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Even Intel's Cloud Business Slowed Way Down

By Timothy Green – Oct 26, 2020 at 7:45AM

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It's unclear how much of a role the pandemic is playing in the weakening demand from Intel's cloud customers.

The big news in Intel's (INTC -6.41%) third-quarter report on Thursday was the collapse in demand for data center chips from enterprise and government customers. Sales to those customers were down a whopping 47% year over year, an about-face from growth of over 30% during the first half of the year.

It's not surprising that something like this eventually happened. The COVID-19 pandemic has gutted state and local government revenue and created unprecedented uncertainty for enterprises of all sizes. Other enterprise-centric tech companies been feeling pain from their customers pulling back on spending throughout the pandemic. It wouldn't make sense for Intel to be immune.

A bit more surprising was a slowdown in growth from cloud customers within the data center segment. By every indication, the pandemic has accelerated the shift to the cloud. But Intel managed a meager 15% year-over-year cloud growth rate in the third quarter

Double-digit growth sounds fine, but not compared to how fast Intel was growing its cloud revenue earlier this year. Cloud data center revenue soared 53% in the first quarter  and was up 47% in the second quarter . The swing in demand among cloud customers wasn't as severe as the steep drop-off from government and enterprise customers, but it was still significant.

A cloud.

Image source: Getty Images.

A period of digestion plus a pandemic

Intel sells server chips to the major cloud computing companies, and those companies don't necessarily expand their cloud infrastructure at a consistent rate. This can lead to periods of intense demand growth for Intel's data center chips followed by weaker periods where cloud companies are working through what they've already bought.

Intel believes one of these weaker periods in cloud demand is upon it following a very strong first half. "...our guide assumes cloud segment demand moderates as key customers enter a digestion period following multiple quarters of above trend line growth," said Intel CFO George Davis during the third quarter earnings call.

One big difference between now and previous periods where Intel saw slower cloud growth is the pandemic. Cloud computing infrastructure providers didn't see any real negative impact on demand early in the pandemic: Amazon Web Services reported growth of 29% in the second quarter, and Microsoft saw growth of 47% for its Azure cloud business in its June quarter .

The big question is whether the effects of the pandemic have finally percolated through the economy to the point where they're starting to hurt the customers of cloud computing infrastructure providers enough for them to pull back on spending in a significant way. It took a surprisingly long time for Intel to see demand from enterprise and government customers take a hit; that same process may now be playing out among its cloud customers.

One narrative during the pandemic has been that the cloud computing industry will benefit from the various shifts going on: e-commerce, work-from-home, etc. But a very weak economy could more than offset that additional demand for cloud computing services in the near term.

Unemployment in the U.S. remains elevated, a new stimulus bill is not a sure thing, and a winter wave of COVID-19 could force renewed stay-at-home orders and further gut the economy. The economy is probably going to remain weak for a while, and it's unlikely that any industry will remain completely untouched.

Microsoft will report its own results on Tuesday, and any sign of a slowdown in software or cloud sales would be another data point suggesting that the economic effects of the pandemic are broadening. This may just be another period where Intel's cloud customers are working through their inventories of server chips. Or it could be the beginning of a prolonged slowdown for Intel's lucrative data center segment as the pandemic takes its toll on an expanding list of industries.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and Microsoft. The Motley Fool recommends Intel and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, short January 2022 $1940 calls on Amazon, and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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