Rumor has it that Intel‘s (INTC -1.22%) Arc’s lineup of video gaming GPUs (Graphics Processing Units) is already going nixed — just a handful of years after they were originally announced and long before any of these dedicated graphics cards ever really got a foothold on the market. The rumor was recently spread by YouTube poster Moore’s Law Is Dead. Sure, it’s just a rumor, and Intel has subsequently defended its Arc gaming lineup as safe. Time will tell what happens next.
Before I get into what I think this all means for the company (and the stock), let me first know that I’m definitely not against Intel. On the contrary; Intel is responsible for advancing much of the computing technology we take for granted every day, and I believe the world really needs this company to succeed.
The fact is, however, that times have changed and the competitive landscape is very different from ten years ago. Intel scrapping its Arc GPUs may not be good news for gaming enthusiasts, but it could really be a good thing for Intel’s long-term health — as well as the health of the tech industry in general. Let me explain.
No low hanging fruit in computer hardware
Let’s not be naive about this. Intel would always have an uphill battle in the consumer GPU market — especially for high-end chips that appeal to serious hobbyists and video game professionals. This is a space dominated solely by Nvidia (NVDA) -1.20%) and Advanced micro-devices (AMD) -1.62%), and they’ve been doing it for years. Even if Intel could design hardware that could compete (and I have no doubt it could with enough financial resources to pour into it), sell it in such a way that consumers take a high-end Arc GPU seriously, is a very different story.
In short, Intel may just have to cancel Arc because the payout could take longer than it can afford to wait. By some industry analyst estimates, Intel has already lost billions on its Accelerated Computing and Graphics Group (AXG), and I don’t think that’s an exaggeration. Even simple chip design is costly and time consuming. And you have to add up the costs of setting up new production lines to produce new chips, because these modern engineering building blocks are nothing short of engineering marvels.
But here’s the real problem: Intel just started breaking AXG’s revenue in 2022, and so far it’s been disappointing. AXG took in $186 million in the second quarter of 2022 (up 5% year-over-year) and just $219 million in the first quarter of 2022 (up 21% year-over-year). You could argue that this GPU segment is growing, but keep in mind that this is happening at a much slower pace than the multibillion-dollar GPU companies from Nvidia and AMD have sustained in recent years. In addition, Intel has long been losing market share in its Client Computing Group (CCG), an all-encompassing consumer PC and laptop division, making AXG’s recent performance all the more painful.
As if that wasn’t bad enough, Intel will take the same blow from the current drop in consumer spending that other chip companies are starting to report. And even CEO Pat Gelsinger admitted that the Data Center Group (DCG, Intel’s second-largest money-maker after CCG) was likely to lose market share for at least a few more years.
If Intel was just a company that did low-power chip engineering, maybe it wouldn’t be such a big deal. At the very least, the company might be able to report lower sales, but still save its profit margins. But this is not a chip engineering company nothing but; it is a vertically integrated engineering and manufacturing company. Lower chip sales indicate that the company has production lines that are not being used efficiently.
In other words, Intel’s profitability is about to take a very big haircut. If so, it’s time to start trimming the excess. My prediction? Goodbye, Arc GPUs, we barely knew you.
If not GPUs, then what?
GPUs may (or may not) only be the latest victim. Gelsinger has let go of many projects that do not fit into the IDM 2.0 strategy the company announced in early 2021. With additional savings realized through these cuts, Intel is renewing its manufacturing capabilities – both for itself and for other chip engineering companies. This new segment is called Intel Foundry Services, or IFS. Yup, another acronym to remember, which really speaks to the sprawling and unfocused nature of Intel’s chip empire in recent years.
IFS is currently one of the smallest business segments, with revenue of just $122 million in Q2 2022. But IFS is at the heart of what Intel wants to do. Traditionally, the company has focused on producing its own silicon designed in-house. Opening up the foundries to outsiders will be a big task – and potentially a game changer for Intel (not to mention the semiconductor industry).
Intel has been busy on this front. It announced new fab investments in existing facilities in Arizona, a new fab complex in Ohio, research and manufacturing facilities across the European continent, and the acquisition of chip fab Tower Semiconductor (SEM -0.11%). With tens of billions in investment expected over the next decade, it’s no wonder Gelsinger has touted the passage of the U.S. Chips Act (about $52 billion earmarked to support U.S. chip manufacturing, as well as 25% tax relief for companies expanding their business). in the States). It’s just in time, because Intel can use the help with its ambitious plan.
But here’s the thing: it takes years to build chip manufacturing facilities and years to ramp up full production capacity. Intel will also receive a marketing push to win over its peers in the semiconductor design field. The good news is that global demand for chips isn’t going to slow down anytime soon. But it will be a long journey for Intel to transform itself.
How does all this affect Intel’s stock?
This is not a cheap stock. Shares are currently trading for less than 16 times the free cash flow of 12 months. However, Gelsinger and the company’s current outlook is that adjusted earnings per share will more than halve this year from 2021 and free cash flow will turn negative. That means a a lot higher P/E ratio and zero free cash flow are coming.
This is an evolving story, and perhaps Intel moving away from its gaming GPU ambitions will help its earnings picture for the foreseeable future. In fact, I think it would be a good thing if Intel tries to support the booming chip production that will be needed in the next decade.
But I wouldn’t buy Intel stock given all the current uncertainty – not yet, anyway. Give it some time to develop. There are better chip stocks for sale right now.
Nicholas Rossolillo and his clients have positions in Advanced Micro Devices and Nvidia. The Motley Fool holds positions in and recommends Advanced Micro Devices, Intel and Nvidia. The Motley Fool recommends the following options: long January 2023 $57.50 for Intel and short January 2023 $57.50 for Intel. The Motley Fool has a disclosure policy.