In the last month or so, a lot has been written about Intel’s (INTC) deficits in what I call the “nanometer war”.
According to the theory, Intel’s manufacturing defects in producing 7 nm products have set them back years and will not be competitive in certain markets. These brands are the ones they compete with AMD (AMD) is basically CPU chips for laptops, desktops and servers. This in turn will lead the AMD share price to unusual levels and Intels to contend.
To some extent, the predicted outcome had already happened with the price of AMD from $ 54 to a sky-high $ 86 in the last 30 days, an increase of almost 60%. During the same period, Intel went down from $ 64 to $ 47, down 25%.
That is quite a contrast.
I have combined more than 50 articles on AMD and Intel and so I am very familiar with their history as competitors. Earlier I had outlined the virtues of AMD under super-CEO Lisa Su, as can be seen here “6 Reasons Why AMD Will Be $ 25 Until 2019 No Tails Big Enough To Weigh This Dog”.
But times change, and at this point I think Intel has the advantage especially long term.
Here are 5 reasons I think Intel is the most superior investment in the next 5 years.
1. Intel’s breadth of product line gives it an enormous advantage going forward
Intel sells complete systems, not just CPU chips. It sells storage with its highly regarded NAND products, including disk drives and the proprietary Non-Volatile RAM through its branded product line called Optane.
It also creates FPGA (Field Programmable Gate Arrays) which allows the client to program ie change, the configuration of their systems.
With this range of products, Intel can offer package deals that include many different components, hardware and software. This is a significant marketing advantage.
Intel, too, has been lagging behind in the nanometer war since at least 2016, but it has had no noticeable effect on results as the charts below show.
Every year more CAPEX + FCF (Free Cash Flow).
More cash from operations means more cash for shareholders.
2. Intel has added to its capabilities every year through acquisitions for the last 5
Since 2015, Intel has made 52 acquisitions including some big ones like FPGA maker Altera and AI mobility company Mobileye.
AMD, on the other hand, has only made 2 small ones: Nitero, a fabless semiconductor company, and HiAlgo, a graphics software company. And that’s because they do not generate enough cash to make significant gains.
Having cash to make acquisitions will be even more important as semi-production companies progress over the next 5-10 years.
3. It’s all about free cash flow, stupid
This point is very simple: Intel is an FCF machine, while AMD is struggling to produce enough FCF to release its next line of products. So far, AMD has done a spectacular job with very limited resources, but long-term limited cash flow will limit its ability to compete.
No doubt AMD’s FCF will get better as time goes on, but how long do you think it will take before AMD’s FCF reaches $ 17 billion?
Or to put it another way, $ 65 billion in FCF over the last 5 years would allow Intel to buy ARM Holdings (OTC: ARMHF) (owned by SoftBank (OTCPK: SFTBY)) for about $ 55 billion leaving $ 10 billion in change. That would be quite a combination.
AMD, on the other hand, could buy another Nitero – perhaps.
4. Intel’s GM (Gross Margin) will always be higher than AMD’s
Another way to look at the huge difference in future potential is to look at gross margin. From an accounting point of view, GM is calculated by dividing revenue by gross profit.
Here are the similar figures from the last 5 years.
Although the chart shows progress for AMD in the long run, they are not likely to match Intel for 3 reasons.
1. Intel’s very large (10x the turnover of AMD) gives the efficiency advantages.
2. Intel produces most of its own chips, while AMD subcontracts all of its chips.
3. AMD has a very low product line (less than 20% GM) in game console sales especially to Microsoft (NASDAQ: MSFT) and Sony (NYSE: SNE).
All this points to AMD never matching Intel’s margin and thus AMD may not be able to match the required future FCF.
5. AMD is involved in two duopoly, but with much larger rivals
While AMD competes with Intel in CPUs, it also competes with Nvidia (NVDA) in video applications. Both are larger and more cost effective than AMD making AMD’s lack of FCF even more difficult.
Here is a graph with margins showing AMD’s problem:
So, if AMD spends more money on competing with NVDA, then it has less money to compete with Intel.
The magnitude of the competition problem facing AMD is clear when comparing FCF:
Conclusion:
AMD has done a great job competing with much bigger rivals in the last 5 years. And the AMD share price reflects that because it currently sells at more than 100x estimated 2020 revenue vs. Intel’s 9x.
But longer term, over the next 5 years or so, AMD will have more difficulty competing with larger rivals due to a lack of FCF. With the advent of 5G and the enormous increases in bandwidth associated with that technology plus new technologies involving IoT, AI and driverless cars will require an enormous investment and capital expenditure that AMD is unlikely to get.
I’m sure AMD will be profitable over that time period, but the ever-increasing amounts of money will shrink all the competitive advantages they can have at the moment in time.
So, if you have a 5-year investment horizon, buy Intel.
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Announcement: I am / we are long INTC. I wrote this article myself, and it expresses my own opinions. I do not receive compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose supply is mentioned in this article.
