Scratching the Surface of the Surface

Never one to ignore a lucrative market niche, Microsoft (Nasdaq: MSFT  ) is now a player in the fast-growing tablet PC space with its new Surface line. Save for a keyboard integrated into its cover and, naturally, a Windows operating system, there's little that seems potentially market-beating about the products. But their father is Microsoft, which means a lot of units are going to move no matter what. So the firms supplying the innards of the new products stand to make a little cash from their efforts.

Choose your CPU
Give Microsoft credit for one thing: It's happy to spread its business around, at least as far as suppliers are concerned. The tech giant announced that Surface will be available in two flavors, one powered by a CPU supplied by PC processor king Intel (Nasdaq: INTC  ) , and the other by its more graphics-oriented rival NVIDIA (Nasdaq: NVDA  ) using architecture licensed from mobile chip leader ARM Holdings (Nasdaq: ARMH  ) .

The Intel version will apparently be targeted to higher-end business customers, while the other is to be more consumer-focused.

At this point, save for anything put out by Apple (Nasdaq: AAPL  ) , no one's getting overly excited about the introduction of yet another tablet product. Microsoft didn't offer many specifics about Surface, including tiny details such as, oh, price, battery life, or date of availability. No matter; unless the tablet's technology is so incredibly powerful compared to the average iPad, or at least one of the two versions is so irresistibly cheaper, it's hard to see how it'll beat the tablet leader. In 2011, Apple had a commanding 58% share of the market, a figure expected to grow to almost 63% this year.

Better late than never
Beating Apple isn't the point, though. The tablet segment is big and rapidly getting bigger. In 2011, around 60 million units were sold, a number that's anticipated to nearly double to 119 million this year. As it's done with products as diverse as MP3 music players and smartphones, Microsoft seems to be shooting for that old "get a small piece of a hot market" strategy.

And that's just fine for the companies lying just under the Surface. The guts they're providing for the machines are basically the latest iterations of their most recent chips and architecture. As such, they didn't require fresh development, which saves them gobs of R&D money.

Time for a reversal
So for them, it's essentially a case of providing goods that have already been developed and are standing on the shelf. Of the participating companies, probably the one that's most relieved to have the work is NVIDIA. A longtime powerhouse in the graphics chip sector, of late the company's results have been slipping more than those of its industry.

In Q1 of this year, for instance, while overall shipments for graphics chips declined over the previous quarter (which is typically seasonal for this business), NVIDIA's shipments fell faster. The market was down just under 1% compared to the previous quarter, while the company suffered a 4.5% setback. Financially speaking, net profit dropped by almost 50% while revenue was down 3%. Both metrics went south for the third straight quarter.

At the moment, it's hard to gauge what impact Surface will have on NVIDIA. Count on it being good, though. Again, Microsoft is going to move a lot of these things no matter what. Plus, since the company always tries hardest to sell to the consumer market, the bulk of its tablet sales should consist of the NVIDIA-powered version.

Adding to the pile
Intel and ARM Holdings are doing pretty well just now, and there's no sign of that changing anytime soon. Intel always seems to find a way to boost its results and keep profitability high. Even in its most recent two quarters, which were relatively slow, net margins exceeded 20%. Meanwhile, the company's fiscal 2011 saw a big top-line advance of 24% year on year. On top of that, it offers one of the fatter dividends in the tech sector, which at an annualized $0.84 means a yield over 3%.

ARM's dividend is comparatively less attractive (with yield under 1%), but in terms of growth the company seems to have plenty left in the tank. Analysts expect it to increase EPS by more than 90% over the next two years, suggesting that its shares are a bargain even at a trailing-12-month P/E of 50-plus.

Surface impressions
Unless Apple somehow stumbles badly over the next few months, or Microsoft starts to, say, offer free PCs with every tablet purchase, the Surface isn't going to change the dynamics of the market significantly. Microsoft is going to devote plenty of money and sales effort to selling it, though, and units will find their way into the hands of consumers. Which, happily, will bring in at least a little pocket change for its chip suppliers.

Ah, technology. It's still a gold mine if one knows the right places to dig. We've done quite a bit of shoveling to discover a trio of stocks that are set to bring in some fortune. Find out which shining nuggets these are by watching our FREE video report "3 Stocks To Own For The New Industrial Revolution"; the video's ready for viewing right here.

Fool contributor Eric Volkman owns no stocks mentioned in the story above. The Motley Fool owns shares of Intel, Apple, and Microsoft. Motley Fool newsletter services have recommended buying shares of Intel, Apple, NVIDIA, and Microsoft. Motley Fool newsletter services have recommended creating a bull call spread position in Apple; creating a bull call spread position in Microsoft; and writing puts on NVIDIA. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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