Is the Cost of Intel's Entry Into Mobile Too High?
Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Intel (NASDAQ: INTC) reported revenue of $12.8 billion and operating income of $2.7 billion for 2013 Q2. Revenue grew 2% from Q1 but was down 5% year over year, but more surprising was the nearly 30% decline in operating income from the year ago quarter. Intel's entry into the mobile business is proving costlier than expected, and Intel management guided slightly lower for the second half.
Continuing PC declines
Investors were prepared to see some year-over-year decline in revenue for the PC Client Group based on the Gartner and IDC reports recently released on worldwide PC sales for Q2. Both showed year-over-year declines of about 11%. Intel reported a PCCG revenue decline of 7.5% year over year, but left for their SEC filing the number for the group's operating income. Operating income has also been falling.
The numbers don't include tablet devices, and so probably reflect a continuing consumer shift away from traditional PC form factors. Since Intel's initial Haswell offerings all required fans of some type, whether desktop or mobile, Haswell has been restricted for the time being to the traditional PC market, where for whatever reason it couldn't make much of an impact.
But the continuing PC decline is only one part, and perhaps not the most important part of the explanation for Intel's earnings decline. As Intel ramps up production of its next generation Bay Trail Atom processors, as well as "fanless" Haswell mobile processors, and prepares to enter production for its most advanced 14 nm process, operating expenses have increased to $2.7 billion. Operating margin has declined from 28% in 2012 Q2 to 21% for the current quarter.
While costs associated with the introduction of new mobile oriented chips have increased, revenue for the Other Intel Architecture (OIA) group has steadily fallen from its high of $1.39 billion in Q2 2011 to $942 billion for the current quarter. OIA includes all processors (Atoms) for tablets and smart phones, as well as mobile device radio chips. As the chart below shows, OIA has been a money loser in every quarter since 2010 Q1, except for one quarter, 2010 Q3.
Although Intel didn't release operating income (or loss) numbers for its segments, when the SEC 10Q comes out, it will probably continue to show a loss of about $600 million for OIA.
So far Intel investors and analysts like myself have tended to focus on the technical advantages of the latest Haswell and Bay Trail Atom processors, which both use Intel's most advanced 22 nm process, a process that continues to be unavailable in the ARM world. When these start appearing in consumer devices in the 3rd and 4th quarters, they will offer better performance and be more energy efficient than anything currently available in the ARM SOC world. So Intel will just crush ARM (NASDAQ: ARMH), right? Maybe not.
All the discussions about processor performance ignore some realities that have existed since the introduction of the Apple iPad in 2010. From the very beginning, the SOC in the iPad was demonstrably slower and less computationally powerful than competing (and less expensive) Netbooks, and we all know what happened to the Netbook. Consumers weren't evaluating the iPad or Android tablets on the basis of processor benchmarks, but looking in a more holistic way at the entire device experience, including apps and services.
Processor performance certainly contributes to the overall experience, but indirectly, so processor performance doesn't really have as much leverage on sales appeal as many have assumed.
Intel has already proven that it can build mobile device chips as energy efficient as the latest ARM processors in its Clover Trail Atom series based on Intel's older 32 nm process. Anandtech's testing of a Clover Trail processor (Z2760) showed that it was just as energy efficient while being more computationally powerful than competing ARM processors. Tablets with iPad-like thinness such as the HP Elitepad 900, which uses the Z2760, have been available since the beginning of the year.
Yet there hasn't been a mass exodus of tablet makers from ARM to Intel, nor have consumers switched en masse to Intel-based tablets. The most noteworthy adoption of Clover Trail has been Samsung's announcement that it would be in the next Galaxy Tab 10.1.
The reason for this is simple, and the hint for the reason is present in OIA operating losses. Manufacturers haven't switch to Intel Clover Trail because it didn't offer a significant cost advantage over ARM. Cost is the last major battle to be fought between ARM and Intel, and based on Intel's OIA track record so far, the outcome is far from certain.
Manufacturing costs and ASPs are secrets that chip makers keep closely guarded. The best information I've been able to glean about ARM chip costs comes from iHS-iSupply teardowns of tablets such as the under $200 Google Nexus 7 with a processor cost of $21 for the nVidia quad core Tegra 3 processor. Likewise, the Amazon Kindle Fire processor costs $14.65 for the Texas Instruments OMAP4430.
Since these were purchased parts from external manufacturers, the costs include design and capital equipment costs, and therefore represent a reasonable basis for comparison with Intel. Can Intel beat ARM processor makers on price, while making a profit? The answer is very much a function of sales volume for Intel chips. Outside of Intel, I doubt anyone knows what the sales volume threshold of profitability will be for Bay Trail, let alone whether that threshold will be met.
Q4 and beyond
Intel's management team, headed by newly appointed CEO Brian Krzanich were very bullish on Bay Trail and fanless dual core Haswell processors, and these will have an impact by elevating the performance of thin form factor tablets. I expect them to carve out a significant market share for Intel in the tablet space in Q4 and into 2014.
How significant depends a lot on how the ARM processor manufacturers and foundries respond to the Intel challenge. Taiwan Semiconductor Manufacturing Company (TSMC) and IBM's Common Platform partners Samsung and Global Foundries are working feverishly on their own 14 nm processes, which should rival Intel's in power efficiency. If the ARM foundries can get the process on line by the middle of 2014, they should be able to hold the line against Bay Trail and its successors. If not, tablet device makers will begin to abandon ARM for Intel in 2014, thereby finally bringing profitability to Intel's mobile business.
Mark Hibben owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel. 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!