Few fields move as rapidly as technology. Businesses creating outsized profits and returns for shareholders quickly get a bull's-eye painted on their back as they become targets of other companies looking to disrupt their products by selling cheaper alternatives that still prove "good enough." Not only that, but even if a company continues to dominate its particular field, other changes in technology can shift spending away from their products. Think about how Microsoft still dominates PCs but feels pressure from the sales shift toward mobile devices such as smartphones and tablets.
With that in mind, today we're looking at how Intel
Technology companies can innovate either through acquisitions or by spending more money on research and development. We'll compare Intel's spending in these areas with that of its closest peers and assess whether the company is investing enough in its future.
Research and development
Over the past five years, Intel has spent an average of 16% of revenues on R&D. The following table summarizes how Intel's R&D expenditures relative to revenues compare with some of the company's closest peers.
Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates above are calendar years; yearly total is for company fiscal years closing in that period.
Intel's R&D spending as a percent of sales lags that of its closest competitor, AMD. That doesn't tell the full story, however, as Intel's absolute R&D spending is 4.8 times the size of AMD. That advantage allows Intel to work on more advanced areas while AMD has to use its smaller budget to stay more focused on fewer initiatives, such as its "Fusion" project to meld graphic and central processors onto the same die.
We recently saw the fruits of Intel's advanced research in the unveiling of a new "Tri-Gate" 3-D transistor technology, which should further cement its leadership in servers and make the company more competitive in mobile processors. Tri-Gate chip architecture should not only allow for better performance but also reduce chip power consumption. That's important, because power consumption is becoming key in both server and mobile markets, the two main processor growth areas.
In technology, some of the best companies have turned growth through acquisitions into an art. IBM has adeptly spun off capital-heavy businesses such as the hard-drive and PC segments, while it focused on acquiring additional services and software expertise that have transformed its business model.
On the opposite end of the spectrum, Hewlett-Packard is often criticized for underinvesting in R&D, to the point that it has to overpay on acquisitions to catch up with its competitors.
Investors should remember, most of all, that companies are valued by the cash flow they can bring in for their shareholders over time. If companies need to continue making purchases in perpetuity to keep growing, that amounts to a reduction in cash flows, and investors should treat acquisition spending as a continuing outflow against cash flow.
Let's take a look at Intel's free cash flow over the past five years against cash spent on acquisitions.
Source: Capital IQ, a division of Standard & Poor’s. LTM = last 12 months. Dates above are calendar years; yearly total is for company fiscal years closing in that period.
Intel produces huge amounts of operating cash flow -- nearly $17 billion in the past 12 months, in fact --but it also has sizeable capital expenditures. That's because Intel, unlike many of its peers that have gone "fabless" and outsourced their manufacturing, still controls the making of its chips. The end result is that the company spent more than $7 billion on capital expenditures last year, resulting in free cash flow near $10 billion.
Aside from its recent acquisitions of McAfee and Infineon's wireless unit, Intel isn't highly acquisitive, so free cash flows aren't distorted by a continuing need to create new growth through acquisitions.
Intel has world-class R&D that's unrivaled in the semiconductor industry. That advantage should help the company defend its lead against AMD in the PC and server market. However, even having unrivaled R&D might not be enough if industry dynamics align against your business -- which may be the case in the mobile market, where Intel sat out long enough to allow the likes of Samsung, Qualcomm, Texas Instruments, Apple, and NVIDIA to align behind ARM Holdings' rival processor technology.
At this point, even if Intel once again assets a technology lead in the market, it'll have to contend with a group of well-funded competitors who have poured significant investments into ARM's designs and will be reluctant to move back to Intel. Investors might be used to the company's domination of processor markets as a given, but the next few years will be crucial to seeing whether Intel remains the undisputed processor king.
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