Competition for Intel

By Lucas Scholhamer

With technology advancing at a mind-blowing pace, constant innovation is required to remain at the forefront. If you're not on the cutting edge, you're taking up too much space. And while Intel (INTC) has been the leader of the pack for years, several companies are stepping up to try to knock it off its throne. Will any of them be successful? Investment Underground takes a look at the giant and several of its competitors:

Maxim Integrated Products (MXIM): This Sunnyvale, California-based company has been designing, producing, and selling semiconductors since 1983. Like most in the field, the company's solutions are applied in a wide variety of industries ranging from computers to automobiles to televisions and medical instruments. Stock appreciated 0.11% to $26.70 at the time of writing. So far in 2011, the price has fluctuated between roughly $23.00 and its $28.44 YTD high earlier this month. MXIM shares have a P/E ratio of 19.2 and an attractive 3.15% dividend yield. In its recent FY 2011 Q3 earnings report, MXIM announced a $607 million net revenue, overcoming "prior supply constraints" to end the quarter 1% below Q2's revenue (but up 19% year-over-year). Furthermore, the company is predicting Q4 revenue between $610-640 million.

So what makes Maxim special? CEO Tunc Doluca touts a business model that stresses the importance of finding "an optimal balance between high profit margins and growth." The company focuses both on the high profit margin industrial/communications sectors as well as the high growth consumer and computing markets, and as a result, it has achieved a 61.4% GAAP gross margin on the quarter. Additionally, this has translated to a very strong cash flow for MXIM ($488 million in Q3), which is great for paying out those high dividends. Aside from the financials, the company may have stumbled into an emerging market with the success of its unique integrated circuits, which combine multiple analog functions onto a single chip that is smaller and consumes less power than traditional circuits. These have become increasingly popular for their use in countless consumer and industrial products, such as smart phones, tablets, smart meters, and portable medical equipment—all emerging markets with potential for huge growth. Maxim's newfound niche and continued innovation with analog integrated circuits certainly give potential investors reason for optimism.

However, Maxim, with a market cap of $8.1 billion, is only a fraction of the size of Intel, and since it has diverted part of its focus and funding towards its industrial/communications segment, it may be hard for it to produce technology that is innovative enough to compete with Intel and AMD on the competitive markets for consumer goods.

Linear Technology (LLTC): Linear Technology is another company specializing in analog integrated circuits, catering to an international customer base and focusing more heavily on industrial markets. Shares appreciated 0.21% to $33.95 at the time of writing, slowly pulling out of an unimpressive Q3 dip. LLTC stock has a 52-week range between $26.25 and $36.14, with a P/E ratio of 14.4 and a dividend yield of 2.83%. The company's Q3 revenue dropped to $353.2 million from $383.6 million in Q2, primarily due to a decrease of orders and sales in the computer-end market and customers rebalancing inventories to hold less safety stock. Additionally, LLTC's automotive bookings, which accounted for 13% of the company's business in Q3, were hit hard by the tsunami in Japan, which represents a major automotive market for LLTC.

However, the numbers paint a deceivingly negative picture. To be fair, LLTC expected unimpressive Q3 results, as CFO Paul Coghlan stressed that "this was a transitional quarter" into a more traditional analog business with less focus on consumer goods. At this point in time, only 5% of LLTC's business was related to cell phones and high-end consumer products. What does this mean? The company's new emphasis on industrial goods has helped it maintain an impressive gross margin of 77.6%, and bookings are already increasing this quarter. Additionally, LLTC has decreased its lead times to 4-6 weeks. In short, the company is quickly and more efficiently producing profitable goods that are in high demand. That sounds like a recipe for success, and luckily for investors, LLTC's disappointing Q3 has made stock more affordable.

On the other hand, LLTC will not be benefiting this quarter from what Coghlan called a "major tablet PC opportunity," as Apple (AAPL) elected to discontinue use of Linear Technology's DC/DC converters and USB controllers for its second-generation iPad. Sales of the original iPad undoubtedly helped bolster LLTC's numbers, and unfortunately for LLTC, it will miss out on a similar boost this quarter.

Advanced Micro Devices (AMD): Perhaps Intel's most direct competitor, Advanced Micro Devices designs and produces microprocessors for computers, video game systems, and various other consumer products. Shares appreciated 0.59% to $8.48 at the time of writing, as prices continue to fluctuate between both ends of the 52-week range of $5.53-$9.58. AMD stock carries a trailing P/E ratio of 9.7, with analysts estimating a forward P/E of just over 11. In its recent Q1 earnings report, AMD announced a 2% year-over-year increase in revenue up to $1.61 billion, although this is a 2% decrease from the previous quarter. AMD has a gross margin of 43% and a market cap of $5.8 billion.

Despite the losses, AMD seems to be well positioned for the near future. A significant portion of the losses in the computer segment were negated by strong microprocessor sales. These, in turn, were fueled by AMD's release of its first Fusion APUs (Accelerated Processing Unit) that offer more power and better graphics while using less energy. These units are especially advantageous for notebooks, and consequently, computer and software producers including HP, Dell, Lenovo, Sony, Toshiba, Adobe, and Microsoft have already placed orders. Additionally, a 3% decrease in revenue for the graphics segment was driven primarily from a seasonal lull in video game console sales — a cyclical trend that shouldn't be a major factor as sales increase in the coming months. And while Intel was Apple's latest choice for upgrading the processors of the MacBook Pro series, AMD didn't miss out on the action, as its discrete HD graphics card also made it into Apple's newest notebooks, displacing the Nvidia (NVDA) card. Price target estimates currently average around $11.00, although we might see prices rise when AMD releases its much-anticipated "Bulldozer" APU in the near future.

However, unlike many of its competitors, AMD doesn't pay dividends. Additionally, the fact that AMD is only a midcap company presents some limitations in itself. AMD simply cannot match Intel's budget for research and development or the cost-efficiency of ARM Holdings' (ARMH) licensing-based business model (which enables a higher percentage of funds to be allocated towards R&D). Despite spinning off its production unit into GlobalFoundries in 2009 to reduce operating costs, the combination of AMD's moderate size and traditional business model may not lend itself to consistently producing innovative, industry-leading technology far into the future.

ARM Holdings PLC ADR (ARMH): As we briefly mentioned earlier, ARM Holdings is a U.K.-based intellectual property holding company that licenses microprocessor designs to foundries and semiconductor companies across the world. Shares traded up 1.08% to $28.00 at the time of writing. ARMH stock has a very high P/E ratio of 89.3 and offers a 0.53% dividend yield. In its recent Q1 earnings report, ARMH announced that revenues for the quarter increased to $185.5 million from $143.3 million in Q1 of FY 2010. Additionally, shipments of ARM-processor based chips increased an impressive 33% during the same period. ARMH has an operating margin of 42.5%, a market cap of $12.7 billion, and price target estimates are averaging around $32.00.

ARMH is taking a slightly different approach to catching Intel. Instead of trying to beat an established giant producing processors largely for personal computers, ARMH is focusing on producing power-efficient processors for use in tablets and smart phones—namely those produced by Apple (AAPL), whose own processors used in the iPad and iPhone are based on ARMH's licensed designs. Furthermore, to Intel's dismay, Microsoft (MSFT) has chosen ARMH processors for use in its next Windows operating system. Similar to AMD, ARMH's license-based business model means that the company can avoid the overhead costs of production and sink more money into research and development. With computing becoming an increasingly mobile activity, lightweight processors that save power and still pack a punch will become even more important, and ARMH's customer-pleasing design flexibility should enable it to compete with Intel in the future.

In my opinion, one major downside for ARMH is also its greatest strength: its industry-leading power efficiency. This factor is arguably the most critical in ARMH's ability to dominate the smart phone and tablet market. If Intel can fund the research and development required to duplicate (or at least challenge) ARMH's power efficiency in a timely matter, ARMH could potentially lose a major competitive advantage. However, ARMH's affordability and customization also offer it an edge up on the competition.

Intel Corporation (INTC): Finally, we'll address the giant. Intel Corporation has been designing and developing integrated circuits since 1968. With a market cap of $118.3 billion, Intel is a behemoth of a company and easily the world's largest producer of computer chips. Shares depreciated 0.79% to $22.50 at the time of writing, continuing a fall off a YTD high of $23.96 achieved last week. Intel has a P/E ratio of 10.5 and an impressive 3.22% dividend yield. In its Q1 earnings report, Intel announced that year-over-year revenue grew an impressive 25%, up $2.5 billion to $12.8 billion on the quarter. The company also boasts a 61% gross margin, and price target estimates are averaging around $26.00.

Despite its growing competition, I believe Intel ultimately holds onto its title as king chip maker. According to CEO Paul Otellini, the impressive first quarter revenue growth was fueled by "double digit annual revenue growth in every major product segment and across all geographies." Clearly, Intel has been doing something right. For one, it holds more than its share of the market. Intel still produces around 80% of the world's CPUs. Also, Intel's extremely strong cash flow and large dividends are extremely attractive to investors. MXIM and LLTC both have higher gross margins, but seeing that they are not focusing primarily on the consumer markets, they don't pose a real threat. AMD is Intel's most similar competitor, but Intel has exponentially greater funds to sink into research and development, which should ultimately allow Intel to continue to push the boundaries of technological innovation. And while ARMH has currently taken over the tablet and smart phone market, Intel will be getting in on mobile computing with its Atom processor through Google's (GOOG) upcoming cloud-based Chrome netbooks. Additionally, Intel has a longstanding relationship with Apple's line of MacBook laptops. However, Intel's largest flaw is, perhaps, its premium pricing. Nonetheless, the competition from niche developers and up-and-coming companies has fueled Intel's innovation, and while AMD and ARMH easily present the biggest potential threats to Intel's dominance, INTC has money to allocate towards research and development of products that should enable it to push back against its challengers and maintain its supremacy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.