The world is changing faster than Intel (INTC -2.40%) can. Smartphones and tablets have seen explosive rates of adoption, yet Intel's technology remains largely stuck inside the PC. This is a bit problematic, considering that mobile computing is threatening to extend the replacement cycle of PCs, a rate that means everything to the industry. Should users decide to extend the typical four-year life of their PCs by just one year, it would shrink the PC industry by 20%.
If this trend continues, Intel likely only has a few years left before mobile computing seriously threatens its core PC business. In other words, it's likely in Intel's best interest to make a big splash in mobile computing sooner rather than later. To that end, Intel will be banking on its technologically superior, leading-edge capacity to carry the weight of its mobile ambitions.
Filling the void
When Intel developed its x86 architecture, raw computing power was the primary objective. You can think of Intel's x86 architecture as the equivalent of an American-made muscle car of the 1960s -- a powerful, yet inefficient gas guzzler. This is contrary to chips based on ARM Holdings' (ARMH) architecture, which are more like your eco-friendly fuel-efficient vehicles.
As you can imagine, Intel's approach to processors hasn't exactly been a great fit in the age of smartphones and tablets, which spend the majority of their lives running on battery power. As a result, ARM designs have become the de facto standard in mobile computing while Intel continues to shrink its x86 architecture so it runs on less energy. Thankfully, Intel has far superior foundries to work with than what Taiwan Semiconductors can offer to ARM chip makers.
To that end, Intel will be the first to market with a 22-nanometer processor specifically meant for tablet computing, a full generation ahead of the ARM competition. Intel's Bay Trail processor is likely to be a compelling tablet processor because it effectively paves the way for $200 tablets running the full version of Microsoft Windows 8. Against the sea of low-cost Google Android tablets, a $200 Windows 8 tablet could be very well received and help improve the negative perceptions surrounding Windows 8.
Unfortunately, it's more complicated for Intel than launching a compelling product or two.
A catch-22
Given the more competitive landscape of mobile computing, Intel must be willing to accept a lower average selling price than it has grown accustomed to in the PC world.
Based on my estimations, which are modeled off of Qualcomm's (QCOM -2.36%) semiconductor business, Intel would need to sell about five smartphone processors to replace the revenue from one PC sale. Assuming Intel sold its smartphone chips for the same $22.03 average selling price that Qualcomm commanded over the last four quarters, and Intel managed to sell all 356 million smartphone processors in its addressable market, it would be worth about $7.8 billion in revenue. On the tablet side, I've modeled Intel's current addressable market to be worth somewhere in the neighborhood of $1.6 billion to $2 billion in revenue.
Combined, we're talking about a roughly $10 billion maximum opportunity for a company that earned over $53 billion in revenue last year. Now, this is before taking into account any cannibalization mobile computing may continue to have on Intel's existing business. Should the PC industry experience a prolonged replacement cycle, it's clear that Intel may face some serious revenue pressure down the road. Not to mention, Intel's underlying profitability may also be at risk because we don't know how Intel will maintain its historically rich gross profit margins as it shifts toward a model that deals with the reality of significantly lower average selling prices.
Low replacement value
Although Intel possesses the most technologically advanced semiconductor foundries on the planet, it's becoming apparent that this factor might not matter as much as once thought. Currently, there's a huge disconnect between Intel's historical earnings and what it could potentially earn as it taps into new markets.
However, the tablet and smartphone markets are both expected to continue growing in the strong double-digits in the coming years. By the end of 2017, the tablet market is expected to reach 350 million annual shipments, about the current size of the PC market today. This growth could help expand Intel's $10 billion addressable market to a far larger figure. Still, the question of profitability remains a bit of a wild card, given the reality that Intel's average selling prices are poised to decline.
For these reasons, shares trade at a 35% discount to the S&P 500, indicating investors' lack of conviction and visibility as Intel diversifies away from the shrinking PC market. In hindsight, I probably shouldn't have been tempted by Intel's extreme value when I purchased shares over a year ago.
