Analyzing Intel's capex boost, PC disconnect

Two key takeaways from Intel's 1Q11 blowout financial performance and execs' comments in the follow-up conference call are resonating across the industry: why bearish analysts were so far off on PC demand, and why Intel is already hiking up its 2011 capex.

Trust our market visibility, not theirs. Despite analysts' assertions and concerns over perceived sluggishness in PC demand, Intel saw 17% Y/Y growth (12% Q/Q) in its PC client business. It may not have direct inroads into chips for mobile/tablet devices, but those devices rely greatly on connectivity, which means accessing backend/server systems, where Intel does have solid business. And as far as the PC market, Intel's Paul Otellini didn't mince words:

Like many of you, I noted that some of the third-party research firms issued reduced forecasts for PCs in 2011. I want to be clear that our views differ from some of theirs. The PC business has evolved into a global industry that is approaching 400 million units this year.

While some channels like PCs sold through consumer retail outlets and mature markets have deep visibility, other channels, especially in emerging markets, are not well reflected in the forecast of third-party firms until shipments from Intel and its competitors have been reconciled.

Over the last 5 years, we have put considerable effort into improving our visibility with systems like just-in-time inventory hubs for our major customers, as well as realtime metrics to monitor sales through all of our worldwide channels. As a result, we were able to call the inflection in our business in Q1 of '09, as well as predicting 2010 growth to within 1 point of accuracy.

Our projections for PC segment growth in 2011 remain in the low double-digit range based on early sell-through strength we are seeing as we begin 2011 and the great reception to Sandy Bridge in both Consumer and Enterprise segments. And while it's too early to call 2012 with an improving global economy, we see no reason for growth to be materially different from what we see in 2011.

Mea culpa, admitted a few analysts. FBR Research's Craig Berger upgraded INTC to "outperform" from "market perform," acknowledging that while PC checks have been weak, "investors (including us) have been overly bearish on Intel," "PCs and tablets/smartphones can co-exist and PC units can still grow," and "more time [needs to] be spent assessing the smartphone/tablet cannibalization impacts on PC growth."

Deutsche Bank's Ross Seymore noted that the disconnect between market analysts and Intel's results is largely explained by "Intel-specific drivers" including emerging markets, Sandy Bridge adoption (and overworries about chipset glitches), and pricing. "The Street (GLCH included) missed the magnitude of burn through 3Q10 and 4Q10 in the channel ahead of Sandy Bridge launch," which led to undershipments for 2010 PC demand, added Gleacher's Doug Freedman. Also a contributing factor: an extra week (14th) of revenue in the quarter.

Better performance needs better silicon. Three months after mapping out a $9B (±$300M) capex plan for 2011, Intel has now raised that ceiling to $10.2B (±$400M), citing a need to support 22nm and 14nm (both production and R&D). Intel says it spent $2.72B of that in 1Q11 alone (up 46% Q/Q). "We think that Intel has placed orders for equipment deliveries through mid-3Q, and we think there should be continued Intel orders in 2Q/3Q to ensure the company spends its capex," writes Credit Suisse's Satya Kumar.

Explained Intel CFO Stacy Smith during the conference call Q&A:

Probably the biggest single chunk that's happening inside of this increase in CapEx is the fact that we've made the decision that for the development fab for 14 nanometer, we're going to make that fab bigger. That gives us the ability to actually, at the early stage of the ramp, move more products to 14 nanometer, take advantage of that process technology leadership, ramp it faster. So we're going to spend some construction dollars today to have that capability in place of 14 nanometer. But over the 14-nanometer life, it should save us money by going faster on that first factory.

What Intel is seeing earlier than anyone is the effect of rising capital intensity, argues Kumar. "The rest of logic is only spending on 28/46nm," he notes, and should start feeling the higher capital intensity pressure next year. Recent pushouts by Samsung and TSMC are not an industrywide weakness trend, he says. Barclays' CJ Muse echoes what Intel execs said in the call: that the needs of emerging mobile devices (notebooks, tablets, phones) require more platform features integrated into the processor, meaning more leading-edge silicon capability for power management and performance in smaller formfactors.

Of course rising capital intensity is good for equipment suppliers, and those with best visibility to new business from Intel (particularly R&D) include ASML and KLAC, Kumar says (adding that LRCX has no Intel exposure). Others, like UBS' Stephen Chin, see others taking advantage, including NVLS and VSEA. Muse adds CYMI, ASMI, and TEL to the list as well.

Intel's capex boost also means overall 2011 industry capex should grow 20% (vs. 15%), notes Muse, with "aggressive spend still on bricks and mortar," and WFE spending loaded into 2H11. Intel's WFE spending also should stay strong in 2012, he notes.

One area Intel isn't really concerned about is foundry. Intel reportedly fabbed a 22nm chip for FPGA maker Achronix, and "we are interested in talking to some very specialized companies in terms of doing foundry things," Smith said, but "we are not building a broad-based foundry business and it's not driving our CapEx number."