Recently, Rule Maker co-manager Rob Landley expressed concerns about microprocessor giant Intel (Nasdaq: INTC). That column actually started out as an e-mail discussion, and I thought I'd share some of my thoughts on the situation.

As an Intel shareholder, I can't deny I have some concerns about how well Advanced Micro Devices (NYSE: AMD) is doing and what its improved execution means to Intel. But there are a couple of reasons that I have less concern over the long haul.

From what I can tell, AMD has made no real inroads into the highly profitable corporate market. Until it does, Intel holds the upper hand, since that's where the real money is made. The snafu related to the recall of the 1.13 GHz Pentium III chip is a potential bad sign, as it could certainly hurt Intel's credibility and reputation for reliability. It's that very reputation, and AMD's poor one, that made so many corporations shy away from AMD's chips.

Since Rob's article, the bad news has continued to mount. First there was the pre-announcement of a shortfall in revenues for the current quarter. Then came news Intel would cancel its Timna microprocessor, and delay the rollout of its next-generation Pentium IV processor.

I'm also frustrated by Intel's inability to meet demand for much of the year. I understand how it could happen, but that doesn't mean I like it. This has given AMD an opportunity, and AMD has taken advantage of it.

This is where a Rule Maker approach to investing really helps. While it's never fun to watch a holding take a nosedive, focusing on the long-term helps. One of the reasons we want Rule Makers to have a bulletproof financial position, after all, is to help in tough times. At the end of the second quarter, Intel had $13.6 billion in cash and equivalents. That's the kind of war chest we want to see our Rule Makers have, as it can be used to help weather the storm. Fortunately though, there's more to Intel than its cash and financial strength.

If you dig deep, you'll see Intel is morphing its business away from desktop processors. In other words, it's reached an inflection point for the second time in its history and is starting to de-emphasize the desktop PC processor and direct more of its resources toward new initiatives. Processors are still an important source of cash, but if you go out five years, it's easy to see how they could be much less so. I talked about this in last year's Industry Focus. Here are Intel's five key initiatives:

  1. Intel architecture platforms (server over PC)
  2. Networking and communication
  3. Intel online services
  4. Business development (this is where all those investments fall)
  5. e-business
Intel is attempting to take its existing knowledge base, one that centers on the world of chipmaking, and leverage it in the world of networking and communications. These efforts revolve around the world of e-business. Its theme is to move from "personal productivity" to "company productivity."

Intel is directing less capital toward PC processors and more toward other areas because that's where officials expect to make real money. This is certainly risky. Success is not guaranteed, and managing multiple businesses is more difficult -- but it's necessary.

There are a couple of reasons for this. First, competition from AMD is making processors more and more of a commodity. With heightened competition, gross margins are likely to fall. From what I can tell, this is something that's potentially more damaging to Intel than AMD, as AMD's average selling price (ASP) looks like it's increasing, while Intel's is falling.

Right now, Intel is merely putting enough into processors to protect its franchise and generate buckets of cash. Once PCs become less important, Intel hopes to end up with an appropriate asset allocation/investment that allows it to continue to succeed in the future.

This is one of the reasons behind Intel Capital. Think about it. Intel invests in companies that further its existing technology or help it learn about new technologies or products. At the same time, it's a profitable venture. I know this makes the operating numbers a mess to understand, but from a business perspective, it's smart.

Intel's focus is changing. It wants to be the center of communications chips, just as it was the center of PC chips. This has led to a number of legal skirmishes with Broadcom (Nasdaq: BRCM), the current leader in this sector. It's pushing its own blueprint for wireless devices called the Personal Internet Client Architecture, which is keyed by the XScale processor (formerly StrongArm). XScale is used in handheld and other portable devices. Intel is also making a push in the optical space.

Intel has invested more than $7 billion over the last two years to acquire about two dozen communications, networking, and software companies. While some members of the Wise aren't paying much attention to these moves, they're important to long-term investors. Even CEO Craig Barrett has acknowledged that he can foresee a time when processors will be a minority division within Intel. He has stressed that Intel's networking and flash memory businesses "are growing faster than our core business."

It's also important that Intel is able to build bigger, better, and more powerful servers. Last year, company officials said more than 50% of Intel's internal content resources would be focused on the IA64 architecture (iTtanium), a product line that has met with numerous delays this year. iTtanium is one of Intel's key products for the future server market. It is important for Intel to put in place a 64-bit solution that can effectively compete against Sun Microsystems (Nasdaq: SUNW) and other competitors.

While Intel has lost some ground this year in the desktop microprocessor market to AMD, an argument can be made that it's part of Intel's long-term strategy to change its business model. While it's certainly not a guarantee that Intel will be successful in morphing its business, I like the approach.

Rob will share some more of his thoughts on these issues tomorrow.

Also, investors have until October 12 to sign up for The Motley Fool's Biotechnology Investing Online Seminar. Check out this link for more information on how to register for this five-week, 15-lesson seminar.

Related Links:
  • Intel Looks Marvelous, Rule Maker Portfolio, 7/19/00
  • After Intel's Fall, Drip Portfolio, 9/26/00
  • Watch the Business, Not the Stock, Rule Maker Portfolio, 9/22/00
  • Why Can't Intel Meet Demand?, Rule Maker Portfolio, 8/9/00
  • Mission: diversity - Intel broadens its sights, but chips still key to profits, By Ken Popovich, eWEEK, 8/28/00