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Intel puts big bet on small chips

Investor Daily: The semiconductor giant needs to move into mobile gadgets to grow again.

By Jon Fortt, senior writer
Last Updated: December 8, 2008: 8:03 AM ET

Intel hopes a new generation of chips for mobile devices will open up a growth market for the company.

SAN FRANCISCO (Fortune) -- Intel stock has sunk to about $13 in the stock market rout, its lowest levels since Bill Clinton's first term. So is it a bargain now?

Sure - if the chipmaker can figure out how to dominate cell phones the way it has PCs.

That won't be easy. Though Intel supplies about 80 percent of the world's computer chips, it so far has failed to repeat that success outside the PC business.

It shut down its consumer electronics business in the last downturn, and today doesn't offer the low-power chips at the heart of hit devices like Apple's (AAPL, Fortune 500) iPhone, Nintendo's DS, and Research in Motion's (RIMM) BlackBerry.

To turn that around, Intel is banking on its tiny Atom processor, which it hopes will soon be ready to power next-generation phones.

"Atom is the heartbeat of Intel; it is the growth strategy," said Pankaj Kedia, Intel's director of business development for mobile Internet devices.

Will it work? Investors should pray it does. Just look at Intel's financial warning from a couple of weeks ago: Sales this quarter will fall far short of Wall Street's expectations, to about $9 billion - from a growth perspective, it might be the company's worst holiday season on record.

Yes, Intel's core business selling PC and server chips remains wildly profitable thanks to its manufacturing prowess, patent portfolio and mammoth scale; the company generated $3 billion in cash last quarter alone, carries little debt, and has a $12 billion war chest.

But the issue is growth. While Intel may be one of tech's big fish, the PC pond these days is stagnant or shrinking. Research firm IDC projects that consumers and businesses will spend less on computers in 2009 than they did this year, the first sequential decline since 2001.

Some of the blame for Intel's plight lies with a global recession that has finally smacked the technology industry, but that's not the whole story. Intel is also scrambling to adapt to a tectonic shift in the digital world, where attention is moving away from powerful Intel-based PCs and toward more energy-efficient and mobile gadgets. The faster Intel proves it can navigate the changed landscape, the sooner its fortunes - and stock price - are likely to improve.

Focus on Atom

So during a recent visit to the company's Silicon Valley headquarters, the discussion centered on Atom, the tiny chip that arrived this spring that's the centerpiece of Intel's mobile growth strategy.

Atom isn't ready for phones yet - so far it's mostly turning up in low-cost laptops like the Dell (DELL, Fortune 500) Mini 9 and the HP Mini 1000. But unlike Intel's bread-and-butter computer chips, Atom is designed from the ground up for small, low-cost, energy-efficient devices (think phones), not performance-focused PCs.

It's a Corolla in a company that has specialized in Corvettes - and Intel is convinced that upcoming versions will be efficient enough to begin appearing in phones.

"By 2010, Atom will be competitive in every aspect of mobile computing," promised Pat Gelsinger, an Intel senior vice president and engineering veteran.

Why does Intel need phone chips? Because, as Willie Sutton put it when asked why he robbed banks, "that's where the money is."

From Manhattan to Mumbai, people around the world open their wallets to buy more than 1 billion cell phones every year, and today practically none of the spoils end up in Intel's pockets. Instead, handset makers like Nokia (NOK), Motorola (MOT, Fortune 500) and Samsung buy chips from companies like Qualcomm (QCOMM) and Texas Instruments (TI).

Common sense dictates that if Intel can cut itself into just a fraction of the cell phone market, voila - it will have the growth it craves.

"Where Atom's going, Intel has potential to gain market share where they have not been in the past," said Jim McGregor, director of semiconductors at the In-Stat research firm. "In cases where customers demand performance, it has potential."

Of course, cracking new chip markets isn't easy, and the cell phone business may prove an especially tough nut for Intel.

The king of the hill in cell phone chips, ARM Holdings (ARMH), plays a tough game. Rather than make its own chips as Intel does, ARM licenses its blueprints to companies like Qualcomm, TI and Samsung, and lets them customize and build the chips built on their own. The result: ARM gets a modest and comfortably profitable licensing business (operating profits so far in 2008 are about $126 million on sales of $397 million), and its customers get the security of knowing their phones aren't built on a cookie-cutter, industry-standard chip.

Some of the most powerful names in the tech industry seem to like that setup; IBM (IBM, Fortune 500) recently signed on to manufacture ARM-based processors, and Apple has engineers working on ARM-based chip designs for future versions of the iPod and iPhone.

To win despite those odds, Intel will have to woo high-profile ARM customers over to Atom - and that may be harder than it sounds. Case in point: the chip giant ended up with egg on its face in October, after Intel executives slammed the Internet performance of Apple's iPhone, suggesting it would work better with an Atom chip. The next day a more senior executive apologized effusively. Intel didn't comment on whether Apple CEO Steve Jobs personally called to demand the backpedaling, but it's safe to assume he didn't send flowers.

Still, analysts agree that there's no company better positioned to take on ARM than Intel. "Everybody's heard of Intel inside," said Will Strauss, president of the Forward Concepts research firm. "Nobody's ever heard of ARM inside."

Consider that alongside the fact that Intel was already running a tight ship before tough times hit, and it's easy to feel good about Intel's chances of figuring out phones, and rescuing its stock.

But this much is also true: It'll feel a lot better to see an Atom chip shipping in an iPhone or a BlackBerry. And for now, it's anyone's guess when that will happen.

Looking for guidance in navigating these choppy markets? Let us know what topics you'd like us to cover and we'll try to address your questions in an upcoming Investor Daily. Please note: Fortune cannot give personalized advice on specific investments in your portfolio. To top of page

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