More Reasons Intel Shouldn't Quit Mobile

Another day, another analyst declares that Intel should exit mobile. Here are more reasons that'd be a bad long-term strategy.

May 7, 2014 at 11:52PM

There's been a lot of chatter from the analyst community as of late urging Intel (NASDAQ:INTC) to reconsider its venture into the realm of mobile computing. While many Intel investors believe that exiting mobile would be a deadly long-term strategic error, others tend to focus on the nearer-term financial "gain" that Intel would see if it were to quit mobile, presumably leading to a higher stock price. However, in this article, I'd like to explain another reason giving up on mobile wouldn't bring the savings many believe it will.

Let's look at the numbers
Here's the breakdown of Intel's revenue and profit per operating segment over the past several quarters and for the full years of 2012 and 2013:

Pnl

Source: Intel.

Obviously, the PC Client Group, or PCCG, is extremely profitable, and the Data Center Group, or DCG, is also quite robust. The Internet of Things group is also looking like a fantastic business, and all told, these three businesses generated a hefty $17.87 billion in operating income during 2013. The eyesore, of course, is the Mobile and Communications Group, or MCG, which lost a whopping $3.148 billion in that same period.

There is more leverage here than the loss implies
The initial, knee-jerk reaction would be that if Intel were to simply shut down MCG that those savings would fall right to the bottom line and the stock would be worth more at a constant earnings multiple. Unfortunately, this is absolutely the wrong way to think about it, simply because much of the IP/chip development that goes on in MCG is leveraged quite nicely by PCCG, DCG, and IoT. In short, while mobile products aren't directly generating operating profitability, much of that R&D is leading to profitability and margin gains in other segments.

For example, the Atom CPU cores and much of the system-on-a-chip IP that's developed primarily for smartphone and tablet products are reused to build low-cost (but high-margin) PC chips, as well as micro-server, communications infrastructure, and storage system-on-a-chip products. Further, Atom-based chips largely similar to their PC and tablet counterparts are sold into the Internet of Things division in things like in-vehicle infotainment systems and point-of-sale terminals. There is a lot of leverage that comes from that mobile investment.

The loss in mobile will narrow with sales volume
Addressing the mobile question directly, it's plain as day that the loss Intel is incurring now will narrow significantly on the following drivers:

  1. Elimination of the contra-revenue support required for this year's roughly 40 million tablets, and growth in that tablet volume (this is likely to happen at the expense of the weaker ARM Holdings (NASDAQ:ARMH) vendors before it encroaches on heavyweights like Qualcomm (NASDAQ:QCOM)).
  2. A ramp of Intel's discrete LTE/LTE-Advanced discrete modems (this is probably the first real LTE competition Qualcomm is going to face).
  3. A ramp of smartphone-focused platforms (in particular, the apps processor).

So, if we make the following assumptions for 2015:

  • Intel ships 60 million tablet chips at an average platform selling price of $20.
  • Intel ships 50 million full smartphone platforms at an average price of $20.
  • Intel sells 30 million discrete modem/RF transceiver parts at an average price of $10.
  • Intel sees $600 million of legacy 2G/3G business.

Then Intel will recognize revenue of about $3.1 billion in its Mobile and Communications group. If we assume gross margins at the 45% level (they'll get better as Intel moves the high-volume parts in-house, and this is a pessimistic estimate to begin with), then assuming roughly $3.7 billion in operating expenses (which is the implied operating expenses at 40% gross margins on the current revenue base), this should lead to an operating loss of about $2.3 billion -- a healthy improvement from a $3.2 billion loss during 2013 and what is likely to be a $3.5 billion to $4.0 billion loss in 2014.

Foolish bottom line
While it's easy to just say "shut down mobile," do remember that the PC market is stagnant at best and that mobile is where the high-dollar-content incremental growth opportunities lie. If Intel wants to grow its $53 billion-a-year revenue base meaningfully, it will need to succeed in both tablets and smartphones. The loss is painful for now, but Intel investors should be confident that this is the correct strategic decision and that Intel is unlikely to give up on mobile at any point in the foreseeable future.

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Ashraf Eassa owns shares of ARM Holdings and Intel. The Motley Fool recommends Amazon.com and Intel and owns shares of Amazon.com, Intel, and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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