Intel Does The Unthinkable

I remember a couple of years ago when I first started writing about Intel (INTC), the big concern was that the company was so drunk on its ultra-high gross margin profile that it would continue to miss the obvious (and potentially lucrative) opportunity in mobile. While management can be faulted for not choosing to participate in the trend early (it is clear from the trend in R&D spending that the company didn't start ramping investments in this space until around the 2009/2010 mark), I believe investors should not make the mistake of believing that the company will price itself out of the market.

Indeed, even in the 2011/2012 timeframe under former CEO Paul Otellini, both Paul and then co-manager of Intel's mobile group, Mike Bell, made it absolutely clear that the company would not lose a design on price. When you are the challenger entering an established market with established pricing, you can't simply charge more than what the market is used to paying; this would imply a failure to understand basic economics.

That being said, an interesting story on the Taiwanese newspaper, Digitimes, ran on December 30, 2013 in which a very interesting set of claims was made. Let's dig into them, shall we?

The Unthinkable Happens: Intel Plans To Crush MediaTek

MediaTek is one of the most successful mobile SoC vendors today. They're known for being exceptionally good at taking off-the-shelf IP from ARM (ARMH) and others, integrating them into an SoC fairly rapidly, and then spread-firing these chips into the market for cutthroat prices. MediaTek, interestingly enough, is one of the chief competitive concerns for the likes of Qualcomm (QCOM), Marvell, and Spreadtrum.

However, it isn't as though MediaTek has a structural advantage that allows it to sell chips cheaper than everybody else, but what it does have is a willingness to accept pretty low gross margins (high 30%/low 40%). After-all, if you have enough volume and reasonable gross margins, you can certainly drive a profitable business with the right fixed cost structure. However, MediaTek is still fabless and still licenses off-the-shelf IP which means that it pays royalties on its chips to ARM (and in some cases, Imagination), and it pays the foundry margins to its partner (for example, TSMC (TSM)).

Intel, on the other hand, does have cost advantages. Since the company owns its own fabs and has the wafer scale to keep them loaded, Intel is able to essentially "keep" the foundry margin (so at the same selling price and die size, Intel's chip should have a significant gross margin advantage). Intel also does packaging and test in-house (this is a significant part of the cost of creating a chip), so - once again - assuming that it can keep its facilities there full, it keeps that margin for itself.

So, what does this have to do with MediaTek? Well, here is a passage from the Digitimes article:

Intel's aggressive coordination with its brand vendor partners recently over product pricing and R&D supports has earned the CPU giant mobile processor orders from these vendors, according to sources from the upstream supply chain.

Most of these vendors originally cooperated with MediaTek and have given up their joint developments with the chipmaker to turn to place orders with Intel, the sources noted.

Essentially, what Intel is planning to do is to aggressively price its parts against MediaTek's. Further, given Intel's manufacturing lead and design prowess (MediaTek is stuck with sub-optimal, off-the-shelf ARM cores while Intel has its own custom cores that do the job better), it is not hard to see that the actual product quality delta or "performance per watt, per dollar" is just going to keep getting better and better against MediaTek which could drive further share gains over time.

Two years ago, Intel bears would have laughed at me for thinking that Intel would be so aggressive in taking tablet share in a fairly short time-span. Now, the bearish argument is simply that Intel isn't (yet) making money on these parts. From a strategic perspective, winning share needs to happen first, then profitability can come later. However, unlike Amazon.com, the chief star of this strategy, Intel does have a path to significantly improve profitability on these parts (I will publish a separate note in which I justify this claim further).

40 Million Tablets? Nah, We're Just Kidding - It's 60 Million

At Intel's Investor Meeting, the company outlined it plans to hit 40 million tablet chip shipments next year. However, according to Digitmes, the real internal goal is 60 million tablet chips. Now, if Intel can actually score 60 million shipments, then this would imply market segment share (if Gartner's 263 million tablet estimate for 2014 is correct) of 23%. Now, strip out iOS based tablets (since these are out of Intel's SAM as a merchant chip vendor) which should do about 25% of the total market (give or take a couple of percentage points), and Intel's market-share of the non-Apple tablet market grows to 30%. Pretty impressive, right?

What would be truly remarkable is if Intel actually hit these numbers in 2014. Why? Simply because Intel could end up owning 35-40% of the tablet market by 2015, particularly as its product portfolio becomes even more competitive than what will be in the market in 2014. This is some really exciting stuff (if you're an Intel shareholder, that is).

The Same Will Happen To Phones

Phones are more difficult to crack than tablets because the communications portion of the solution as well as connectivity plays a pretty vital role. Today, Qualcomm essentially owns the entire high end smartphone market because it has the most highly integrated solutions (and the only real LTE solutions available today). Intel - and others - will be coming to market with LTE modems shortly that, frankly, look pretty compelling.

It's not too much of a stretch to see Intel employing precisely these tactics during 2015 in a bid to quickly gain smartphone share. The nice thing, too, is that by 2015 Intel's parts won't have the BoM deficiency that they currently carry today which means that the venture can be profitable from the get-go. The only snag is that the high volume smartphone parts and the low-end/high volume tablet parts will be built at TSMC during 2015, so Intel won't have the pricing power advantage that it will have on internally built, high-end phone and tablet parts. That being said, a dual core Silvermont is likely to be much more attractive for most mobile workloads than a quad Cortex A7/A53, so from a design perspective Intel will probably have the more attractive low end 28nm part.

Conclusion

It's good to finally see it happen; Intel is dead-serious about owning the mobile space and is going to leverage every bit of its financial and technological muscle to get there. It'll be a pretty bloody battle, and the 40-60 million unit shipment target in tablets isn't guaranteed, but if Intel can execute, I'm confident that the Street will finally cheer Intel's mobile efforts and the company will finally be able to put "we missed mobile" behind it.

Oh, and I wouldn't want to be long MediaTek at this point. This is going to get exceptionally ugly for them as they are a much easier target to pick off than Qualcomm.

Source: Intel Does The Unthinkable

Disclosure: I am long INTC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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