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Investment thesis
Intel (NASDAQ:INTC) (GRANT:INTC:CA) has had more than just a few difficult weeks this year. The company has been caught in the crosswinds of the chip war for over a decade, but the pace has picked up in recent 5 years.
The company brought in Pat Gelsinger as CEO in 2021 to lead Intel through a new phase of company transition and put Intel back on track to product and process leadership. The new management laid out an ambitious plan in 2022 to return Intel to its former glory.
However, with several years left to meet its 2026 targets, Intel is even further behind, as shown in its latest second-quarter earnings report.
This prompted investors to bail out Intel shares on a large scale, giving the company one of its worst annual returns since 1975.
Exhibit A: Intel stock is on track to deliver one of the worst annual performances on the stock market since 1975. (Market data)
Such an animalistic reaction from investors to the company forced management to do everything it could to solve the bigger problem: restore investor confidence and bring the company's transformation process back into its own ranks.
I believe Intel is valued at a level that reflects the worst-case scenario at prices well below book value. I recommend buying Intel at current levels.
The financial burden of Intel's turnaround and the interim solution
It's not easy to look at Intel's revenues in Figure B below and see the optimism inherent in Gelsinger's bold turnaround plan announced in 2022.
Appendix B: Intel's revenue by segment (Company documents)
Intel promised mid- to high-single-digit revenue growth through 2023 and boldly declared that revenue would grow to an ambitious target of over $110 billion by 2026. Gross margins were expected to remain at around 52% through 2024 and eventually increase to 56% by 2026, while operating expenses would be just under 30% of revenue in 2024 before declining to around 26% of revenue by 2026.
All of this was to be achieved with disciplined and targeted investments to execute on the DCAI (Data Centre & AI) roadmap, while the CCG (Client Computing Group) would continue to deliver value for its leadership position in PC processors and related components. Most importantly, Intel's foundry business was to grow its manufacturing capabilities in a profitable manner while attracting external customers to its business.
What has unfolded since then is as if the company had its feet stuck in quicksand. Revenue growth continued to decline, margins shrank even faster, and Intel now has a huge financial burden to bear as it has made expensive investments in foundries in its capital-intensive business that cost at least $30 billion. This puts Intel in a precarious position as its margins are the worst in a decade, as seen in Exhibit C.
Exhibit C: Intel's margins are the worst in a decade (Company documents)
This forced management to suspend the dividend, reduce the workforce by 15%, and save the company $10 billion in costs. With management forecasting total revenue of $13 billion for the third quarter and analysts expecting revenue of $13.7 billion, this represents a 3% decline in revenue to $52-53 billion.
However, the $10 billion in savings suggests that the company's margin profile is changing from current levels, where investors have estimated the worst pricing for Intel and the next few quarters.
At a recent conference, Gelsinger acknowledged the defeat his company's stock price had suffered and the wake-up call it provided:
We understand that and we take the signals from the market seriously. We hear them clearly. But we remain very focused on implementing the many things we have set out to do. We have outlined a number of cost reductions. I can tell you today that most of them are already well underway. Like everyone in the industry, we are aware that we have to be efficient, flexible and quick.
Intel is reportedly doing everything it can to restore investor confidence. Management is already considering extracting value from some of its assets by selling either a portion or all of its PLD manufacturing business, Altera, which it acquired about a decade ago for around $17 billion. In addition, there is also the option for Intel to separate its capital-intensive foundry business from its design business, which should also increase value for shareholders, at least in the short term.
Contrary to reports, management clarified just last week that it is actively reviewing Intel’s business and investment portfolio and will have largely completed the streamlining of the business portfolio “by the time we [they] announce results in the third quarter.”
Markets have priced in Intel shares because they feared the worst
I would like to point out that my bullish thesis is based on management actions that should strengthen the company's position financially, at least in the short term. And the markets seem to be misjudging this aspect of the company when valuing Intel.
Intel is valued at 0.7x book value, which is somewhat of a floor for the current bearish sentiment on Intel. Moreover, these levels are not seen in Intel's book value prices per data as far back as I can look.
Exhibit D: Markets value Intel at the lowest level relative to its book value (yCharts)
Intel has ~$206 billion worth of assets, the majority of which are its foundry assets, including land, and ~$29.3 billion in cash, equivalents, and investments. Intel's $10 billion worth of cost-cutting initiatives should help unlock value from its assets, which can be used to reduce the ~$53 billion debt load the company currently carries.
Despite its problems, Intel is still one of the most strategically important companies for the United States, and the current misvaluation ignores this fact as well.
Risks and other factors to consider
As mentioned, part of Intel's cost-cutting plan involves spinning off assets or completely divesting parts of the company. The foundry business in particular has some considerations to take into account as it has benefited from the CHIPS Act and receives federal funding and tax credits in return for its investments on US soil. This means that any sale of the foundry business will be subject to scrutiny by the US government should Intel decide to sell due to the sensitive nature of the business.
Intel may also decide to keep the foundry business if it can attract more customers. Currently, Microsoft and Broadcom are some customers that Intel has secured for its future 18A node, although reports suggest that Broadcom is already working with Intel to iron out deficiencies through its QA process. However, the decision to keep the foundry business will impact margins as Intel may undercut competitors to sell exclusive capacity contracts, which are hard to come by in the fab world these days.
My thesis does not reflect my long-term view of the company. I believe there are still fundamental problems with its products that the company needs to solve. Right now, management is focused on righting the ship with its investors. I believe investors will not factor that in next year.
Findings
Investor sentiment toward Intel appears to be at an all-time low as the company has failed to meet its 2026 targets. However, this angry sentiment toward Intel has driven the stock to a notable discount level, with Intel's market cap trading well below its book value, without taking into account the margin improvements already visible on a TTM basis or the additional $10 billion in cost savings that its cost-cutting strategies are expected to deliver.
Intel's management is doing everything it can to restore investor confidence, and I expect Intel's share price to turn around in the coming weeks.
I recommend buying Intel with caution.
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