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By ponch73
January 18, 2008

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Just to follow up on recent posts from the distinguished and tireless Stuyvesant Grad and LGRandall, I thought I'd revisit and refresh my Intel financial model.

If you'll forgive the shameless plug, I humbly submit this TMF article from a year and a half ago as a decent read on Intel. I can't speak to the credentials of the author other than to say that he is painfully good-looking. But I digress.

Intel reported fourth quarter and full-year results a few days ago. As you no doubt realize by now, the stock got killed. Revenues for the quarter came in a little light, but more concerning to the Street were (1) conservative forward guidance (particularly for Q1) coming in below expectations and (2) Intel senior management conceding that, while they're not seeing a massive macroeconomic deterioration in their business, they're worried about it (based on watching CNBC, among other things).

Like many on this board, I prefer to take a longer-term view of things (rather than focus on one or two quarters) and perhaps unlike many on this board, I like to focus on free cash flows rather than on earnings. So, with regard to Intel, I wanted to look under the hood and kick the tires (financially) for myself. I'm not averse to "looking through" the upcoming recession or cyclical semiconductor downturn in the hopes of enjoying a market-beating long-term return.

Diving into the cash flow numbers for Intel proved to be easier said than done. Much to my annoyance, the company failed to provide a detailed statement of cash flows in its most recent Q4 financial release (instead, it merely offered some selected cash flow information). For your reference, the Q4 release is available here.

This failure probably didn't directly lead to the drubbing that Intel stock took the day following the earnings release. Nevertheless, I can't help but wonder if a nice, clean statement of cash flows for 2007 might have helped Intel attract some opportunistic value-oriented investors to its stock sooner.

Not to be deterred, however, I thought I'd take a crack at backing into Intel's cash flow numbers and EV/FCFu valuation by analyzing the balance sheet (which Intel was nice enough to provide us).

At the end of 2006, Intel had $8.372 bil in net cash (which I define as $10.4 bil in cash and equivalents, short-term investments, trading assets and marketable securities minus $2.028 bil in net debt). By the end of 2007, Intel's net cash had grown to $14.228 bil ($16.35 bil in cash and investments minus $2.122 bil in net debt). So, in essence, "net cash" on the balance sheet grew by $5.950 bil.

Starting with this number, I'm hopeful that we can reconstruct Intel's cash flow from operations.

$5.950 bil = increase in net cash/investments on the balance sheet.

Going through the release, we learn that Intel paid $0.658 bil in dividends in Q4. Adding this to the $1.959 bil paid in dividends in the first three quarters gets us to $2.617 bil in dividends paid in 2007.


Adding this to the $5.950 bil number above gets us to $8.567 bil.

$5.950 bil + $2.617 bil = $8.567 bil = cash generated before Intel paid dividends.

The release also tells us that, in Q4, Intel repurchased $1.5 bil of its stock to offset the $0.838 bil "sold" to employees (in the form of stock purchase plans and tax benefits from stock options). Adding this to the nearly $1 bil of stock "sold" in the prior three quarters gets us to $0.334 bil in cash inflows from options exercises and employee stock plans.

$8.567 bil - $0.334 = $8.233 bil = cash generated before net stock issuance.

My Intel model tells me that Intel spent $0.074 bil on acquisitions in the first three quarters of 2007. The Q4 release doesn't break out the relevant number for Q4. So, we'll go with what we have.

$8.233 + $0.074 bil = $8.307 bil = cash generated before acquisitions.

Moving on, the Q4 release indicates that Intel spent $1.273 bil on capital expenditures. Adding this to the $3.727 bil spent in the prior three quarters yields $5 bil in capex.

$8.307 bil + $5 bil = $13.307 bil = cash generated before capex.

So having worked backwards, we've come to a cash flow from operations for 2007:

$13.307 bil cash flow from operations
(5.000) bil cap ex
(0.074) bil acquisitions
0.334 bil proceeds from net stock issuance
(2.617) bil dividends
-------
$5.950 bil net increase in cash/investments on the balance sheet.

Now, let's try to create a clean summary cash flow statement.

$6.967 bil net income
$6.340 bil adjustments to net income (the bulk of this comes from depreciation and amortization)
$13.307 bil cash flow from operations
$(5.000) bil cap ex
$(0.604) bil deduct after-tax net interest income to "unlever" FCF
--------
$ 7.703 bil unlevered free cash flow

So, in 2007, Intel generated $7.7 bil in unlevered free cash flow (representing a 20% free cash flow margin).

At the current price of $19.33, Intel trades at just over 13x enterprise value to unlevered free cash flows. And, you might argue that this is a conservative take because it doesn't give Intel credit for the $4.4 bil of other long-term investments on its balance sheet (doing so would take the EV/FCFu multiple down to 12.6).

So, Intel's EV/FCFu margin tells us that the market expects long-term growth of 2-3%.

Another interesting thing to consider (to help assess whether or not Intel is a good business or not) is the unlevered free cash flow generation in relation to invested capital. This metric is CROIC (cash return on invested capital).

Using the Q4 balance sheet figures to calculate invested capital (total assets minus net cash and minus non-interest bearing current liabilities), Intel had $30.382 bil in invested capital.

So, the $7.7 bil it generated in unlevered free cash flow represents a 25% cash return on invested capital.

Just to reiterate, a business that generates a 25% return on invested capital is now trading at roughly 13x cash flow. Sounds pretty good to me, although I wouldn't mind picking up some more shares at $18 or below. My rough guess is that Intel's absolute downside would be $15 or $16. I'd also guess that Intel's long-term upside is in the $30-40 range. Just my humble opinion.

Cheers,

Vik