On April 2, Bloomberg reported that Apple (NASDAQ:AAPL) is planning to design chip giant Intel (NASDAQ:INTC) out of future Mac personal computers beginning with devices expected to ship as early as 2020. Intel's chips are said to be replaced by chips designed by Apple itself.
Unsurprisingly, once this news broke, Intel shares dropped. As of writing, the company's shares are down 5.38%, having recovered significantly from the initial drop.
One analyst, Kevin Cassidy with Stifel Nicolaus (via Barron's), thinks investors are "overreacting" to Intel's potential loss of Apple as a processor customer as Apple's market share stood at just 7.3% during the fourth quarter of 2017, per estimates from IDC.
Is Cassidy's argument that investors are overreacting sound? Let's dive in.
The financial impact
Based on my estimates, Intel generates about $3 billion in annual revenue from sales of processors to Apple. If we assume Intel generates a gross profit margin percentage of around 60% on these chip sales, then Intel stands to lose out on roughly $1.8 billion in gross profit.
For some context, Intel generated $62.8 billion in sales during 2017 and $17.8 billion in operating income. Excluding Apple, Intel would've generated about $60 billion in sales and about $16 billion in operating income (assuming a straight deduction of the gross profit from Intel's operating income).
Though a clear financial setback that should rightly lead to a decline in Intel's stock price (since investors now expect Intel to earn less than they did before this news broke), it's worth keeping in mind that Intel generated just $12.8 billion in operating income during 2016, so even excluding Apple's business, Intel's business today would likely be in substantially better shape than it was in at the end of 2016.
Losing Apple is going to sting, but it's not going to fundamentally break Intel's business.
What does Intel do now?
If Intel does indeed lose the entirety of the Mac processor business over time, the company's best bet is to try to simply work hard to minimize further customer defections (either by major customers to internally designed processors or to competing processors) and to try to further expand its reach into new, adjacent segments of computing.
For the most part, Intel is doing just that. The company is doing things like trying to expand into the market for stand-alone graphics processors, working to become a major self-driving car platform vendor, doubling down on its data center business, and rapidly trying to grow its presence in the market for non-volatile memory.
That being said, it's important for Intel to also understand why Apple wants to shift away from its processors and toward its own. Did Intel fail to meet Apple's product requirements? Did product slips on Intel's part lead to slips in Apple's own product introduction cadence? Does Apple simply not have faith in Intel's future product direction?
Although it's unlikely Intel would be able to win Apple back as a Mac processor customer even if it were to dramatically improve its execution, Intel cleaning up its act could serve to minimize the potential damage from further customer defections -- in PCs and elsewhere.
Circling back to the titular question: Is the drop in Intel's stock an overreaction? No, probably not. Intel closed down $3.16 per share, translating into roughly $16 billion in market value. That's a loss of about ten years' worth of gross profit that it would've otherwise been able to count on from Apple, which is probably appropriate.