New Chip Won't Change Old Story at Intel

Cheap chips are all well and good, but Intel (INTC) is going where the money is.

So on Monday the Santa Clara, Calif., chip giant began shipping a 1.8-gigahertz Pentium 4 processor. The new processor, listed at $562, is Intel's fastest, most expensive chip, and it expands Intel's offerings in the small, but lucrative market of personal computers costing $2,000 or more. Investors applauded, sending the stock up 97 cents, or 3%, to $30.22.

But the new chip alone won't reverse the worrying decline in Intel's profit margins over recent quarters, analysts say. The new chip is only a little faster than existing chips, so demand is likely to be on the weak side until prices come down. The bigger problem is that sales of personal computers, the big users of Intel chips, are expected to rise only slightly this year, and Intel will need a rebound in PC sales before it can regain its robust financial health. Yet there's been no sign of a bounce in PC sales.

Pressure

The newly launched chip's faster speed and higher performance appeal primarily to users such as graphic designers who put a premium on processing speed, says Martin Reynolds, a research fellow at Gartner Dataquest. And, he explains, the significantly higher price means a small market.

"We'll see machines that have the 1.8 in it, but they won't be big sellers until the price comes in," Reynolds explains. Intel typically lowers chip prices over time as it introduces higher-performing products. Chips priced at these levels typically go into PCs priced at $2,000 or above. According to Gartner Dataquest, PCs priced from $2,000 to $2,999 made up 15.3% of the market in the first quarter, while PCs costing from $1,500 to $1,999 accounted for 22% and those below $1,500 took 56%.

Intel introduced the Pentium 4 last November and has been steadily launching faster versions of the chip since. But waning personal computer sales growth and an inventory glut have conspired to keep sales down. Intel has said it will ship 18 million to 20 million units, but analysts expect the company to ship fewer than that. Meanwhile, competitor Advanced Micro Devices (AMD) made some surprising headway into Intel's market share with its low-priced, high-performance chips.

Intel's new chip replaces a 1.7-gigahertz Pentium 4 that was launched in April. That chip's price, $352, was about half of the typical introductory price, which enabled Intel to increase volume by selling to more markets. By pricing at that level, Intel could include the chip in cheaper personal computers, especially important as PC prices continue their steady decline.

So far, the lower price point seems to be helping Intel put its chips in more midrange computers, according to Mike Feibus, principal analyst at Mercury Research in Scottsdale, Ariz. Intel has been gaining traction in the $1,500-and-above PC market, he says. Last quarter, AMD had picked up market share in that sector with its high-end Athlon chip, he said.

Pounding

That said, the competitive pricing is pounding Intel's bottom line. In the first quarter, Intel's gross margin fell to 52% from 63% in the fourth quarter, as chip prices fell. The company says margins will be about 49% in the second quarter ended last month. Narrowing margins have stung earnings: According to Thomson Financial/First Call, analysts expect Intel to make 11 cents a share for its second quarter, down from 50 cents a share a year ago. Intel is due to report second-quarter earnings July 17.

And it's going to take more than a 1.8-gigahertz chip, or the 1.6-gigahertz chip that Intel also launched Monday, to create consumer demand at the high end, Feibus says. "When we get up this high in clock rate, consumer buying patterns are suggesting that buyers don't really register less than 200-megahertz upticks and these are 100-megahertz upticks," he explains.

The next such jump will come in a few months, when Intel launches a 2.0-gigahertz chip just as back-to-school buying is in full swing. Maybe, just maybe, Intel's pricing, and margins, will get a boost then.