Every great company must periodically reinvent itself. Andy Grove calls it an "inflection point." Johnson & Johnson, IBM, American Express, and General Electric are just a few examples of companies that have survived many inflection points during the 20th century as they've expanded into countless new lines of business. As a result, their stocks have been great long-term investments because at various times each one of these companies has been willing to "bet it all" on a risky new venture. Such risk taking is the only way a company can keep growing once existing markets become saturated.
For Intel, the chip-making business is still thriving, but the company's future will be based on silicon solutions to the Internet economy. The company envisions millions of servers, billions of connected computers, and trillions of dollars of e-commerce. Will it become a reality? That's what last night's webcast set out to answer.
The two-hour presentation covered a whole slew of topics, but I've whittled my notes down to five key themes:
- Worldwide PC outlook
- New products
- Server market progress
- Growth areas
- Acquisitions and equity investments
Worldwide PC Outlook -- Since April, the worldwide PC forecast has improved significantly. Earlier this year, the industry thought PC shipments for 1999 would grow in the low teens, but the latest forecast from Dataquest is calling for growth in the high teens. Quite simply, the Internet is driving PC growth. In fact, the robust demand for PCs is causing prices to stabilize for the first time since 1996. In the sub-$1K value market, Intel has doubled its market share in the past six months to 70% as of September. Best of all, this strength in the value segment hasn't hurt Intel's margins because the overall value/performance mix has remained steady.
More good news for margins is that the ongoing move to 0.18 micron process technology along with more efficient packaging is enabling a 20% decrease in unit cost for Celeron and a 50% decrease for the Pentium III. During the next 12 months, Intel will be transitioning entirely to the 0.18 micron technology.
New Products -- Looking ahead to next year, Intel has several exciting new products. In the first half of 2000, the company will bring to market 800 mhz. Pentium III processors for the desktop. In notebook machines, SpeedStep technology (formerly called "Geyserville") will improve battery life without sacrificing performance. SpeedStep is set to arrive in Q1, although that's now six months behind schedule. By the second half of the year, the first 1 Ghz. (1000 mhz.) processors will arrive. Also in the second half, Intel will market a high-performance "PC on a chip" Timna processor, targeting the value segment. Also in the new product arena, Intel is entering the Internet appliance market. The company has been chosen for set-top box production by PCC in Asia, Hughes here in the U.S., and Nokia in Europe.
Server Market Progress -- More and more, Intel is focusing its resources on the high-profit server market. International Data Corp. (IDC) expects Intel Architecture products to continue to gain share. Half of all server market revenue is for systems costing north of $100k, even though this segment makes up only 2% of server units. Right now, Intel has only 6% of the ultra-high-end market, but IDC expects Intel to capture 21% of that market segment by 2003. Intel is well-positioned to thrive in the high-end server market with four forthcoming versions of the Itanium Processor (formerly codenamed "Merced"), set to arrive in the second half of next year.
Growth Areas -- CEO Craig Barrett outlined five key growth areas. First up was flash memory, which isn't new but will benefit from increasing demand as it's utilized in cellular phones as well as all basic Internet infrastructure devices. Second, in the networking and communications arena, applied computing is an imbedded Intel processor that will be used inside communications infrastructure such as routers and switches. Third, Intel's Internet Exchange Architecture (IXA) enables intelligent networking via a reprogrammable technology that Intel expects will form the standard building blocks of the communications industry.
Fourth, Intel intends to serve the communications industry with a variety of common building blocks and open interfaces in order to deliver a standard platform solution. On this point Intel was vague, but the company emphasized the strategy of developing an open platform upon which the entire communications industry could converge. Finally, Intel's Online Services Business is targeting the anticipated massive need for ultra-reliable Web hosting by large and small businesses alike, in which Intel provides all the necessary hardware and software within an Intel facility.
The most interesting aspect of this business is the international push. The ISP business is growing 100-200% per year in emerging economies. Intel's goal is to get in at the bottom and grow with them. Another interesting aspect of Intel's strategy for online services is the horizontal structure, which includes a number of key partners such as WorldCom's UUNet division and professional services giant PricewaterhouseCoopers.
Acquisitions and Equity Investments -- In the past year, Intel has amassed more than $8 billion in free cash flow. More than $6 billion of that sum has been used to make nine acquisitions this year alone. Most of these have been focused on Intel's emerging growth areas in networking and communications. Intel expects to make even more acquisitions next year, with at least half of them based overseas. In addition, Intel has an equity investment portfolio of more than 300 holdings valued at $4.8 billion. (Remember, the Fool recommends a portfolio of no more than 15 individual stocks!)
Even with all of this investment activity, Intel has also been plowing cash into the repurchase of its own shares. Whereas most tech companies are constantly diluting their ownership with a heavy tide of stock options, Intel's vigilant repurchase program has actually reduced the outstanding shares in the past year. That's outstanding.
Most impressive perhaps is that Intel is undergoing this reinvention before growth stalled in the core microprocessor business. Many companies resist change until there's a gun pointed at its head, but the prudence of Intel's new strategy proves to me that Intel management is among the very best in the corporate world. Even so, Intel shares aren't trading at a substantial premium to the S&P 500 on a trailing earnings basis. And on a cash flow basis, Intel's position is much stronger than the market average. The same can be said of Intel's balance sheet, which boasts of nearly $12 billion in cash, scant debt, and a flowie that's been declining over the last year and now stands at a two-year low of 0.97.
Count me in with Rob and Phil. My vote is for an additional $500 of Intel shares.