Intel: Anatomy of a Tech Value Trap

Is Intel “cheap”?

Sure, at ten times earnings, why not?

Only it’s more like 12 times forward earnings given the drop in gross margins and operating income The Street is now expecting on the heels of last night’s call.

Revenue growth is stangnant-to-collapsing too, depending on the season. There is a piddling amount of growth happening in one small area of the business, but where it counts there is only deterioration in both demand and pricing. After posting a year-over-year drop in revenue of 2.5% (and a 6.7% sequential drop from Q4), Intel is now forecasting single-digits sales growth for full-year 2013 but I’d take the under on that.

And despite this, the stock is inexplicably selling for almost 2 times sales – I can’t imagine why this should be the case, I can only come up with “for old time’s sake” as it’s a Dow component and a former darling. There is no growth here to justify a market multiple.

Competitively speaking, you’d have to say that Intel is dominant in a dying market (like being the ship’s captain on the Titanic). And it is merely an also-ran in the future of computing – mobile – where it must contend with entrenched giants Qualcomm and ARM Holdings. It is in Intel’s DNA to be the incumbent and ward off smaller foes like AMD, it is not accustomed to fighting uphill. Recent announcements about making in-roads into software and “wireless TV” sound like the flailing of a desperate company in pursuit of new growth opportunities, I’m not sure why anyone should expect them to automatically find success in these “foreign” markets.

The current CEO just reported his last quarter and is now heading in retirement. It was a weak quarter but he did not lower guidance on the call. How much would you like to bet that the company spared him the ignominious exit and that a warning is coming sometime between now and the next quarter? We already know that the PC market contracted by 14% in just the first quarter of this year, and Intel’s PC revenues are four times the size of its decent data services business.

Intel has played the expectations game extraordinarily well over the last few years – they’ve beaten the consensus estimates by an average of 10% going back to the July 2011 quarter. Unfortunately, this has not translated to any kind of benefit for longs – the stock has been down an average of 4.2% in the week following these reports. In other words, nobody’s been fooled.

The armchair value investor looks at the stock and says it’s “cheap” and pays a nice dividend.I can cite a million examples of formerly cutting edge technology and industrial companies that shrank for years even as they always looked undervalued and paid a decent yield.

Intel has bought back a tenth of the float over the last few years and now pays a 4% dividend yield. Unfortunately, this does not signal underlying strength at the business. The company now sports a $11o billion market cap, has $17 billion in cash and about $13 billion in debt. This is a net cash position of under $4 billion, nothing special. The question is whether or not this type of ongoing return of cash to shareholders is wise given the fact that Intel is in a strategic transition and attempting to tackle brand new lines of business with heavy capex spending requirements.

Besides, it’s not as though the buybacks or dividends are bringing investors in or helping the stock price – Intel is down some 20% over the last year in the midst of an “everybody wins” broad market rally.

The bottom line is that Intel is a very well-managed, gigantic company and has gotten by lately with tight inventory controls and conservative guidance. This is why the reckoning has taken place in slow-motion and value investors have been crushed gently rather than in sharp, jagged falls.

But I do not think the positive sentiment surrounding this company and its vaunted legacy in the high-tech pantheon has been sufficiently washed away yet. There is still way too much belief that Intel can seamlessly compete in mobile and cloud. There are still hopeful longs who believe the turnaround begins any day now. This can be seen in the valuation, in my opinion, and in the media’s hesitance to talk about the company the way they now do Microsoft and Hewlett-Packard. Until there are signs that Intel has either truly turned things around or has become more detested, I see very little opportunity for an investment here.

This is precisely what a Value Trap looks like.