Up until a few years ago, Intel (INTC +4.89%) kept its semiconductor manufacturing prowess to itself. This strategy worked well when Intel had a clear edge in manufacturing technology over the rest of the industry. It was effectively impossible for rival AMD to truly catch up.
But times have changed. Foundry TSMC, which AMD now relies on for manufacturing, is the undisputed leader in semiconductor manufacturing. Intel's edge has disappeared. To catch up, the company must invest heavily in new facilities and new manufacturing technology. But if it were limited to only making its own chips, primarily PC and server CPUs, the economics would be hard to justify.
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The gravy train
Under the model where Intel only makes chips for itself, manufacturing investments have a short lifespan. Once Intel moves its PC and server CPU families to new process nodes, those old process nodes quickly become obsolete. There are plenty of types of chips that use mature, cost-effective process nodes, such as power management chips, but designing those types of chips isn't Intel's core business.
Under CEO Pat Gelsinger, Intel has moved onto a new model. On top of designing and manufacturing its own chips, the company is ramping up its foundry business. In addition to offering the most advanced process nodes to foundry customers, the company is also catering to those looking for mature process nodes. One example: The Intel 16 process, which is a revamped version of one of the company's older nodes, is now supported by the major third-party chip design tools.
Moving to a foundry model has more benefits than just additional revenue from foundry customers. Gelsinger laid out the rationale in an interview during Deutsche Bank's 2023 Technology Conference:
...I am going to keep those factories full forever, right? Because we're going to -- instead of turning over those factories when they start getting good cash flow, we're going to be filling them...And that's always been the gravy train of the foundry business, right? It's being able to run those depreciated assets on a much longer basis with good margin wafers.
Market leader TSMC generated nearly half of its revenue in the second quarter from 16nm or older process nodes. A full 11% of its revenue came from its 28nm process node, which dates back to 2011. When Intel was only making chips for itself, it missed out on this long tail. Under the foundry model, the company's manufacturing assets can generate solid cash flows for a much longer period.
"I think this is an extraordinary value creation cycle for the shareholders as we pull this off," Gelsinger concluded.
A 2025 story
Intel's foundry business doesn't generate much in terms of revenue today as the company works to complete its manufacturing roadmap. The Intel 18A process, which is set to come online by the end of 2024, will mark an inflection point. Intel expects this process to usher in a new era of manufacturing dominance by leapfrogging TSMC.
Intel's foundry revenue can grow rapidly in 2025 and beyond as it wins customers, and its capital spending will become less intense as it completes the various manufacturing capacity expansions it's currently building out. Combined with a longer lifespan where these investments are generating cash flow, Intel's profitability could look a lot better five years from now than it does today.
Intel stock doesn't look cheap based on the company's current earnings, but the foundry model has the potential to boost Intel's profits to record levels as its manufacturing investments pay off.
