Samsung reported preliminary earnings results yesterday and missed consensus by a wide margin, bringing in 7.2 trillion South Korean won, or KRW, in operating profit against estimates of 8.1 trillion KRW. Though the principal driver of the miss was weakness in low- to mid-range smartphones from competitive pressures, there was a comment in the news release that may be relevant to Intel (NASDAQ:INTC) investors.
Phablets are cannibalizing small tablets
Samsung had the following to say with respect to its weaker-than-expected tablet shipments (emphasis mine):
For tablets, shipments declined more than expected level due to weak overall market demand and, unlike smartphone, lack of carriers' subsidies policy led to low replacement demand.
The demand for 5-to-6 inch smartphones also cannibalized the demand for 7-to-8 inch tablets.
As some may have expected, it seems that "phablets" are cannibalizing tablets. This makes sense, particularly as a smartphone is a more essential device than a tablet, which means that it gets dibs for limited consumer dollars. Further, while the difference between 5 to 6-inch screens and 7- to 8-inch screens is material, it's probably not material enough to warrant two devices for most consumers.
What does this mean for Intel?
Intel's participation in mobile this year is very focused on tablets, since that is where it can offer a competitive product lineup -- in phones, it still needs to get its integrated modem and apps processor products out the door before it can really have a chance of a meaningful impact there. Even then, Intel won't be able to fully leverage its silicon leadership in phones until late 2015 or early 2016.
This is perfectly fine -- for now. Even if large phones are cannibalizing small tablets, Intel has a long runway of share to take in the tablet market. If Intel hits its 40 million tablet goal this year, then it will have anywhere from 15% to 20% market share depending on what your estimates are for tablet shipments this year.
Longer term, phones are required
That said, note that Intel is spending about $3 billion per year in fixed operating costs for its mobile division, so to get to breakeven at about 40% gross margins, the company will need to scale sales to somewhere north of $7 billion, although if Intel can do better on the gross margin front, then the breakeven point is lower.
The entire tablet market isn't enough to really recoup that investment, as it's doubtful that it will get the entire market to itself, so smartphone participation in a meaningful way is required -- especially if tablet market growth slows significantly.
Some good news, some bad news
The good news is that the smartphone market is absolutely gigantic, and if Intel can grab just 20% of the units in this market, this should be enough -- along with about 35% of the tablet market -- to get to about breakeven with underlying market growth, and potentially further share gains, driving the division to eventual profitability.
The bad news is that Samsung and Apple still control about half of the smartphone market. Given that Samsung builds its own chips and is trying to win the foundry business of mobile-chip giant Qualcomm (NASDAQ:QCOM), there's not much that would compel Samsung to broadly adopt Intel processors in its phones. (Rumors suggest that Samsung will be doing one low-end phone with Intel's latest smartphone chip, however.)
Put numerically, gaining 20% of the overall market would mean gaining 40% of the non-Apple, non-Samsung business, which is a much higher bar to clear.
Foolish bottom line
With tablet growth looking as though it's going to fizzle out well before smartphone growth does, and with the cannibalization of smaller tablets by larger phones that Samsung has indicated, Intel needs to succeed in phones over the long run.
In the nearer term, if PCs have stabilized and if Intel can grow share in tablets for the next few years, then the stock should continue to do well.
Ashraf Eassa owns shares of Intel. The Motley Fool recommends and owns shares of Apple, Intel, and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.