October 19, 2005
The Story of Intel
By Brady Willett

After the bell yesterday Intel reported record quarterly revenues of nearly $10 billion, and earnings of nearly $2 billion. And although earnings missed the mark by a penny a share, the company pointed out that a one-time legal settlement agreement with MicroUnity for $140 million was to blame.  Not surprisingly, what Intel did not highlight was that EPS improved year-over-year partially because of stock repurchases. Apparently at Intel legal charges are one-time nuisances that do not reflect the cost of doing business whereas recurring stock repurchases - regardless of cost/price - are a sound business practice.

Intel has been buying stock to smooth earnings for so long that you would think everyone would be picking up on it by now. Wrong. Rather, concerned with speculating on the minute-to-minute share price movements on INTC stock, the mainstream media has reverted to speculation about the psychological impact of pennies. If only Intel could have somehow manufactured a penny more...perhaps shares would have rallied rather than fallen?

For the record, by lowering its share count Intel bought 1.5 cents in EPS growth in 3Q05 (compared to 3Q04).  Accordingly, if you discount stock buybacks and if you forget about repatriated earnings (which were expected), Intel missed EPS estimates by either 3 ½ cents (including the legal settlement) or a ½ cent (excluding legal settlement).  Following Intel’s release IBD ran the headline “Intel's Q3 Beats Profit, Sales Expectations”, and AP led with “Intel profit falls short”. Neither of these contradicting articles took the time to mention share count.

Another thing the mainstream didn’t pick up on was that despite its strong financial performance Intel has recorded a decline in shareholders’ equity in each of the last 3-quarters. The cost of share purchases and dividends paid partially explain why INTC’s net equity position is in decline in 2005. However, even when you factor in stock repurchases (another $2.5 billion worth in the latest quarter), Intel’s net equity per share still declined in 3Q05 for the first time since 4Q02. While a quarter does not a trend make, it is nonetheless surprising that as Intel reported ‘record’ results equity declined.


The reason why shareholder equity trends are important is self evident: equity, which equals assets minus liabilities, is the simplest reading of corporate worth. Over the long-term understanding equity trends is an important tool to understanding a company’s market position.  For example, one of the most prolific equity gainers in history, Wal-Mart, has increased shareholder equity every year since the company went public. Despite the fact that WMT’s equity growth trend is declining as it becomes a larger enterprise, 35-years of consistent equity gains says the company has been a great success, and is likely to continuing being successful in the future.


An example of a company consistently adding to its equity position for more than a decade but that has not reached a slow down yet is Lifeway Foods (covered in 1Q05 WL report).  Lifeway is one of those rare company’s that always seems to be growing but is never really expanding.  This trend - of stable assets and increasing net worth - is the result of core growth in the business (this trend will be changing at Lifeway thanks to a noteworthy distribution deal with Target).



Now for another look at Intel’s recent equity trends, which are essentially that of boom and bust. In contrast to WMT and LWAY, these numbers suggest that Intel is a cyclical company.


While equity trends hardly offer a rounded opinion of a business, they do tell a story.  In the case of Intel this story reads as follows: groundbreaking company conquers the world and is suddenly left with nothing to conquer.

How does Intel respond to being a dominate company trapped inside of a cyclically susceptible industry?  By trying to maximize returns (note the rising ROE trend in the first chart).

Intel Outlook

During Intel’s Conference Call a Merrill analyst asked Intel CFO, Andy Bryant, why the company continues to spend so much money on stock repurchases rather than say doubling its dividend payout.  Skirting the question completely Mr. Bryant responded that the Board decided whether or not the company’s dividend policy. Suffice to say, Intel’s management - who previously resisted expensing options so strongly that they went against a shareholder majority vote - has always been overly concerned with presenting earnings in the best possible light.  Unfortunately, in the case of massive buybacks of an extremely an expensive stock that has gone nowhere for more than 5-years (INTC), this has come at the expense of shareholders.

Thanks to favorable seasonal trends, along with what could be a well received product pipeline, the aging Intel is not at any immediate risk of becoming dead money. Nevertheless, there are some challenges Intel must tackle now (capacity issues, dual-core duel with AMD, and top line lethargy), and others that could end up tackling Intel (a US led global recession). These challenges are enough to warrant caution on INTC stock.

In sum, that Intel’s best recent year-over-year increase in book value struggled to match Wal-Mart’s worst is reason enough to believe that Intel does not have another period of super-growth left in it.  At four times book the company is extremely expensive and the dividend yield alone is not attractive. The board would do well to scrap all buybacks and increase dividends until, and if INTC shares get low enough that they start purchasing some for themselves. That’s my story and I am sticking to it -- at least until Intel’s highly anticipated January call...



BWillett@fallstreet.com