Last October, Qualcomm (NASDAQ:QCOM) started sampling its first batch of 24-core data center chips to tier-1 data centers. At the time, it didn't seem like Qualcomm's server chips could threaten Intel (NASDAQ:INTC), which controls over 99% of the data center market. But in January, Qualcomm formed a joint venture in China to design, develop, and manufacture chips for Chinese servers -- showing that it was getting serious about stepping on Intel's toes.
But looking ahead, Qualcomm's data center business could soon gain its biggest ever backer -- Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google. According to a recent Bloomberg report, Google is expected to publicly back Qualcomm's data center chips at an upcoming investor event. Qualcomm and Google previously collaborated on the chip designs, and Google reportedly pledged to back Qualcomm if the processors met certain performance goals.
Google orders as many as 300,000 processors every quarter for its servers, making it the third largest buyer of data center processors on the planet. Those orders account for over 5% of all processor shipments worldwide according to IDC. Let's take a closer look at how much Google's support could help Qualcomm, and how deeply that partnership could wound Intel.
What's in it for Google?
The growth of data-hungry web and computing services caused Google's equipment costs to nearly triple since 2011. By partnering with Qualcomm, Google could reduce those expenses by securing more favorable prices for data center chips. That partnership might force Intel to lower its prices, which would make it cheaper for Google to expand its data centers with either company's processors.
Since Google writes its own software, it can optimize its systems for Qualcomm's ARM-based processors more easily than large businesses which use third-party software designed for Intel's x86 processors.
How does this help Qualcomm?
Qualcomm expanded into the data center market to offset declines in its core business of mobile chips and wireless modems. Higher-end customers like Samsung have started using their own silicon instead of Qualcomm's Snapdragon SoCs, while lower-end ones are buying cheaper SoCs from rivals like MediaTek.
Those headwinds caused Qualcomm's chipmaking revenue to decline 22% annually last quarter as operating profit plummeted 49%. To stop that bleeding, Qualcomm introduced new chips for connected cameras, cars, drones, wearable devices, and data centers. Intel expanded into many of the same markets to offset sales declines in its core PC market.
When Qualcomm introduced its data center chips last year, it claimed that they would "be competitive in performance and price" with Intel's Xeons. Few people took that claim seriously, since Qualcomm was known for making smartphone chips instead of high-powered Xeon killers. But Google's vote of confidence is a game changer, and other giants might consider following the search giant's lead.
How does this hurt Intel?
Intel has been relying heavily on the growth of its data center business to offset declines in its PC and mobile businesses. In 2015, revenue at its Client Computing Group, which includes PC and mobile chips, fell 8%. Data center revenue rose 11%, but that missed the company's prior target of 15% growth. Operating income from the unit grew 6% and accounted for over half of Intel's operating profits.
Shares of Intel fell over 9% the day after it released those earnings on Jan. 14, and the stock remains down 14% for the year. Several analysts subsequently downgraded the stock on concerns about the data center business.
Qualcomm's alliance with Google now raises fresh concerns about that business. In a worst-case scenario where Google orders all of its new processors from Qualcomm, Intel could theoretically lose around 5% of its quarterly orders. If Google's rivals also give Qualcomm a chance, those losses could widen. That growth might eventually fulfill ARM's claim that its chip designs would account for 10% of the server market by 2017.
But it's not a magic bullet for Qualcomm
Qualcomm's progress in data center chips is promising, but it definitely won't offset the chipmaker's other major problems anytime soon. Its chipmaking business still mainly relies on smartphone and tablet makers, while its more profitable patent licensing business remains under relentless pressure from regulators and defiant smartphone makers.
Qualcomm's data center chips won't solve its core problems, but they introduce plenty of new headaches for Intel. If Google aggressively backs Qualcomm in this data center battle, Intel might need to rethink its annual growth targets for the business.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Qualcomm. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Qualcomm. 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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