Though the buzz around the Internet of Things, or IoT, has probably been more focused on the ARM Holdings (NASDAQ:ARMH) ecosystem, it's actually quite stunning just how profitable Intel's (NASDAQ:INTC) own IoT division is. Now, do keep in mind that Intel's IoT group is a relabeling of its Intelligent Systems group, which in turn was a relabeling of its embedded division, but the point is that this is a very interesting -- and highly profitable -- business.
How big is this business?
Since the IoT group was -- before the most recent quarter's earnings release -- lumped in with the rest of the entities in the Other Intel Architecture group, it was hard to get a precise read on the size of the business. However, thanks to a restating of the financials with various segments broken out separately, investors can now keep tabs on this business as a separate entity.
During the 2013 fiscal year, the Internet of Things group did a whopping $1.8 billion in sales and generated $550 million in operating income, translating into nearly 31% operating margin. To put this into perspective, Intel's IoT group generated nearly as much operating profit as ARM Holdings' entire business did last year.
Why is it so profitable?
There are a couple of things that contribute to the immense operating profitability of the company's IoT group:
- Significant R&D leverage. The chips that Intel sells into this space (medical, automotive, industrial, retail, and other markets) are largely based on the same Core and Atom designs that Intel sells into a broad array of markets. This means that, at the chip level, incremental R&D is minimal.
- Software a large part of the equation. In this segment, Intel isn't just selling chips, but also entire system as well as software solutions. Software, in particular, is very high gross margin business, and with scale, the operating margins look quite good too.
The question that investors should then ask is whether this growth is likely to continue longer-term.
So far, so good
During 2013, Intel's IoT group saw revenues grow from $1.6 billion to $1.8 billion – or about 12.5%. At the company's Investor Meeting, management signaled that growth would be in the "mid-teens" for this business for 2014, implying revenues in the range of $2.07-$2.10 billion and an acceleration from the growth rate seen during 2013. While this isn't a huge part of Intel's revenue base (simply because Intel is a gigantic company), this is a strong, profitable business.
No wonder Advanced Micro Devices is interested!
Interestingly enough, it's clear from Intel's financial results here just why Advanced Micro Devices (NASDAQ:AMD) is so attracted to the semi-custom/embedded market. While Intel can probably get better operating leverage than AMD can by virtue of its scale and in-house manufacturing operations, this opportunity could be quite nice -- and material -- to AMD, which is on track to do just under $6 billion in sales this year.
Foolish bottom line
Though Intel is known as a PC and server chip company, and while those two divisions are what move the needle for the company, this business is a very smart way to leverage its internal assets for meaningful incremental revenue and operating profit.