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Intel Corp.'s Data Center Business Is Truly Wonderful

By Ashraf Eassa – Feb 4, 2016 at 8:30AM

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A look at why this segment is well positioned to keep the Intel story interesting over the long term.

I've been quite critical of Intel (INTC -1.96%) lately, particularly with respect to its messaging around its chip manufacturing technology and its mobile efforts. However, the company does a lot of very important things right. One of those things is its data center business.

In this article, I'd like to go over why that business is just awesome for Intel and why I expect that it will continue to serve its shareholders well in the coming years.

Large, high-margin, and growing quickly
The explosion in the sheer number of devices that connect to the Internet has led to a corresponding boom in demand for, in the words of Intel CEO Brian Krzanich, "the infrastructure powering the smart and connected world."

Indeed, Intel's data center group turned in $15.98 billion in revenue in 2015, representing just over 11% year-over-year growth. This was a miss relative to the company's prior expectations of "more than 15%" growth, but respectable nonetheless.

While a double-digit billion business growing at more than 10% is interesting, it's even more interesting when that business generates extremely fat operating margins. In 2015, Intel raked in $7.844 billion in operating income, representing operating margin of 49%.

Interestingly, even though the bulk of the company's sales in this segment consist of very high value processors, Intel has been reasonably successful in growing the non-CPU portion of this business. In 2014 revenues from the non-platform part of this business was $1.021 billion and in 2015 this grew about 7% to $1.095 billion.

My guess is that as Intel rolls out increasingly competitive non-platform components (such as Ethernet adapters, switches, and so on), it will see an acceleration in revenue there.

But wait, isn't it at risk from competition?
Perhaps the biggest risk that investors see to this business is that there are a lot of chip companies trying to go after the markets that Intel currently serve. In chip terms, $16 billion is a lot of revenue and Intel's high operating margins might suggest that there is room for competition to drive down Intel's selling prices and ultimately margins.

I agree that competitive threats are always a risk, especially in attractive businesses, so investors should keep a close eye on what the competition brings. However, I believe that Intel is very well positioned to stay ahead of the competition here for a couple of reasons.

First of all, there is momentum that comes with being the incumbent. However, over time a complacent incumbent player is very likely to be displaced by a hungry underdog.

Fortunately, Intel also seems to be investing very aggressively in future products and additional platform features. To put this into perspective, at its most recent investor meeting, Intel said that in going from 2014 to 2016, the company will increase its data center group-specific spending (research and development as well as marketing) by more than $1 billion.

This incremental spending is larger than the entire operating expense budgets of many of the companies that have been very vocal about challenging Intel in this market. The barriers to entry into this business are extremely high and Intel seems to be working to make sure that they only get higher.

This is the best reason to own Intel stock
At the end of the day, I believe that Intel's data center group is the key to making Intel stock a worthwhile investment. I don't expect any growth from the company's PC business going forward, and the company's other businesses are just too small and growing too slowly to really be material anytime soon.

Ashraf Eassa owns shares of Intel. The Motley Fool recommends 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.

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