Jahanara Nissar

Despite the ~60% rise in the stock over the past three months, despite having had a superior return than AMD/NVDA/AVGO over the quarter, Intel finds few takers on the Street. And for good reason. From a purely quant perspective the stock is un-investable. At the call today, there is no saying how far below long term target might land the overall corporate gross margin, IFS op profitability and free cash flow. The stock is not trading on the strength of its financials. It is trading on the declining probability of insolvency, it is trading on hopes pinned to the CEO’s strategic vision.

Of course, every incoming Intel CEO in the past has had a strategic vision. And every one of them failed. Investors are paying for ringside seats to see whether Mr. Tan succeeds. It is a high risk/reward play and may not be appropriate for many investors. But if Mr. Tan succeeds, the reward could be substantial. The outsized return investors experienced over the past few months may be just a taste of things to come. We like the stock as a strategy play.

We think the CEO is making moves to save core segments in the Intel Products group by revamping the product portfolio, by developing an exit plan from IFS and by migrating all advanced products, client as well as server CPUs, to TSM over the next 2-4 years. No company can sustain ~$10bn in operating losses indefinitely, as IFS has been printing in recent years. There is no way to ensure a return to operating profitability if IFS is continued to operate in its current form. The experiment to compete with TSM in foundry services has been tried; the lesson has been painful.

Investors suspect as much but simply cannot imagine a future where IFS is simply allowed to shrivel up. But there are no real alternatives, in our view. The search for a potential buyer and external customers at advanced nodes may have been exhausted. The CEO needs to consolidate the events over the quarter and convey his strategic direction to investors.

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On a near-term basis, we think the CCG segment should surprise to the upside. There has been a surprise bump up in PC demand, thanks in part to China’s domestic stimulus program. We have seen media reports of Intel raising price on Raptor Lake processors, which should be accretive to margin, given that the product runs on the fully depreciated Intel 7 process. Traditional servers too may see a bit of traction. Intel’s upcoming 192-core Diamond Rapids may have made inroads at AWS.  At the OCP Summit, Intel launched Cresent Island, a credible GPU for inference workloads, an interesting product as it claims to not need liquid-cooling or expensive HBM stacks.

Something drastic: Into the June quarter earnings call our preview called for ‘something drastic needs to happen’ (link). Over the past three months the CEO ran through a series of dramatic moves 1) bolstering liquidity on the balance sheet by bringing in the US Government, NVDA and Softbank as stake holders and 2) consummating a critically important product development partnership with NVDA. What did not happen during the quarter – no new external customers for IFS. Our view – the fresh capital injected by new stake holders is not for use as IFS capex as is commonly assumed on the Street. We think it goes towards product development and for improving liquidity ratios for bond rating agencies. The dramatic part – we do not think Mr. Tan plans to resuscitate IFS. We think dramatic changes are headed IFS’ way.

Could Mr. Tan’s vision succeed? For one, he has developed lot more friends in high places. Between the 10% stake held by the USG and ~15+% held by NVDA, Softbank, Apollo and Brookfield, outside parties have an interest in not letting Intel fail. Obviously, that is not enough. The CEO must make a couple of very tough, historic decisions while maintaining the Board’s support. We think the CEO faces a ‘Sophie’s choice’ moment. Can he save both Intel Products and IFS? Or would he have to let one go? We think he has made his choice. We think his choice is buried in the product partnership he signed recently with NVDA.

INTC-NVDA custom x86 is headed for TSM: We have high conviction that the custom x86 CPU Intel is designing for NVDA is to run on TSM’s 3nm process. At its recent earnings call TSM’s CEO had a throw-away line when asked about Intel as a competitor. Mr. Wei said that Intel is not only an important customer of TSM (he meant Intel’s client products), but he also went on to say that ‘we are working with them for their most advanced product’. We think he means Intel’s custom x86 CPU for NVDA. We think porting this custom server CPU to TSM opens the flood gates for more server CPUs from Intel to migrate away from IFS and to TSM.

Future of IFS: We think the CEO needs to make a critically important decision regarding the future of IFS. We think the CEO may be leaning towards terminating R&D and capex at nodes beyond 18A and may instead choose to focus on expanding operations and external customer base at older nodes. TSM’s lead at advanced nodes may have become insurmountable. And with TSM agreeing to develop substantial wafer capacity at 3nm and beyond, the US government’s long sought goal of being self-sufficient at advanced nodes may be met without help from Intel. In the long run, we think there is simply no way to improve Intel’s operating profitability without letting go of the drag from IFS.

Drastic moves: Three months ago, we previewed the June quarter earnings by saying ‘something drastic needs to happen’. Over the course of the quarter something indeed did. Some of the elements we had suggested three months ago have been put into action by the CEO.

• A16 mothballed: In our June quarter preview, we called for cutting capex/R&D at advanced nodes, as we saw no scenario where Intel could have a competitive performance/cost advantage at TSM at advanced nodes. At the June earnings call, the CEO announced he was mothballing the A16 process development unless he could identify major external customers. We think the process node is as good as dead. Some investors hope NVDA could be an A16 customer given the recent partnership announcement. We think this is an erroneous assumption.
• Migration of server CPUs to TSMC: We called for migrating server chips to TSMC, an idea Intel had entertained in the past but never executed given the damage that would do to IFS profitability. We think the Intel-nVidia custom chip announced recently is the lead chip to migrate to TSM. Others are likely to follow.

A credible AI play at Intel? Intel’s Cresent Island GPU for inference workloads, launched with little fanfare at the OCP summit last week may be one of the more interesting products Intel has launched in a long time. We think internal teams simply dusted off the GPU architecture developed by Raja Koturi’s GPU team a few years ago. According to our industry checks, the design has power efficiency advantages over GPUs out of NVDA and AMD. The design claims to not need liquid cooling and not need HBM. Its claims to need just air cooling and traditional DRAM memory. However, developing the software stack could be a multi-year effort, the timeline for which is unclear to us. But at the very least, after sitting out the AI revolution all these years, we may be seeing nascent stirrings of renewed effort.

Net/net: We like the stock as a high risk/reward strategic play as the CEO makes tentative moves to bolster liquidity on the balance sheet and improve long-term profitability.

KC Rajkumar
Jahanara Nissar

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