Don't expect breakout year for chip bellwether Intel


NEW YORK -- Sometime in the near future, Paul S. Otellini, Intel Corp.'s new chief executive, hopes we'll all be chanting the word "Viiv," as in rhymes with "five."

That's Intel's name for the technology powering a new generation of devices for the "digital home." These machines are designed to make it easy to connect your personal computer with your TV, your stereo, your digital phone and any other gadget you've recently been persuaded to buy.

In tech jargon, that's called "interoperability." And Intel is hoping these devices become as commonplace as the PC.

But while Otellini, who took over the job in May, plans to spend billions more perfecting chips for home media centers, Intel remains much as it has for the past decade: the world's dominant maker of chips that act as a PC's brains.

PC chips, of course, are a good business - Intel regularly posts gross margins of more than 60 percent. But Wall Street wants growth, and growth in worldwide PC demand is slowing.

"Intel needs to get revenue growth outside of the PC," said Adam Parker, a semiconductor analyst at Sanford C. Bernstein & Co. "Many of their other investments have not and maybe will not generate incremental profits anytime over the next couple of years."

Last year, Intel unceremoniously dropped plans to enter the high-definition TV business. Another expensive foray - developing WiMax - has generated lots of prognostications but no earnings. (WiMax promises to greatly extend the range of Wi-Fi, which powers wireless computer connections).

Even as investors clamor for diversification, though, Intel's size makes it the industry bellwether. And as one of the first tech stocks to report earnings each quarter, Intel often sets the mood for other semiconductor and computer stocks.

When Intel announces its 2005 earnings Tuesday, it's expected to post fourth-quarter sales of $10.4 billion to $10.6 billion, and about $39.2 billion for the year. That reflects a reduction of estimates in December, but it's a nice amount of cash, and a 15 percent increase over 2004.

Investors, though, already have digested those numbers and will instead be eager to hear Otellini's take on 2006. According to consensus estimates of Wall Street analysts compiled by Thomson Financial, Intel's sales growth is expected to fall to 7.6 percent.

Earnings tell a similar story. While Intel is expecting to show a 30 percent profit gain for the fourth quarter and a 23 percent increase for 2005, the Thomson consensus forecasts a 14 percent earnings growth for 2006. Intel's share price was up nearly 7 percent last year.

In other words, the focus is on the trend line.

After worldwide demand for personal computers grew 14 percent to 15 percent last year, growth is expected to slip to 10 percent this year, Parker said.

That downward movement is one reason Walter Price, a portfolio manager at the Allianz RCM Global Technology Fund in San Francisco, isn't optimistic about Intel's growth prospects over the next 12 months.

Intel's corporate clients, he said, are not likely to spend huge dollars upgrading their systems until late this year when Microsoft Corp. ships Vista, its next version of its Windows operating system.

Internationally, Intel should have better luck, Price added. Expanding middle classes in China, India and elsewhere can be expected to buy lots of PCs.

But Intel chips sold in the developing world sell at a discount to the prices they fetch in the U.S. and Europe. Sales outside the U.S. represent about 70 percent of Intel's sales.

Another big concern for Intel is stepped-up competition from its smaller but increasingly proficient rival, Advanced Micro Devices Inc.

After years of running in second place, AMD's desktop and server microprocessors gained wider acceptance last year even as Intel's mobile units remained dominant.

Rather than the historic 80-20 split in the processor market in favor of Intel, Price said "a more natural relationship is probably 60-40."

Although such a ratio may still be a ways off, Morgan Stanley analyst Mark Edelstone agrees that AMD's market share is rising, and likely reached 21 percent at the end of 2005.

Investors last year liked what they saw in Intel's indefatigable adversary. AMD shares were up 39 percent.

But for all the talk of slowing PC sales, Intel still generates a lot of cash. For that reason, value investors, seeking oversold companies with high rates of return on capital, appreciate the underlying strength of Intel's business.

The company boasts a return on equity of 22 percent on an operating margin of 31 percent. Those are numbers more typical of a growth company like Starbucks Corp.

In addition, Apple Computer Inc. unveiled last week computers using Intel chips for the first time, which for Intel is less a question of revenue than innovation.

While the total number of chips Intel will sell to Apple represents just a fraction of its overall revenue, the relationship is designed to crank up the company's creativity quotient.

Investors are looking for a good story. Otellini must show investors that the company's forays into portable wireless products, game boxes and other consumer applications are translating into bottom-line gains.

For Intel's stock to break out of the mid-$20s, Otellini needs more than a splashy marketing campaign to persuade us to all chant "Viiv."

Leon Lazaroff writes for the Chicago Tribune.

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