Intel's (INTC -9.20%) worst mistake in recent history was its failure to make the technological leap from personal computer CPUs to mobile CPUs. It flopped because the British chip designer Arm Holdings (ARM 4.11%) licensed more power-efficient designs to chipmakers like Qualcomm, MediaTek, and Apple.
Intel (which divested its own Arm-based chip unit in 2006 and actually rejected Apple's offer to produce the CPUs for the first iPhone) thought it could conquer the mobile market with more power-efficient versions of its x86 CPUs. But it was dead wrong, and Arm-based chips now power over 95% of the world's smartphones.
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Arm recently went public again after spending the past seven years as a subsidiary of the Japanese conglomerate SoftBank. It had also nearly been acquired by Nvidia before antitrust regulators scuttled the deal in early 2022. The market's reception to Arm's IPO has been chilly so far, but is it a better buy than Intel?
The key differences between Arm and Intel
Arm and Intel produce competing chip architectures, but they operate different business models. Arm doesn't manufacture any chips; it only licenses its designs to chipmakers and generates most of its revenue from royalties and licensing fees.
Intel is an integrated device manufacturer (IDM) that designs, manufactures, and sells its own chips. That sets Intel apart from "fabless" chipmakers, which outsource their production to third-party foundries like Taiwan Semiconductor Manufacturing (TSM 1.26%), but it still outsources a small percentage of its non-core chips (most notably its GPUs) to TSMC and other foundries.
Arm's asset-light model operates at higher margins than Intel. In their latest quarters, Arm posted a gross margin of 95% and an operating margin of 16%, while Intel had a gross margin of 36% and an operating margin of negative 8%.
Arm is well diversified since it licenses its designs to a wide range of chipmakers, and it faces only a few niche competitors. It also doesn't have much exposure to the post-pandemic slowdown of the PC market. But Arm is still heavily dependent on the smartphone market, which also faces sluggish sales this year as the 5G upgrade cycle ends.
Intel faces stiff competition from Advanced Micro Devices, its fabless x86 rival, which outsources the production of its top-tier CPUs to TSMC. That relationship enabled AMD to produce more advanced chips than Intel in recent years.
Intel is scrambling to catch up to TSMC in that "process race," but its higher spending is compressing its margins as it deals with the PC market's post-pandemic slowdown. On the bright side, it doesn't have too much exposure to the smartphone market.
Which company has been growing faster?
Arm's revenue rose 33% in fiscal 2021 (which ended in March 2022), but it declined 1% in fiscal 2022 and slipped another 2% year over year in the first quarter of fiscal 2023. That slowdown was caused by the decline of the global smartphone market. IDC estimates that global smartphone shipments fell 11% in calendar 2022 and will likely slip another 1% in calendar 2023 before finally growing 6% in calendar 2024.
As Arm's growth cooled off, it ramped up its research and development spending on new chip designs. As a result, its operating margins contracted. After rising 41% in fiscal 2021, its net income dipped 5% in fiscal 2022 and fell 53% year over year in the first quarter of fiscal 2023.
That slowdown seems painful, but analysts expect its revenue and earnings per share (EPS) to grow 8% and 20%, respectively, for the full year as the smartphone market stabilizes. But based on those estimates, Arm still looks expensive at 84 times forward earnings.
Intel's adjusted revenue (which excludes its ongoing divestment of its NAND memory chip business) rose 2% in 2021 but declined 16% in 2022. Its adjusted net income rose 4% in 2021 but plunged 65% in 2022.
Those declines were caused by the market's sluggish demand for new PCs. According to IDC, global PC shipments fell nearly 17% in 2022 and will likely drop another 14% in 2023 before finally growing 4% in 2024. But as Intel waits for the PC market to stabilize, it's trying to catch up to TSMC by upgrading its foundries.
Analysts expect that mix of slowing growth and rising expenses to cause Intel's revenue and adjusted EPS to tumble 22% and 69%, respectively, this year. However, its stock still looks reasonably valued at 20 times forward earnings.
The winner: Intel
I'm not a fan of either of these chip stocks right now. But if I had to pick one over the other, I'd stick with Intel because a lot of its near-term problems are already baked into its current valuations. Arm's valuations are simply too high relative to its growth potential, and it would only be worth buying if its stock drops significantly below its IPO price.
