Shares of Intel (NASDAQ:INTC) have already fallen about 14% in 2016 due to tepid demand for its PC chips and a slowdown in its data center business. In 2015, revenue at its Client Computing Group, which includes chips for PCs and mobile devices, slumped 8%. Its data center revenue grew 11%, but that missed the chipmaker's own target of 15% growth.
The bright spot in Intel's lackluster report was its Internet of Things (IoT) business, which was formed in 2013 to capitalize on the growth of connected devices like wearables, smart appliances, drones, and connected cars. Let's discuss four key numbers which explain how this business is doing.
1. 200 billion devices by 2020
Intel estimates that the number of connected devices will soar from 15 billion in 2015 to 200 billion by 2020. That will equal about 26 smart objects for every person in the world. This means that, in addition to PCs and mobile devices, our cars, home appliances, watches, and other gadgets will all be connected to each other and the cloud.
To capitalize on this growth, Intel developed new IoT SoCs (system on chips) with less horsepower but longer battery lives. These new products include Curie, a button-sized module for wearable devices, and Edison, an SD card-sized module which can be installed in smart appliances.
2. $0.70 microchips
However, low-power IoT modules also cost a lot less than Intel's PC and data center chips. During a Credit Suisse tech and telecom conference last December (as transcribed by Seeking Alpha), Credit Suisse analyst John Pitzer asked Intel CEO Brian Krzanich an interesting question: "Given that your average selling price is $100, and the perception is IoT is all about $0.70 microchip, how do you actually turn the profit in this business?"
Krzanich didn't deny that some of Intel's stand-alone IoT chips (not complex modules like Curie or Edison) cost $0.70, but he noted that the company would avoid ultra-low end markets like $0.05 RFID tags. He also stated that IoT chips didn't have to be profitable on their own, but that they could complement its data center business by delivering more data over the cloud to Intel-powered servers. "I look for anything that feeds the data center," said Krzanich. "And I try to feed that".
3. $2.3 billion in revenue
In 2015, Intel's IoT revenue rose 7% to $2.3 billion, compared to 19% growth in 2014. The company didn't break down those sales by individual categories, but the company noted that its retail, transportation, and video segments all posted double-digit growth. Yet the business is unlikely to become a major pillar of growth for Intel anytime soon -- it accounted for just over 4% of Intel's full year sales.
Intel's biggest competitor in the IoT module space is Qualcomm (NASDAQ:QCOM), the top mobile chipmaker in the world. To diversify away from mobile chips, Qualcomm acquired IoT chipmaker CSR for $2.4 billion last year, and expanded into new markets like connected cameras, drones, and cars. Qualcomm doesn't report its IoT sales on a quarterly basis, but it claimed to have sold $1 billion in IoT chips in 2014 during an event in San Francisco last May.
4. $515 million in operating income
While Intel's IoT revenue grew last year, the unit's operating income fell 12% to $515 million and accounted for less than 4% of Intel's operating profits. Between 2014 and 2015, its operating margin declined from 27.2% to 22.4%.
Intel didn't discuss why the unit's profitability declined, but it's likely due to competition from other chipmakers. Qualcomm's biggest mobile rival, Taiwanese chipmaker MediaTek, also started developing chips for IoT and wearables in late 2014. Since MediaTek's mobile chips are often used by low to mid-range smartphone OEMs in China, its IoT chips could spread quickly across that lucrative market. This means that market commoditization could occur in the near future.
What investors should watch
Intel often mentions its IoT, data centers, and non-volatile memory businesses in the same breath, because they represent three key ways to diversify its business beyond PCs. Unfortunately, the IoT business still doesn't generate enough revenue to cover up the growth soft spots in PCs and mobile devices. Therefore, investors should keep an eye on Intel's progress in IoT devices, but also maintain realistic expectations for its long-term growth potential.