The new year has barely begun, and Intel ( INTC) has already raised serious doubts about where its stock can go in 2007. With competition from rival Advanced Micro Devices ( AMD) as intense as ever, Intel projected that its gross margins would remain stunted at a 50% level for 2007 -- well below the happy days of 60% that investors hoped would soon return. That impaired profitability leaves the fate of Intel's stock dependent on either a major catalyst or an end to the price war with AMD. And with Intel's management offering scant evidence of either during the post-earnings conference call, investors bid down the stock 5.4%, or $1.22, to $21.08 in trading Wednesday. "I don't know how this dance ends," says Fred Weiss, chip analyst at Atlantic Trust SteinRoe. "Pricing is a big variable that nobody can get a handle on, because each company wants the other company to be the first one to say, 'I'm going to back off a little,'" says Weiss, whose firm has a small position in Intel. So far, the thirst for market share appears to be trumping the mounting evidence of the price war's mutually destructive effects on each chipmaker's financial statements. Last week, AMD warned that "significantly lower" average selling prices for its microprocessors would
crush its fourth-quarter profit, largely offsetting the company's increase in unit sales.
Bolstered by a new product lineup, Intel seemed to have gotten an edge -- average selling prices for server and mobile chips increased sequentially in the fourth quarter, while desktop prices were flat. But its stagnant profit margin projections belie the notion that it is impervious to pricing pressure. During the conference call Tuesday, Intel ascribed 2007's depressed gross margins to the costs of prepping its factories to produce a new generation of processors with 45-nanometer circuitry. According to Intel's management, such start-up costs typically take 2 percentage points out of gross margin, as occurred in 2005 when Intel was preparing to roll out its previous generation of 65-nanometer chips. However, at the height of that ramp -- during the first two quarters of 2005 -- gross margin was 59.3% and 56.4%, respectively, significantly higher than Intel's current projections. While CFO Andy Bryant said Intel would have to fight to win orders in a competitive business environment, he gave no indication about whether the 50% gross margin projection was based on a worst-case pricing scenario, leaving room for upside, or whether margins could suffer further deterioration from price pressure as the year progresses. Analysts were divided on the issue, with some predicting that AMD's various financial obligations (including its recent $5.4 billion acquisition of ATI and its capital spending plans) would force it to ease up on the price battle, while some, such as CIBC's Allan Mishan, predicted that the "severe" pricing environment will persist as Intel and AMD duke it out for market share. CIBC makes a market in Intel shares.
If pricing peace does not come in 2007, the other key potential spark for Intel's stock comes form Vista, Microsoft's ( MSFT) new operating system slated to be released at the end of the month. Intel CEO Paul Otellini offered little more than platitudes when asked about the effect of Vista, noting that he expects "instant adoption for new machines right out of the chute," as if anyone would buy a computer with the old operating system once Vista is available. As far as how much of a stimulus Vista will have on demand, however, Otellini said the effect on corporate PC buyers was unknown at this point, and he cited consumer notebook sales as the most likely product category to immediately benefit from Vista. This could be enough to get Intel shares moving again, according to some investors. Michael Church, a portfolio manager at Church Capital Management, held off on augmenting his Intel position ahead of Tuesday's earnings report, fearing that the margin woes plaguing AMD would hit Intel as well. But he believes Intel will benefit in the later part of 2007 as Vista gains traction, particularly in the consumer PC market. "Say what you will about
betting on the U.S. consumer, it's proven to be a fairly successful strategy for Apple ( AAPL) and other companies," says Church. Given the PC's stodgy image these days, a consumer frenzy is hardly a sure thing -- but it may be Intel's best hope at this point.