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Why Intel's Foundry Services Push Makes Sense

By Timothy Green - Mar 30, 2021 at 7:30AM

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Making chips for other companies is a good idea for a few reasons.

Intel (INTC 2.21%) CEO Pat Gelsinger, who took charge of the chip giant earlier this year, laid out his plan on March 23 to return the company to its former glory. Intel has faced chronic issues with its in-house manufacturing technology, leading to long delays and opening the door for rival AMD to win significant market share. The company also no longer has any kind of manufacturing edge over third-party foundries such as Taiwan Semiconductor (TSM 2.92%) (TSMC).

Instead of caving in to pressure from an activist investor and spinning off its manufacturing operations, Intel is doubling down on what it views as a key competitive advantage. Intel will continue to manufacture the majority of its products in-house, fueled by a $20 billion investment in two new facilities in Arizona.

Those new factories will also support Intel's new foundry services business unit. Intel has offered to manufacture some chips for other companies in the past, but that effort never really got off the ground.

"Our past attempts were somewhat half-hearted," Gelsinger said in a presentation to analysts, as reported by Bloomberg.

This time around, Intel appears fully committed to becoming a major player in the foundry business. The company will be able to offer manufacturing capacity in the U.S. and Europe, and customers will be able to make use of Intel's intellectual-property portfolio, including its x86 cores.

Given Intel's previous failure at getting a foundry business off the ground, along with its years-long struggles with manufacturing, the push into offering foundry services may seem unexpected. But given how profitable TSMC has become, it makes perfect sense.

A semiconductor chip.

Image source: Getty Images.

A cash machine

Intel's core business of manufacturing PC and server chips is highly profitable, even with its manufacturing missteps. The company generated $20 billion of revenue, a gross margin of 56.8%, an operating margin of 29.5%, and net income of $5.9 billion in the fourth quarter of 2020. Intel is still a cash machine.

In the past, it made little sense to use manufacturing capacity to make chips for third parties when it was more lucrative to use that capacity for its own chips. But things have changed. Intel's profits are impressive, but so are foundry market leader TSMC's.

TSMC reported revenue of $12.1 billion in its latest quarter, up 29% from the prior-year period. The company managed a gross margin of 53.4% and an operating margin of 42.1%, leading to net income of about $4.8 billion. In other words, TSMC is producing nearly as much net profit as Intel on quite a bit less revenue, solely by making products for other companies.

If Intel succeeds in becoming a major provider of foundry services, margin could potentially improve, given how profitable TSMC has become. Intel faces a lot of challenges: Its manufacturing difficulties remain, competitors may not want to turn to Intel for manufacturing, and it will take huge investments to overcome the manufacturing lead that TSMC has built. But the foundry business could be very profitable for Intel in the long run if everything goes right.

Companies that have given up on semiconductor manufacturing, including AMD and IBM, have done so because the investments required to stay competitive simply didn't make sense given the volume of chips those companies were producing. If Intel stuck with only manufacturing its own products, it may have eventually run into the same issue. By offering foundry services, Intel can make sure it has enough volume running through its factories to be able to make the massive investments necessary to keep pace with TSMC.

Intel's push into foundry services may seem odd, given its recent struggles with manufacturing, but it may be the only way to justify the massive investments Intel will have to make to regain its manufacturing edge. And foundry services could become a highly profitable business in its own right for Intel if everything goes according to plan.

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Intel Corporation Stock Quote
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Taiwan Semiconductor Manufacturing Company Limited
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