Finding Intel Corporation's True Mobile Breakeven Point

Intel's (NASDAQ: INTC  ) Mobile and Communications Group had a pretty terrible quarter, generating $1.124 billion in losses on just $51 million in revenue. Unfortunately, Intel reported on its call that the boost it had previously expected from its LTE-Advanced solution ramp would be shifted out about a quarter, as its XMM 7260 product was delayed from Q2 to Q3 (as previously reported here) -- giving rival Qualcomm (NASDAQ: QCOM  ) a distinct advantage, as its own LTE-Advanced Cat. 6 model successfully rolled out in the Samsung Galaxy S5 LTE-Advanced variant (and could be found in this fall's iPhone release). 

The silver lining here is that thanks to this essentially zero-revenue quarter, we now have a pretty good idea of Intel's investment level in mobile.

$51 million in sales, $1.124 billion in losses, and 10 million tablet chips shipped
We know that the company lost $1.124 billion in its mobile group. We also know that this was on sales of just $51 million -- small enough that our "guess" on gross margins doesn't really matter much in trying to figure out the division's operating expense run-rate (I'd wager it's in the 20%-30% range, since it's still mostly old 2G/3G modems). We also know that the contra-revenue impact from 10 million tablet chips shipped (an increase of 5 million from Q1) resulted in an impact of 1.0 points on the gross margin front.

With all of this in mind, we can calculate to a fairly high degree of accuracy the operating expense run-rate for the company's mobile efforts.

What's the magic number?
The 1% negative impact to gross margin that the incremental 5 million tablet chips incurred means that those incremental 5 million units cost Intel roughly $142 million (about $28 per unit). To get the adjusted operating expense run rate (i.e., excluding the temporary contra-revenue impact), let's use the following data:

  • Contra-revenue per tablet chip unit is $28 across 10 million units.
  • Total operating loss of $1.124 billion.
  • Total revenue of $51 million for the quarter at 25% gross margin.

If we strip away the one-time contra-revenue impact, which works out to approximately $280 million, and if we add back the gross profit of approximately $13 million, then we have fixed operating expenses of $831 million. Multiply that by four (assuming that this represents an "average" quarter), and we get total operating expenses of $3.324 billion.

So, what's the breakeven point?
With fixed annual operating expenses of roughly $3.3 billion, the division needs to generate about $6.6 billion at 50% gross margin to break even. If you relax the assumption on gross margin to more along the lines of 60% (this should be achievable once Intel has moved all of these products to in-house manufacturing), then the division needs to do about $5.54 billion in sales to break even.

With revenue of just $51 million in the most recent quarter, this may appear to be a pipe dream, but it's actually achievable within the next two to three years if we make the following assumptions:

  • 20% of the $18 billion (and growing quickly) smartphone applications processor market.
  • 35% of the $3.6 billion (and growing) tablet applications processor market.

That gets us to about $4.8 billion in sales, but keep in mind that over the next two to three years the total addressable market, or TAM, will grow substantially. If we assume that the TAM for both smartphone and tablet processors grows at a 15% compound annual growth rate, then those market share numbers get Intel combined revenue of about $7.3 billion by 2016 -- getting the division to breakeven or better, even if operating expenses rise modestly from current levels.

Foolish bottom line
Intel is investing to the tune of $3.3 billion in research and development and in sales, general, and administrative costs aimed at the mobile market. This investment pipeline won't bear fruit until 2015, but once it does, there is a reasonable chance that the division can fairly quickly grow into this cost structure, particularly if the products are largely manufactured in Intel's own factories.

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