Here's What Intel's Deal With Altera Really Means

A lot of folks seem to think that Intel (NASDAQ: INTC  ) should simply give up its mobile ambitions and become a foundry. While the economics of that don't really seem to work, there's another problem here. Being a foundry isn't as easy as simply handing over a chip design and telling a company to hit the "on" button to build the chips -- it's far more complicated and something that Taiwan Semiconductor (NYSE: TSM  ) has far more experience at than Intel currently does.

Intel is trying to build experience
Remember how Intel and its foundry partner, Altera (NASDAQ: ALTR  ) , have been making a big deal about their partnership? Well, that partnership is a big deal, but not in the way you might think. The actual revenue contribution from Altera to Intel from this deal is probably minimal. How do we know this? Well, look at Altera's cost of goods sold for the full year of 2013 -- it came in at $546 million.

Since we know that Intel is only going to be building the very bleeding-edge high-end chips for Altera (the mid-range and below will still be built at TSMC), let's say that 10% of Altera's 2016 COGS goes to Intel. This would translate into a whopping $50 million to $60 million in revenue for Intel, which does well north of $50 billion per year in sales annually.

It's clear that Intel isn't building chips for Altera to dramatically boost its top and bottom lines, but instead to gain experience building products outside its traditional comfort zone. Remember, foundries like TSMC are used to building a wide variety of products and working with a broad number of design teams with various skill levels and requirements.

Will Intel be a more aggressive foundry in the future?
Intel's best bet as a foundry is to keep it limited to customers that don't compete with Intel's core products. This means that building mobile apps processors that go into phones and tablets from the likes of Qualcomm isn't going to happen (especially as mobile devices encroach on Intel's PC cash cow). However, building, say, high-performance network chips for a company like Broadcom or large custom ASICs for a company like Cisco would make perfect sense.

Add up enough of these customers, and Intel could have a respectable, although probably not Earth-shattering, foundry business. It allows Intel to drive utilization of its factories even higher (which improves gross margins across the board), adds a non-trivial amount of revenue and profit, and on top of all of that probably provides valuable input to Intel's manufacturing and process teams that Intel's internal teams may not have the perspective to provide.

Foolish bottom line
Intel's future isn't as a foundry -- TSMC and apparently Samsung seem to be on top of the high-volume foundry side of things -- but this could make a pretty decent side business that could ultimately drive utilization and provide valuable knowledge to Intel's teams. That said, if you want to be really pessimistic, this new knowledge ultimately serves as a plan B for Intel if its mobile efforts never take off and it needs to end up building chips for its mobile competitors.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 23, 2014, at 4:13 PM, drborst wrote:

    Ashraf,

    I think you're half right. Its true that Intel learning to be a foundry will help them do their day job better, and add some revenue, but the other side of the story is Intel operates in a very competitive environment.

    Taking some revenue away from the competition removes some of the money that could be used to develop a better process. Over time that could become a feedback loop...

    DRB

  • Report this Comment On May 23, 2014, at 9:12 PM, rav55 wrote:

    This has nothing to do with Intel learning anything from Altera.

    This is Intel's foot in the door to begin to fill the excess Capex of their foundries.

    Fill the capex reduce your costs. In fact Intel is likely giving Altera a sweet deal just to get them on-board and away from Taiwan Semi. Maybe not as sweet a deal that they are giving the tablet OEM's!

    But other reports have made a rather more oblique and ominous suggestions and that is that Intel would experience growth as a foundry. At first glance this is a good thing. However unless Intel is breakiing ground on new foundries where is the capex for this additional growth?

    For Intel to experience growth in the foundry business then it would have to experience an increase in capacity first. Does that excess capacity come from reduced demand from their own foundry output?

    Are they anticipating a drop in pc sales? Is Intel planning on ending the move into the Mobile market? This would suggest where this capex is coming from.

    The need to begin filling capex to keep the foundries running at high margiins says more about Intel's prospects for future x86 growth than it does for Intel's prospects in foundry growth.

    My last rhetorical question why are folks getting excited about Intel experiening growth from what it is not and at the same time applauding Intel for spending BILLIONs to earn MILLIONs in a market that is severely limited?

    You wrote a piece on March 5 "Did Intel Lose Altera?" which seems to suggest that Intel may have "thrown the baby out with the bathwater." just to keep the Altera deal viable. This piece now seems to reinforce that.

    I am not criticising Intel's move in to providing custom foundry services. I am questioning the implications that have not been fully explored.

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