Rumor has it that Intel's (INTC -1.60%) Arc lineup of video gaming GPUs (graphics processing units) is already being nixed -- just a handful of years after originally being announced and long before any of these dedicated graphics cards ever really took root in the market. The rumor was recently circulated by YouTube poster Moore's Law Is Dead. For sure, it's just a rumor, and Intel has subsequently defended its Arc gaming lineup as safe. Time will tell what happens next.
Before I go into what I think all this means for the company (and the stock), I first want it known that I'm certainly not rooting against Intel. On the contrary; Intel is responsible for advancing much of the computing technology we take for granted every day, and I believe the world really needs this company to succeed.
However, the fact is that times have changed, and the competitive landscape is very different than it was a decade ago. Intel axing its Arc GPUs might not be happy news for gaming enthusiasts, but it could actually be a really good thing for Intel's long-term health -- as well as the health of the tech industry at large. Let me explain.
No low-hanging fruit in computing hardware
Let's not be naive about this. Intel was always going to have a steep uphill battle in the consumer GPU market -- especially for high-end chips that appeal to serious video game hobbyists and professionals. This is a space exclusively dominated by Nvidia (NVDA -3.87%) and Advanced Micro Devices (AMD -5.78%), and they've been at it for years. Even if Intel could design hardware that could compete (and I don't doubt it could with enough financial resources to pour into it), marketing it in such a way that consumers would take a high-end Arc GPU seriously is another story entirely.
Basically, Intel might simply need to cancel Arc because the payoff could take longer than it can afford to wait. Some estimates by industry analysts claim Intel has already lost billions on its Accelerated Computing and Graphics Group (AXG), and I don't think that is an exaggeration. Even simple chip-design work is costly and time-intensive. And you have to add the cost to set up new manufacturing lines to produce new chips because these modern tech building blocks are nothing short of marvels of engineering.
But here's the real rub: Intel just started breaking out the revenue of AXG in 2022, and so far, it's been underwhelming. AXG hauled in $186 million in Q2 2022 (up 5% year over year) and just $219 million in Q1 2022 (up 21% year over year). One might argue that this GPU segment is growing, but bear in mind that this is at a far slower pace than the multibillion-dollar GPU businesses of Nvidia and AMD have maintained for the last few years. Plus Intel has been losing market share in its Client Computing Group (CCG), a catch-all division for consumer-facing PCs and laptops, for quite some time, which makes the recent AXG performance all that more painful.
If that wasn't bad enough, Intel is going to take the same hit from the current downturn in consumer spending that other chip companies are starting to report. And even CEO Pat Gelsinger admitted that the Data Center Group (DCG, Intel's second-biggest moneymaker after CCG) would likely lose market share for at least a couple more years.
If Intel was an asset-light chip-engineering company only, maybe this wouldn't be such a big deal. At the very least, perhaps the company could report lower sales but still salvage its profit margins. But this isn't an asset-light chip-engineering company only; it's a vertically integrated engineering and manufacturing company. Lower chip sales indicate the company is running manufacturing lines that aren't being utilized at an efficient capacity.
In other words, Intel's profitability is about to get a really big haircut. With that being the case, it's time to start trimming the excess. My prediction? Farewell, Arc GPUs, we hardly knew you.
If not GPUs, then what?
GPUs might (or might not) be only the latest casualty. Gelsinger has been cutting loose lots of projects that don't jive with the IDM 2.0 strategy the company announced in early 2021. With extra savings realized from these cuts, Intel is revamping its manufacturing capabilities -- both for itself and for other chip-engineering companies. This new segment is called Intel Foundry Services, or IFS. Yup, another acronym to memorize, which really speaks to the sprawling and unfocused nature of Intel's chip empire in years past.
IFS is currently one of the tiniest business segments, bringing in just $122 million in sales in Q2 2022. But IFS lies at the heart of what Intel wants to do. Historically, the company has focused on producing its own in-house-designed silicon. Opening up its foundries to outsiders will be a big task -- and potentially a game changer for Intel (not to mention the semiconductor industry).
Intel's been busy on this front. It announced new fab investments at existing facilities in Arizona, a new fab complex in Ohio, research and manufacturing facilities across the European continent, and the acquisition of chip fab Tower Semiconductor (TSEM -0.66%). With tens of billions in expected investment over the next decade, it's no wonder Gelsinger has been praising the passage of the U.S. Chips Act (about $52 billion dedicated to support U.S. chip manufacturing, as well as 25% tax credits for companies that expand operations in the States). It's just in time because Intel could surely use the help with its ambitious plan.
But here's the thing: Chip-manufacturing facilities take years to build and years more to ramp up to full production capacity. Intel will also have a marketing push to make as it tries to woo its semiconductor-design peers. The good news is that the world's demand for chips isn't going to diminish anytime soon. But it's going to be a long journey for Intel to transform itself.
How does all this affect Intel's stock?
This is no cheap stock. Shares currently trade for less than 16 times trailing-12-month free cash flow. However, the current outlook from Gelsinger and company is for adjusted earnings per share to get more than cut in half this year from 2021 and for free cash flow to turn negative. That means a much higher price-to-earnings ratio and nil free cash flow are coming.
This is an evolving story, and perhaps Intel moving on from its gaming GPU ambitions will help the profit picture for the immediate future. In fact, I believe it would be a good thing as Intel tries to support the booming chip manufacturing that will be needed in the decade ahead.
But I wouldn't buy Intel stock given all the present uncertainty -- not yet at least. Give this one some time to develop. There are better chip stock buys out there for now.
