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Intel: Back in the Chips

By Olga Kharif

All through the economic downturn, Intel fared better than most rivals, persevering while its competitors struggled. However, the world's largest semiconductor manufacturer didn't endure the slowdown unscathed. When Intel's revenues slid 21%, from $33.7 billion in 2000 to $26.7 billion in 2002, its income fell from $10.5 billion to $3.1 billion and the company had to let go thousands of workers.

Now the tide appears to be turning. On Aug. 22, Intel (INTC) served up a pleasant surprise: The chipmaker increased guidance for the current quarter, ending Sept. 27, to between $7.3 billion and $7.8 billion in sales, vs. the previous range of $6.9 billion to $7.5 billion, thanks to stronger than expected sales of its processors for desktops and notebooks. To put the improved numbers in context, listen to CIBC World Markets analyst James Jungjohann: "This is one of the strongest growth quarters for the company in the past decade."

Investors were pleased, pushing Intel shares up 6%, to $28, soon after the announcement. Other semiconductor stocks also moved higher, on the belief that Intel's news signals an industry recovery. While Intel CEO Craig Barrett urged caution, emphasizing that the market remains spotty and uncertain, industry observers see more reason to be upbeat about Intel's future.

STRONG MARGINS. Like other chipmakers, Intel is benefiting from recovering demand in Asia, where sales could soar 20% over the next couple of quarters as the SARS panic recedes, according to semiconductor consultancy IC Insights. Intel also is gaining from the gradual improvement of corporate spending on information-technology spending, which should become more pronounced by the first quarter of 2004, says analyst Greg Sheppard of chip consultancy iSuppli.

Company-specific factors are what set Intel's improved revenue-and-earnings outlook apart from the pack. Intel's margins are rocketing, for example, thanks to product introductions and technological investments it made over the past three years. In the recent preannouncement, guidance was for gross margins of about 56%, vs. the 54% company-specific factors previously company-specific factors, which Fulcrum Global Partners analyst Clark Fuhs believes should rise into the low 60s within the next year to 18 months. Given year-over-year sales growth of between 11% and 14%, Fuhs sees Intel's earnings per share rising by between 25% and 40%.

Such numbers would justify a higher stock price, adds Fuhs, who recently upped his 12-month target for Intel to $37 a share -- a 32% premium on the current $28.59, which is just off the 52-week high it hit Aug. 22. Others think that outlook is too rosy. For example, Michael Mahoney, a portfolio manager with EGM Capital in San Francisco, thinks the stock could move to the low 30s and recommends jumping in on any seasonal market dips. (Mahoney doesn't own the stock.)

The higher margins are partly due to greater economies of scale. Most of the chipmaker's costs are fixed, so as it ramps up production, margins should rise. Intel will benefit greatly from its new pair of 300-mm high-volume plants, which stamp out twice as many chips as the older, industry-standard 200-mm facilities, lowering per-chip costs. As Intel makes its chips ever tinier, unit costs should be down by 50%, as of 18 months to 24 months from now, according to Morgan Stanley.

WiFi's MARKET. Margins also stand to benefit from the growing demand for notebooks. The dominant supplier of laptop processors with 88.1% of the market, Intel has gained 1.5% share from main rival Advanced Micro Devices (AMD) over the past year, according to tech consultancy IDC. The market is expanding at about twice the rate for desktop processors and offers higher margins, says Dean McCarron, founder of PC components consultancy Mercury Research in Cave Creek, Ariz. Better still, most of the growth is still ahead: Laptops accounted for 26.5% of total PC shipments in the second quarter -- a figure that will grow to 35% by 2007, estimates Alan Promisel, an analyst with IDC.

Intel is positioned to take advantage of that growth, thanks to its Centrino package of chips, which integrates the Wi-Fi wireless broadband for use in homes, airports, schools, and other public places. About 42% of notebooks shipped in 2003 will be Wi-Fi enabled, estimates Promisel -- up from 20% last year. The Centrino chips, released in March, are specifically designed for laptops, and sales should rise from 1 million units in the second quarter to roughly 5 million units by yearend, estimates Pacific Crest Securities analyst Michael McConnel, who notes that Intel will be mounting a major marketing campaign in the fall.

What's more, Intel has benefited from the price war that has been raging since the beginning of the year between PC giants Dell Computer (DELL) and Hewlett-Packard (HPQ). Dell recently lowered prices by an average of about 22% -- more than usual during the back-to-school season, says Megan Graham-Hackett, an analyst with rating service Standard & Poor's. Intel's dominance in this market gives PC makers little leverage to demand similar discounts from their suppliers. Indeed, the average price of processors should grow 15% in 2003, estimates Brian Matas, an analyst with IC Insights.

NOTEBOOK UPSTART.Not everything is rosy, however. Intel will see more competition in the notebook market from tiny competitor Transmeta (TMTA), which unveiled its Efficion energy-efficient chip on Aug. 12. "Our customers think our product is competitive to Intel's [current products] in clock speed [a key measure of a chip's efficiency]," says Mike DeNeffe, Transmeta's director of marketing, who adds, "and we'll be less than Intel in price." That could undercut Intel's margins on Centrino, which have been high and stable since the product's introduction. However, Intel will counter Transmeta's move later this year with a new iteration of the Centrino processor, says a company spokesperson. That should help keep chip prices up.

A bigger problem for Intel could be AMD's new PC chip, Athlon 64, due later this month. The chip could help AMD grab the fastest-chip crown from Intel -- at least temporarily -- and even take away some market share in 2004. AMD believes the chip will "begin a new evolution in computing technology," says John Morris, a senior brand manager at the company. Still, the victory could be short-lived. Intel plans by yearend to come out with its own new chip, Prescott, which will offer at least as good a performance as the upcoming Athlon, says Peter Glaskowsky, editor-in-chief at industry research newsletter Microprocessor Report. "Intel has a long history of underpromising and overdelivering," he says. Intel, says it's "very confident that the performance of Prescott will be outstanding," says a company spokesperson.

The stars seem to be in alignment for Intel. If a recovery kicks into full swing next year, as expected, it appears poised to ride the wave -- with what many investors see as plenty of room to run. Kharifcovers technology for BusinessWeek Online in Portland, Ore.

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