In late 2014, Intel (NASDAQ: INTC) disclosed that its newly announced Bay Trail platform intended for Windows and Android tablets had a pretty serious cost structure problem. According to the company, the platform bill of materials that Bay Trail required was much higher than that of competing tablet solutions.
According to Intel, this meant that in order for a tablet vendor to actually use an Intel chip over, say, one from MediaTek, said vendor would see its tablet costs rise by at least $15 in many cases. So, in order to "neutralize" this platform cost disadvantage, Intel provided "contra-revenue" to tablet vendors that used its chips to "level the playing field", so to speak.
Intel has made it clear the contra revenue is a short-term issue -- future platforms are expected to not have the bill of materials deficiency seen with Bay Trail. At Intel's 2013 investor meeting, the company indicated its low-cost SoFIA products and its high-end platform known as Broxton would not require any contra revenue.
That being said, with Broxton pushed into 2016, and with Intel replacing Bay Trail with a platform known as Cherry Trail in 2015, a question investors may have is whether Cherry Trail will require the contra-revenue offsets.
Intel employee implies the answer is "no"
An Intel employee, posting on the AnandTech forums, had the following to say about all of this platform bill of materials business:
In the mean time, contra revenue was a way to address some of the fact that original Baytrail was a "netbook" chip and thus was designed such that it required OEMs to add other components besides the SoC that drove up platform costs. Baytrail CR corrected some of that gap and didn't require as much contra revenue. Cherrytrail and beyond were designed with the total platform [bill of materials] in mind.
In other words, all future Intel mobile platforms -- including Cherry Trail -- should have competitive levels of integration and a cost-competitive platform bill of materials.
With platform bill of materials hurdle out of the way, the focus is on product competitiveness
The next challenge, then, will be to build parts that are competitive on performance, power, and features. When or if Intel shows it can consistently release such parts, then I expect the company's mobile group to experience a sharp upturn in its financials.
Intel's mobile group lost about $4.2 billion in 2014, and the company expects the loss to narrow by $800 million to $3.4 billion in 2015. I believe the company can reduce the loss by at least $1 billion in 2016 as a result of even more competitive products (for more details, see here). If Intel can keep up the momentum, I wouldn't be surprised if the division were profitable by the end of 2018.
What this could mean for Intel's stock price
In 2014, Intel generated $15.8 billion in pre-tax income, horrific mobile losses included. If Intel can just keep the rest of its businesses flat and rely solely on improving economics in the mobile business to drive profit growth, then by 2018 the company could generate annual operating income of about $20 billion. Assuming a 28% tax rate (which seems to be about what Intel pays), this works out to $14.4 billion in net income.
Assuming a 15 times earnings multiple, this would suggest a stock price of about $44-$45 by the 2018 time frame.
However, I think it is quite pessimistic to expect the rest of Intel's business (data center group, PCs, the Internet of Things, etc.) will remain flat with only mobile loss reduction serving to improve profits. My bet is that PCs grow modestly from now through 2018, while the company's other divisions provide anywhere from "solid" to "extremely strong" revenue and profit growth.
All told, if Intel can wipe away these mobile losses and keep up the momentum in its other businesses, patient investors willing to hold the stock for the long term should see healthy appreciation in their investments.
Ashraf Eassa owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.