texas Instrument's wireless-strategy marketing manager.

Intel is on equal footing with other companies in one area: networking. Later this year, it'll release its new IXP 2800 family of networking processors, which are used to control communications-network routers and switches. Each processor will contain 16 chips, 1.4 Gigahertz each. The market for such chips should grow 30% annually for the next five years, starting from $90 million in 2001, according to IDC.

Many companies want a piece of that pie, of course. "We're out there knocking on every door," says Cary Ziter, an IBM (IBM) spokesperson. In February, 2002, Consultancy Cahners In-Stat selected IBM's PowerNP NP 4GS3 network processor unit as its choice for processor-of-the-year in its class. Big Blue also should announce a new networking chip within 12 months to 18 months, Ziter says.

IRISH EFFICIENCY. What should help Intel in all of these areas is its work on making cheaper, smaller chips. It's building a factory in Ireland that will use new manufacturing processes, while most of its competitors are still migrating to previous-generation technology, says Shane Rau, an IDC analyst. By some estimates, the new fabrication plant could cut manufacturing costs by as much as 35%.

Still, Intel might have to cut prices again to boost demand, speculates Pacific Crest Securities analyst Michael McConnell, who has a buy rating on the stock. "Our goal is to do a great job preparing for the upturn -- whenever it comes," says Intel spokesperson Howard High. Of 23 analysts covering the chipmaker, 15 believe it's doing a good job and recommend its shares. On June 24, Investec initiated coverage with a strong buy rating.

Intel has little debt, $8.14 billion in cash, and is expected to earn more this year than it did in 2001. Yet the rest of 2002 will remain challenging, as PC sales stay slack. On June 6, Intel cut its second-quarter revenue guidance from the range of $6.5 billion to $7 billion to between $6.2 billion and $6.5 billion. Its margins slipped as well, as consumers increasingly opted for PCs priced below $1,000.

Clearly, plenty is riding on Intel's new strategy. If it's executed successfully, investors may well be holding a company with the capacity to bounce ahead of competitors in a tech sector that, sooner or later, is destined to rebound. Kharif writes about technology for BusinessWeek Online in Portland, Ore.

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