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Intel's Evolution to Wireless: Second Quarter's Report Card

Bob is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Computer chip giant Intel (NASDAQ: INTC) is clearly in transition mode. Though most analysts seem to focus on its ties to a declining PC market, Intel’s prospects have little to do with computers. Its future lies in the wireless space. I believe the company will either prosper or whither based on the progress it makes in four critical areas. Here’s how the company fared in the latest quarter.

Market acceptance of new chips

The most important thing for Intel is getting customers to buy into its latest offerings. In that light, the recent news has been pretty good. Fast growing vendor Lenovo recently announced the release of an Intel-powered multi-mode tablet. This 10.1-inch device called Miix also converts into a fully functioning Windows 8 laptop. In addition, mobile products leader Samsung announced a similarly Intel configured 10-inch offering called the Galaxy Tab 3.

Besides gains with these major brands, the company seems to be building a niche in the specialty device area. GammaTech Computer announced that their Durabook line of heavy-duty tablets will be powered by Intel. Xplore Technologies, another top rugged tablet maker, and TabletKiosk, an innovative provider of Tablet PCs for certain industries, also announced new Intel-based products. The good news is that each of these manufacturers noted Intel’s enhanced performance and security features, greatly improved battery life, and expanded connectivity, which all seem to be making a good impression in the sector.

Grade: B

Continued product development

Intel was definitely late to the mobile market, but looks to have recognized its fault. Recent comments by top management indicate that it is now truly committed to being a major player in the space. New Intel Chief Brian Krzanich said, after the company released earnings, “Looking ahead, the market will continue buying a wide range of computing products. Intel Atom and Core processors and increased SOC integration will be Intel's future. We will leave no computing opportunity untapped. To embrace these opportunities, I've made it Intel's highest priority to create the best products for the fast growing ultra-mobile market segment.”

Company CFO Stacy Smith reiterated this resolve in a recent interview. He admitted that the chipmaker currently has woeful market share in smartphones and tablets, but noted "we're targeting those designs and really focused on that with the full might of the company and the full power of our manufacturing engine. Intel doesn't enter markets to have small amounts of share."

Given management’s focus, in addition to the funds and talent available, continued mobile product advancements look likely.

Grade: B+

Transition of revenue

Intel is almost sure to post declining sales numbers during its transformation. The hope is that with increases in mobile market share, revenue will eventually stabilize and then set a base for improvement.

The company’s second-quarter total revenue figure of $12.6 billion, down 3% from a year prior, wasn’t bad given that mobile gains aren’t expected for a while. The quarter’s sales drop was mainly due to a 7.5% reduction in the PC Client Group, mostly related to PC's and ultrabooks. Though the decline in PC business was anticipated, flat Data Center Group revenue of $2.7 billion was a slight disappointment. These mostly server-based sales were expected to be higher. Intel’s business segment of the future, the Other Architecture Group, which includes tablets and phone products, was basically a no-show. It reported a year-to-year revenue drop of 15% to $942 million.

The second quarter’s sales result, though acceptable, didn’t provide any positive evidence of the necessary transition toward mobile revenue and would thus have to be considered a letdown.

Grade: C-

Valuation and the competition

Intel's successful evolution cannot be assured, so its stock should trade at a discount to fair value. Using a cash earnings times market capitalization multiplier valuation method, the company’s fair business worth looks to be around $25 to $29 per share. Calculated on estimated annual sales of around $53 billion, average cash earnings of $11 billion at a profit margin near 20%, and a reduced industry multiplier of 12 to 14 times. Given the business uncertainties and relative to peer valuations, Intel’s fair value and current market discount both seem credible.

Broadcom (NASDAQ: BRCM), a well-known semiconductor provider in the wireless market, is an interesting peer comparison. An optimistically valued sector performer historically, the company recently lost favor when sales growth came in below expectations. Its latest quarterly sales of $2.09 billion, an increase of 6% compared with the prior year, were deemed okay, but the future quarter’s guidance of around $2.13 billion undershot Wall Street forecasts of $2.25 billion.

Based on revenue of $8.4 billion, average earnings of $1.02 billion, and a profit margin of 12%, Broadcom’s shares may look more reasonably priced at the recent 15 times earnings level than its previous 19 times valuation. Especially given the concerns about its sales growth.

Qualcomm (NASDAQ: QCOM), a leader in the wireless space, is always a key comparison. The company’s recent wins into Samsung’s Galaxy Note II and Google’s Nexus 7 tablets were impressive, and indicate that Intel is unlikely to make any meaningful headway against this powerhouse anytime soon. Qualcomm’s announcement that its premier Snapdragon 800 processor successfully powered the world's first LTE-Advanced smartphone further demonstrates its clout in the mobile marketplace.

The company’s shares currently trade at a premium 20 times cash earnings, based on sales of $24.7 billion, earnings of $5.4 billion, and a profit margin of about 22%. This enthusiastic valuation seems fully justified by Qualcomm’s strong profitability and rock solid position in the mobile arena.

Grade: B

Conclusion

Intel is just starting its evolution towards being a player in the mobile space. Management seems committed to making it happen and the latest quarter had some good signs. Overall, the company has done well so far, but it will need to notch further achievements if the company’s shares are expected to see noticeable gains.

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Bob Chandler has a long position in Intel. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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