Fortifying the Castle
Intel's Franchise

By George Runkle (TMFRunkle@aol.com)

Atlanta, GA (Jan. 4, 1999) -- In my past two DRIP columns, I discussed franchises. As I mentioned earlier, I'm not talking about McDonald's franchises or 7-11. Instead, a franchise that concerns us as DRIP investors is defined by John Train in his book The Money Masters as a business that "has attained a privileged position of some sort, so that another company can't muscle in to squeeze its prices and profits." In previous columns I looked at Procter and Gamble and Home Depot as companies with DRIP plans that I feel meet this definition. The reason, of course, for DRIPing in a franchise is it can be a company that will be in a profitable position year in and year out, which is perfect for our needs as DRIP investors.

The next business I wanted to cover came to my mind after watching a videotape of Warren Buffett speaking to some business students. He made an analogy of a franchise to a castle with a moat around it. There is always someone trying to storm across that moat, and the moat is either being made deeper and harder to cross or becoming smaller and less effective. I interpreted that to mean a franchise may be in a preeminent position, but may not always stay that way. Someone will try to storm that moat and, perhaps, take the castle.

One company that I've seen fighting off a horde of angry barbarians is Intel (Nasdaq: INTC). Over the years we've seen AMD, Cyrix, and Digital Equipment try to bridge that moat, climb the battlements, and take control of the castle. Every time a new chip is introduced by a competitor, there is a lot of excitement in the computer press. Experts seem to predict Intel losing market share "this time," but they hedge their language in enough generalities so they can't be said to be wrong if it doesn't work out that way. Could the Wise also inhabit the computer press?

With a quick search of the Web for possible competitors of Intel, I found the Alpha chip, which was initially introduced by Digital Equipment before its acquisition by Compaq (NYSE: CPQ). The Alpha chip is based on 64-bit architecture, and it is used for Windows NT and Unix operating systems, so it won't be in home or desktop computing anytime soon. It's basically used for servers and workstations. Right now, Intel has no chip to compete with it, although ultimately it will ship the Merced chip sometime around year 2001. Also, Intel is manufacturing the Alpha, as part of a lawsuit settlement. However, Samsung has recently begun the manufacture of the same chip.

Perhaps the most vigorous competitor of Intel is Advanced Micro Devices (NYSE: AMD). It has been effective in introducing chips that beat Intel in both initial benchmark tests and price. The company's also been predicting for some time that it would take major market share from Intel. Well, two out of three isn't bad, is it? Of course, I don't think AMD would say something like, "We've got this new K7 chip that will beat every version of the Pentium II, but we expect Intel to continue crushing us like an ant."

Why is Intel able to continue drowning these guys in the moat? I suspect three reasons: brand name recognition, distribution, and manufacturing capability.

Intel gained brand recognition from its "Intel Inside" campaign; in the past, many PC users were only vaguely aware of who manufactured the chips in their computers. Intel also has agreements with the different PC manufacturers, many of whom may be unwilling to disrupt this agreement by going to AMD, which may not be able to meet the demand they have for chips. Finally, Intel has the manufacturing muscle to meet the chip demand, so it can drop prices as necessary to match the competition. Several years ago, AMD introduced the K5 to compete with Intel, and manufacturing problems made it difficult for it to meet supply demands. I remember it well because I bought AMD stock and watched it drop while Intel poured boiling oil down the castle wall.

Will AMD's K7 chip be able to drain the Intel moat? Will the Alpha chip from Compaq/Digital undermine the castle foundations? If history is any indicator, I don't think so. However, the competition introduces a higher level of risk for the Intel DRIP investor. There will be dips in price as the market worries that Intel may lose market share. If the competition fails (as it has in the past), the price of Intel stock will shoot back up. If AMD or another competitor does succeed in taking market share from Intel, this could cause a loss of Intel's franchise, with a drop in share price, too. Therefore, as a DRIP, Intel may represent more of a possible risk (and reward) than the usual franchise business.

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1/4/99 Close

Stock    Close     Change
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