Will Apple and Sharp Soon Have Intel Inside?

Concern over worldwide PC sales, or lack thereof, continues to plague Intel (Nasdaq: INTC  ) and its shareholders. Even as non-PC-related revenues improve, Intel stock is mired in a slump that has it flirting with 52-week lows.

The unexpected early retirement of CEO Paul Otellini certainly hasn't helped Intel's share price. But there are a couple of possibilities on Intel's radar that could have long-lasting ramifications and put Otellini's early retirement news on the back burner.

What's happening in Intel's world
According to an analyst at RBC Capital, Intel and iEverything maker Apple (Nasdaq: AAPL  ) are in serious discussions about having Intel take over the chipmaking duties from Samsung, which provides ARM Holdings (Nasdaq: ARMH  ) chips for Apple's iPhones and iPads. Apple and Intel watchers have seen this movie before, but according to RBC, this time it's for real, and that includes a few particulars of the potential deal.

It's no secret Apple likes its ARM chips, and one of its closest rivals, Samsung, has been its supplier of choice. But demand could outpace Samsung's ability to supply, as early as next year, and it recently announced a price bump -- all of which gives a bit more credence to the current Intel and Apple discussions. What'll it mean? According to RBC, if the deal goes down, Intel could see as much as $2 billion in Apple-related revenue next year, not to mention making major strides into the mobile computing space -- a sandbox Intel has made clear it wants to play in.

Intel's been mentioned in the same breath as beleaguered, Japanese-based Sharp for some time now. As recently as two weeks ago, the rumors were that Intel and Qualcomm (Nasdaq: QCOM  ) , one of its primary competitors in the mobile chip space, were going to team up and acquire a healthy stake in Sharp. Qualcomm is still in the Sharp investment picture, but it's no longer interested in a major stake.

Now, here we are two weeks later, and Sharp is courting Intel and Dell (Nasdaq: DELL  ) as possible suitors, asking for significant investments from each. According to The Wall Street Journal, Sharp management is looking for a total of $480 million, split evenly between Intel and Dell.

There are legitimate concerns, voiced by Sharp itself, as to whether it can continue as a viable concern if it's unable to secure funds. The benefit to Sharp of an Intel and Dell cash infusion is pretty clear: staying in business. But what does Sharp have to offer Intel or Dell that's worth $480 million?

Sharp has two primary business segments -- electronic equipment and electronic components. Though it dabbles in solar cells, satellite broadcasting, and the like, what Sharp brings to the Intel and Dell table (respectively) are displays. One display technology in particular stands out and would fit nicely in both Intel's and Dell's plans.

The latest display from Sharp is called IGZO, and any deal with Intel or Dell would have to include access to the cutting-edge technology to make sense. The new screen increases the pixels per square inch, improving resolution, while at the same time -- and this is a big one for Intel -- it uses less power than existing displays. Nice combination, particularly the increased mobile battery life -- a problem Intel's had with its underperforming Ultrabook.

Going forward
Intel's new Ultrabook with Windows 8 is hardly dead, despite rumors to the contrary. The new fourth-generation Haswell processor, Intel's self-described "once in a decade" improvement, is coming to an Ultrabook near you in 2013. The additional processing speed and the reduced power consumption of Intel's Haswell processor could be a game-changer. Now add an improved, more efficient display from Sharp, and bring the price point down a nudge, and Intel can breathe life into its Ultrabook -- a market that research firm IHS expects to grow in 2013.

With all the changes coming Intel's way -- a CEO departure, major strategic partnership possibilities, and acquisitions, among others -- some things haven't changed at all. Intel still provides shareholders with an outstanding 4.6% dividend yield, and it remains the best value in the chipmaking space. Bottom line? Virtually all mid- to long-term portfolios should have Intel inside.

When it comes to dominating markets, it doesn't get much better than Intel's position in the PC microprocessor arena. However, that market is maturing, and Intel needs to find new avenues for growth, including mobile computing. In this premium research report on Intel, our analyst runs through all of the key topics investors should understand about the chip giant. Better yet, you'll continue to receive updates for an entire year. Click here now to learn more.



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  • Report this Comment On December 02, 2012, at 12:06 AM, inor35 wrote:

    you have been trying to push ARMH and discount INTC..... ARMH at 70 x earnings will not be able to grow into this multiplier, INTC will eat ARMH for lunch...

    please do your readers and yourself a faviour and read the following article :

    The age of the smartphone and tablet has brought about a rather sharp and unexpected revival of companies that, since the dot-com bubble, have generally been considered unremarkable by investors. Firms that were either left-for-dead or simply ignored by the investment community have now essentially become superstars in this "new" era of technology investment. This means high multiples, strong media hype, and a jarring disconnect between investor-perception and the underlying financial fundamentals. This type of hype creates some of the most lucrative short-selling opportunities on the market.

    The latest and greatest example of such financial market folly lies in shares of ARM Holdings (ARMH), the U.K.-based developer of processor IP for low-power embedded systems such as micro-controllers, smartphones, and tablets. The company exhibits the classic signs of a bubble, similar in nature and sentiment to previous pie-in-the-sky stocks such as Netflix (NFLX), Groupon (GRPN), and Zynga (ZNGA). These companies each saw a sharp drop in share price and valuation once it became clear that these business models could not hope to generate the kinds of returns that the hordes of sell-side analysts as well as giddy retail investors had previously expected.

    ARM Holdings is one of the most expensive semiconductors in the world, trading at 68x trailing-twelve-month earnings (against an industry average of 24.08x), 18.61x sales (against an industry average of 3.66x), and PEG ratio of 3.68 against an industry mean of 1.99. More importantly, ARM generated $386.31M in cash from operations, which values the company at 42.5x free-cash-flow. Compare this to its peers (data sourced from Yahoo Finance)

    Qualcomm (QCOM): 23.4x FCF

    Intel (INTC): 18.42x FCF

    Nvidia (NVDA): 17.75x FCF

    Texas Instruments (TXN): 11.6x FCF

    Broadcom (BRCM): 14.36x FCF

    One would suspect that for this premium, a potential investor would be buying fairly explosive growth. Not so with ARM Holdings. According to the 11 sell-side analysts that cover the company, ARM is expected to post 12.8% sales growth in the current fiscal year. While nothing to sneeze at, it certainly does not support the firm's current valuation. However, this but scratches the surface of the absurdity of ARM's current price, as we will detail here.

    Understanding The Company's Technology

    ARM Holdings is a U.K.-based semiconductor firm that focuses on developing low-power embedded processor IP for use in a broad range of applications from the now in-vogue smartphones and tablets to more mundane applications such as microcontrollers (which comprise the majority of ARM's business). In particular, there seems to be much confusion as to what ARM actually produces, so it is worth a few paragraphs to go into a little more detail.

    There are two critical -- but distinguishable -- aspects to microprocessor design worth mentioning here (there are others). First, we have what is known as "instruction set architecture," which essentially defines what commands that processor understands. These commands -- known as the processor's assembly language -- are what define a particular processor from a programmer/compiler writer's perspective. This is why a program written for an Intel-based machine (which runs a different instruction set) will not run on an ARM-based machine.

    The next aspect of microprocessor design is called the micro-architecture. This is the actual design of hardware that can execute the instructions defined by the instruction set architecture. The quality of the micro-architecture as well as the particular design target for that particular micro-architecture are generally what determine performance and power efficiency. For example, one could design a very low power 2W system-on-chip for a tablet or a 150W power-hungry high-performance processor by implementing the same instruction set with wildly different microarchitectures, fabrication processes, and so forth.

    ARM Holdings designs a base instruction set as well as a handful of micro-architectures for use by product licensees. Customers can choose either to simply license the right to design a CPU that implements the ARM instruction set (and thus gain software compatibility with all pre-existing ARM code), or it can simply use ARM's off-the-shelf designs and then build a system-on-chip around them.

    Separating The Hype From The Business Model

    There is no doubt that ARM's technology has come to the forefront of the technology stock universe as the media and the sell-side analysts champion ARM Holdings' positioning as the core and/or instruction-set supplier for the majority of the world's smartphones. The company collects a small royalty for every ARM-compatible chip that is shipped, and despite 2.2B ARM-compatible products shipped in Q2 (but license revenue recognized in Q3), ARM only saw $107M in profits before tax.

    To make it perfectly clear, despite having nearly 100% of the smartphone and tablet market, as well as nearly the entirety of the microcontroller and embedded space, ARM fails to generate net income that comes out to even a fraction of that of its licensees and peers in the semiconductor industry.

    The company's initial success in the mobile computing markets has been primarily due to the firm's long-standing focus on the low power/embedded space, which allowed its products to evolve, due primarily to process technology advancements, to become fast enough to enable smartphones and tablets. The low power, low ASP application processor segment was largely overlooked by larger competitors early on, which gave ARM and its licensees the spotlight in the mobile processor world.

    However, going forward, it is clear that the actual ARM core designs will become less important, and that ARM's primary role in the mobile world will be as an instruction set licensee, given that there is now a substantial software base for the firm's instruction set in place. No other company could reasonably hope to compete in designing its own instruction set (other than Intel and its already established X86 ISA) since the software support and toolset -- usually the product of many years of development -- would be an almost intractable barrier to overcome.

    In short, ARM's business model will generate consistent, but low amounts of revenue and net income compared to its peers, which means that it is very unlikely that it will ever grow the top and bottom lines enough to warrant its valuation.

    However, the stock has seen an extraordinary run post-earnings and even more recently over the last couple of days. The earnings report was nothing to write home about -- it beat analyst revenue forecasts by $2M (for a total quarterly sales figure of $227M) , and as a result, the company has gained over $4B in market capitalization.

    But now there's a new catalyst propelling ARM to even higher, more shortable, Internet-bubble like valuations: a buyout rumor.

    Intel Buying ARM Makes No Sense

    The rumor that began spreading was that ARM was in "off-the-record" talks with Intel about a potential acquisition. The source is questionable, as vague notions of "dealers" hearing "whispers" certainly does not lend itself to credibility. However, shady sources are not the problem here. The problem here is that this makes zero sense.

    First, there is a misconception that Intel cannot design low power chips to fit into smartphones. This is patently false, and has been disproven by highly competitive shipping products from Intel today. For instance, Intel is now shipping its Atom Z2460 mobile processor for smartphones, and in every relevant metric -- performance, power consumption, and compatibility -- it is as good or better than leading edge ARM processors. In fact, Anandtech -- a leading technology review website -- compared the Motorola Droid Razr i (powered by the aforementioned Intel chip) to the leading smartphones with the highest-end ARM processors in them, including Apple's (AAPL) iPhone. The site had this to say:

    At least based on this data, it looks like Intel is the closest to offering a real competitor to Apple's own platform from a power efficiency standpoint.

    Further, performance is not a concern (the "rumor" suggests Intel's chips are slower than the various designs from the ARM camp) as evidenced in the very same review. Not only is the Intel chip a formidable competitor, it is also the fastest processor available:

    Intel's Atom core remains very competitive with the best of the ARM world. A single core Atom still ends up being the only CPU that can regularly outperform Apple's Swift

    So right off the bat, the rumor is predicated on a very serious and egregious error. Keep in mind that Intel's processor is using what is essentially a design that has been unchanged since 2008, only fit into a lower power envelope. A next generation chip, built from the ground up, should only further Intel's lead.

    In terms of chip design, Intel is fighting the best of the best in the ARM ecosystem. With a 5-year-old design.

    Compatibility - Still No Reason To Go ARM

    Since ARM processors were in mobile devices before Intel's, a substantial software base for ARM's processors was built up. However, due to the way that the Google (GOOG) Android operating system and its programs are designed, instruction set is not relevant to the majority of applications since almost every Android application is written in Java. Java programs are written in a high level language and then compiled down into an intermediate form called bytecode. This bytecode is then, at execution time, translated into the actual machine instructions by a virtual machine. This means that the only barrier to compatibility is having a virtual machine built into Android that can translate Java bytecode into native instructions. Intel and Google have achieved this, which is why software compatibility on Android is essentially a non-issue. This is also why we have shipping Android phones with Intel processors in them today.

    So the main barrier to entry for a new instruction set -- X86 in the mobile world -- is a non-issue on the target platform that Intel is aiming for in phones. It also helps that Android's global market share is 75%. That means that Intel's chips could power the majority of the world's smartphones without any technical limitations. The remaining 25% -- which consists of iOS, Blackberry, and Windows Phone -- is locked up mostly by Apple, which designs its own processors. There should be very little in the way of a barrier to entry for an Intel-powered Windows Phone, as Microsoft's applications are built in a very similar "virtual-machine" based way. This is how Windows RT and Windows 8 will be able to run the same, "modern UI" applications despite running on different instruction sets.

    These arguments all apply to tablets, with an additional edge for Intel, as Windows 8 tablets are natively X86 compatible.

    Even If Intel Went ARM, No Need To Buy The Company

    ARM doesn't build chips. It licenses core designs and instruction sets. Intel, if it were to go ARM, would not use off-the-shelf ARM cores, but would likely design its own ARM compatible chips. There is, of course, no technical reason to do this (and certainly no financial, as it would need to pay for a license and royalty fees -- not to mention that it loses all ability to modify/enhance the instruction set). But if it were to do so, it would simply buy an ARM license and pay the 1.8% royalty to build and sell the chips. Why pay $17B (plus whatever extra fee) when Intel could accomplish the same goal with less risk, and for substantially cheaper?

    Keep in mind that Intel already builds many ARM chips for things such as network processors and SSD controllers. In fact, Intel is one of the largest ARM licensees!

    Also, as discussed above, ARM trades at ~43x free-cash-flow and 70x earnings at current levels. A buyout premium would likely increase that significantly. This makes no sense when an instruction set license is cheap.

    Insider Sales Confirm Bubble

  • Report this Comment On December 02, 2012, at 12:21 AM, applefan1 wrote:

    I don't think ARM will get bought out, they control IP, they don't MAKE chips, they just hold onto the IP and release it to other chip designers buying into ARM.

  • Report this Comment On December 02, 2012, at 3:26 AM, inor35 wrote:

    buy INTC at 8 x EPS and lots of cash and short ARMH at 71 x eps = no brainer...

    ARMH collects a small royalty for every ARM-compatible chip that is shipped, and despite 2.2B ARM-compatible products shipped in Q2 (but license revenue recognized in Q3), ARM only saw $107M in profits before tax.

    To make it perfectly clear, despite having nearly 100% of the smartphone and tablet market, as well as nearly the entirety of the microcontroller and embedded space, ARM fails to generate net income that comes out to even a fraction of that of its licensees and peers in the semiconductor industry.

    Going forward, it is clear that the actual ARM core designs will become less important, and that ARM's primary role in the mobile world will be as an instruction set licensee, given that there is now a substantial software base for the firm's instruction set in place.

    In short, ARM's business model will generate consistent, but low amounts of revenue and net income compared to its peers, which means that it is very unlikely that it will ever grow the top and bottom lines enough to warrant its valuation.

    However, the stock has seen an extraordinary run post-earnings and even more recently over the last couple of days. The earnings report was nothing to write home about -- it beat analyst revenue forecasts by $2M (for a total quarterly sales figure of $227M) , and as a result, the company has gained over $4B in market capitalization.

    An overvalue hype that will quickly fade away..

  • Report this Comment On December 02, 2012, at 7:41 AM, timbrugger wrote:

    inor35,

    Great points, all. Though, not sure how you came to the conclusion I'm in the ARM Holdings camp, to the detriment of INTC. I couldn't agree with you more, which I tried to reinforce in the article, that Intel is a fantastic value. And, with that dividend, belongs in most portfolios at these levels.

    As you (correctly) point out, ARMH is beyond expensive by nearly all measures. My gut feeling is its affiliation with Apple and its myriad of iStuff is what ARMH investors hold onto. If so, should the Intel/Apple deal come to pass, ARMH will disappear off most radars faster than Amelia Earhart.

    Thanks for the post! Tim.

  • Report this Comment On December 02, 2012, at 9:53 PM, Arkbro wrote:

    Funny that last month all the articles were about Apple dumping Intel and going all ARM for everything!! Wonder how this will all turn out! Would definately like to see more intel inside more mobile, definately think they are good enough to compete!

  • Report this Comment On December 03, 2012, at 2:22 PM, russfischer1013 wrote:

    Here's another reason that Intel might be interested in Sharp.

    http://www.engadget.com/2011/09/14/idts-power-saving-panel-s...

    Besides that, sharp could become the low cost producer of LCD displays when Japan devalues the yen.

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