Don't Count Intel Out

Never mind the dismal earnings: The chipmaker's introduction of a powerful new chip and efficiencies in production will soon put archrival AMD back on the defensive

Slicing into a steak at a San Francisco restaurant earlier this year, Henri Richard, vice-president of worldwide sales at chipmaker Advanced Micro Devices, couldn't resist ribbing an executive at rival Intel. The competitor's recent poor financial performance, he joked, explained why Intel Executive Vice-President Sean Maloney recently stopped driving an $80,000 Jaguar, instead buying a $22,000 Toyota.

As it turns out, it's AMD (AMD) that may have to operate a bit more frugally in the future. After two years on the defense, Intel (INTC) is at last staging a major counterattack against its smaller rival. And not a moment too soon, considering the giant chipmaker's July 19 earnings. The Santa Clara (Calif.) company said revenue fell 13%, to $8 billion. Net income tumbled a whopping 57%, to $885 million. A forecast for sales of $8.3 billion to $8.9 billion in the current period also fell short of analysts' predictions. The backdrop: price pressure and market-share losses to AMD.

The results are a stark contrast to numbers released the same day from a handful of other tech giants. Apple Computer (AAPL) pleasantly surprised investors with a higher-than-expected increase in computer sales, which contributed to a 48% jump in profit and 24% gain in revenue (see, 7/20/06, "How Do You Like Them Apples?"). Motorola (MOT) also reported an almost 50% increase in net income amid surging sales of cell phones (see, 7/20/06, "Does Motorola Have Nokia's Number?").


  It's not that all of Intel's news was dour. Gross margins—a key yardstick of profitability—came in above expectations, at 52%, vs. an earlier forecast for 49%. And per-share profit beat Wall Street's pessimistic expectations. The unexpectedly strong margins are one indicator Intel may be getting back on track. Thanks to new manufacturing techniques at three giant plants that squeeze more transistors onto a chip, Intel's processors cost less to make than AMD's.

The manufacturing advantage will come in handy during what many expect to be an escalating price war in coming months. AMD has already tipped its hand to a second-quarter sales slip because of price pressures. The company will release full results July 20.

With the new plants, which began coming online last year, Intel will be able to offer lower chip prices without the dramatic declines in profit margins it has experienced over the first half of the year. "We intend to energetically compete for every single microprocessor opportunity in the industry," Maloney says.


  And to make it a one-two punch aimed at knocking AMD down a peg, Intel on July 27 will introduce a new family of personal computer chips, called the Core 2 Duo, that combine the performance of its Pentium 4 desktop chips with the energy-saving features of its processors for notebook computers (see, 7/20/06, "Intel Sharpens Its Offensive Game"). Analysts say the chip beats AMD at most tasks. Intel says the chips offer at least 40% better performance and 40% better battery life. AMD chips will be unlikely to match or exceed Intel's in performance and energy efficiency until mid-2007, when it completes its transition to the same manufacturing process Intel uses.

Intel likely will win market share, though it will have trouble regaining all the territory AMD has seized in the past two years—particularly in the market for high-end corporate servers, considered an AMD stronghold. "While Intel's chips offer dramatic improvements, it will not be a trivial challenge to get AMD out of certain markets," particularly the low-end server market, where it has a strong product lineup, says Dean McCarron at Mercury Research.

Even with new chips and new manufacturing, Intel's woes aren't over. It has been forced to respond to the strong AMD competition this year by cutting 1,000 managers, and as many as 10,000 rank-and-file employees may get the ax later this year. Intel has also accelerated its chip rollouts and sold its cellular communication chip business last month to Marvell Technology (MRVL).


  The company's inventories also have swelled to their largest in history—$4.3 billion, or a quarter's worth of sales. That's worrying to analysts, though Paul Otellini insisted the stockpile is manageable. "I'm very comfortable with our build plans and factory loadings," the Intel CEO said in a conference call after earnings were announced. "At the end of the day, our job is to make sure we build the best products. With this new class of products, we can perhaps lift the entire market going forward."

The high inventories could become a major problem, though, later this year. Analysts at Merrill Lynch have joined a growing chorus of industry watchers who predict Dell (DELL) will expand its new partnership with AMD by offering AMD-based desktop and notebook PCs in time for the holiday shopping season.

This latest twist in a decades-long battle between AMD and Intel has far-reaching implications for customers. The world's two largest chipmakers are racing to outdo each other with powerful chips that can perform several processor-intensive tasks at the same time. For consumers, that means being able to watch high-definition movies while downloading music. Corporations, meanwhile, are demanding energy-sipping server chips that take up less space in data centers because they don't need large cooling fans.

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