Intel In The Price War Era

Intel (NASDAQ:INTC) just reported the best quarter in its history with a record profit of $2.9 billion driven by the boost in corporate PC buying. Intel has been eyeing the smartphone microprocessor market, which is dominated by ARM. Let’s take a closer look.

In its second quarter, Intel reported revenue of $10.8 billion, up 34%. Net income was $2.9 billion or $0.51 per share up 175% over last year’s profit of $1.1 billion. Gross margin was 67% up from 63.4% last quarter. Intel ended the quarter with $18 billion in cash and investments, $1.4 billion higher than last quarter. During the quarter, it paid $900 million in dividends and purchased over $1 billion in capital assets. Q1 coverage is available here.

Since launching the Atom processor two years ago, Intel has sold 75 million of them.  Over thirty tablets based on the Atom microprocessor were shown at COMPUTEX in June. But it is not in tablets that Intel expects more growth this year but rather the embedded market with products such as the Google TV. Intel recently won a design win with the Netgear ReadyNAS Ultra.
Atom-based televisions, set-top boxes, and DVD players are expected to ship in the holiday season. The company’s Atom business grew 16% sequentially to $413 million. Intel recently introduced dual core versions of Atom, which helped drive incremental demand. Its PC client group revenue was up 2% q-o-q, while data center group revenue was up 13% q-o-q as the server microprocessor market recovered.

Intel expects third quarter revenue to be $11.6 billion. For 2010, it forecasts a record annual gross margin of about 66%. The stock is trading around $21.37 with market cap of about $119 billion. It hit a 52-week high of $22.82 on April 13.

The smartphone industry is intensely competitive, and innovation happens quickly. Steve Cheney on Programming Blog says that rapid advancement in mobile industry is often attributed to the natural disruption that takes place when emerging industries innovate quickly, while established markets such as PCs follow a slower, more sustained trajectory. In PCs, Intel dictates the pace of hardware releases, while in the smartphone industry the intense competition ensures constant innovation. However, this competition also drives margins down rapidly.

Intel CEO Paul Otellini says “ARM isn’t a threat. If you look at Intel margins versus foundry margins, [Intel’s] are substantially higher. Other architectures obey the same law of physics. It’s very difficult to make money by licensing designs. We’ve been there, done that.”

But ARM has an edge over Intel in the mobile market as its technology is in millions of smartphones and devices. Intel has very few design wins in the iPhone or the iPad, while ARM’s technology is licensed by all smartphone vendors.

In my Forbes column, I bet in favor of Intel’s technical capability but against its culture to excel in the low-margin price-war game. I believe Intel’s efforts in the smartphone market will help it to eventually overcome the technological barrier of low-power design, which will increase its presence in the mobile world.

However, winning the price war in smartphones and tablets will be a whole other story. Whether Otellini likes it or not, this decade will be about price wars and mobile computing. I am very curious to see how Intel plays in this unfamiliar game!