DLJ's Nice Call on Intel

The chip giant must resolve six big problems before it can move forward, and that spells a sinking spell in the stock.
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Puh-leeze. Don't tell me you were surprised by

Donaldson Lufkin & Jenrette's

downgrade of

Intel

(INTC) - Get Report

to market perform from buy. There have been signs everywhere of a slowing market for the kinds of chips Intel makes; there have been signs of eroding (if still huge) market share for the company; Intel's prices are clearly under pressure.

And you were surprised?

There were, of course, a lot of innocent bystanders -- tech-stock holders who got whacked when a market leader got slammed. But, hey, that's the game. And DLJ's downgrade -- to be followed, I suspect, by a few more over the next couple of weeks -- has the "defensible advantage" of being right on the button

Intel is one of those growth stocks I love, period. But not enough to own it, at least not right now and probably not for the next couple of quarters and maybe not for the rest of the year.

Consider six bad indicators for Intel:

Market growth slows.

I've been saying for a year now that we'll see a flattening demand curve for business PCs throughout 1999 as we approach Jan. 3, 2000. Companies are spending their money on services, not PC hardware; capital-investment budgets are being raided left and right to carry the higher-than-forecast costs of becoming Y2K-compatible. Look at what's happening with

Dell

(DELL) - Get Report

,

Compaq

(CPQ)

and

Hewlett-Packard

(HWP)

. This may yet be an OK year for them, but it's pretty clearly

not

going to be the kind of bang-up year for corporate multiple-unit sales they, and their shareholders, expected.

These PC manufacturers are Intel's most important customers by far -- to whom else would they sell Pentium IIIs? -- and as go the Dells of the world, so goes Intel.

AMD muscles in.

For the first time ever, according to market researcher

PC Data

,

Advanced Micro Devices'

(AMD) - Get Report

sales in January in both the business-priced PCs and the sub-$1,000 consumer PC retail markets exceeded Intel's. In January, AMD topped Intel 44% to 40% in the overall market, and in the burgeoning sub-$1,000 market, the tally was AMD 50%, Intel 25%. With its K6-3 ("Sharptooth") chip now out (but not available during January, and hence not represented in AMD's win), and the powerful 500-megahertz K7 coming soon and aimed squarely at the P-3, AMD has finally become the serious threat to Intel it should been 15 years ago.

Yes, AMD's been the heartbreaker of all time for a lot of investors over that time: AMD wudda, cudda, shudda -- but

didn't

. Now the numbers show it's finally doing its job.

And, yes, the PC Data study covered only sales at retail, not direct sales of large numbers of units direct to large corporate customers. But the K7, positioned squarely against Intel's Pentium III, will be reasonably successful in that field as well.

CPU prices falling.

With that decline in demand, as market share erodes, Intel's prices are slipping faster than usual on that deadliest declining curve -- driven down, of course, by constant pressure from AMD, whose new K6-3 400-MHz processor hit the market a week ago at just $284. The P-3 sells for $580 to $825. 'Nuff said?

Worse, Intel has only two ways of combating market-share erosion: cutting prices and spending more to increase its marketing support for all those "Intel Inside" ads.

New product blahs.

Intel has made a big marketing bet on the Pentium III, which arrived last week to ... yawns and snores. Tests show this chip is only marginally faster than the existing and much less expensive Pentium II and AMD K6-3 CPUs. Intel's selling point for the P-3 is that it has 70 new instructions, which are supposed to make both applications and Web sites run much faster. Few existing commercial apps exploit the speed advantages, and I can't see much difference in Web-site performance on the P-3-equipped PC I've been using for the past two months. A less-than-charitable observer might say Intel chose the Web connection to promote the P-3 because the Web is hot, hot, hot and the P-3 is ... not.

Productus interruptus.

The P-3 is just a transition chip in Intel's plan, and in today's 400- to 500-MHz speeds, just barely makes that definition. (A 1,000-MHz version has been demoed by Intel execs, who said we should not look for it anytime soon.) Intel's much-ballyhooed Merced processor, a 64-bit CPU using much faster "IA-64" architecture, is the real play for Intel.

But don't look for the Merced to hit your desktop anytime soon, says Albert Yu, senior VP and GM of Intel's Microprocessor Products Group. Maybe the middle of 2000. In other words, late.

Intel's going to try to plug the obvious hole (read: market opportunity for AMD) with the P-3/Xeon chip this summer. It's a great server and workstation chip and will be better when tech software starts using Xeon-specific features. But Intel will have trouble justifying its initially high price. And it's not the right chip at the right time.

Fun with Andy and Craig on spring break.

The

Federal Trade Commission

suit against Intel starts a week from tomorrow in Washington. You can expect Intel to be much better prepared than was

Microsoft

(MSFT) - Get Report

, which never took its defense against the

Justice Department's

antitrust charges seriously.

Unfortunately, the FTC has a much stronger case on the facts against Intel than Justice was able to press against Microsoft. In fact, lead prosecutor David Boies had to fall back on embarrassing Microsoft witnesses and undermining their credibility as he built a case he hoped would stand up on appeal. (Old Lawyer's Maxim, v. 1.1: "When the law is in your favor, argue the law. When the facts are in your favor, argue the facts. When neither is in your favor, stir up confusion.")

Intel is at real risk in this FTC action. The FTC's basic contention -- that Intel sold microprocessors for 2% to 3% less to PC makers that did not form partnerships with competitors such as AMD and

National Semiconductor's

(NSM)

Cyrix unit; and that Intel cut off critical advance design information to companies such as

Intergraph

(INGR) - Get Report

as a means of punishing them for relationships with other chip makers -- are a lot more provable than Justice's mushy charges against Microsoft.

The real issue for Intel is how to bridge the next 15 months or so till it starts migrating us all into the 64-bit world. That bridge is going to involve some painful and expensive charges for Intel -- and some painful and expensive times for Intel holders. Nice call, DLJ.

Jim Seymour is president of Seymour Group, an information-strategies consulting firm working with corporate clients in the U.S., Europe and Asia, and a longtime columnist for PC Magazine. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At the time of publication, Seymour had no positions in stocks mentioned in this column, though positions can change at any time.