Apple, Intel Deal on the Way? (Update 1)

Updated from 9:00 a.m. EST to provide additional analyst comments in the tenth paragraph.

NEW YORK ( TheStreet) -- Rumors continue to circulate about a deal in which Intel ( INTC) will make chips for Apple's ( AAPL) iPhone and iPad. It's not what you think though.

According to Reuters, Intel has spoken to Apple about manufacturing chips for Apple's iPhone and iPad as part of its burgeoning, foundry business. Intel's -x86 chips would not be inside the iPhone or iPad, but rather Intel would manufacture the A-series chips for Apple, as opposed to Samsung, which Apple is increasingly trying to move away from.

This is something TheStreet predicted would happen in 2013, though nothing is official as of yet.

With the PC market stagnant and in decline and Intel's mobile business not taking off like it had hoped, many have said Intel has "lost the mobile race" to other semiconductor companies, such as Qualcomm ( QCOM). Qualcomm, Broadcom ( BRCM), Apple, Samsung and others all use intellectual property from ARM Holdings ( ARMH), which holds a 90% market share in the smartphone market.

An Intel spokesman declined to comment on the speculation.

When Intel issued first-quarter guidance, it raised its capital spending budget to $13 billion, suggesting to some that it would be upping its foundry business, trying to get a piece of the Apple pie (pun intended).

JPMorgan analyst Christopher Danely said he believes it could be big business for Intel, especially if it wins 50% of Apple's business. " W e believe Intel has a decent chance to land some of the business over the next few years. If Intel were to win 50% of Apple's foundry business, we estimate it would add $3.6 billion (6%) in incremental sales and $0.08 EPS (4%) in 2017," Danely said in a research note.

A foundry business is vastly different to what Intel is used to, especially as it relates to gross margins. Intel's fourth-quarter gross margins were 58%, and it expects gross margins for the first-quarter to be 58%, plus or minus a few hundred basis points. Foundry businesses are built on volume and may wind up compressing margins in an uncertain economic environment.

Intel recently upped its foundry business, winning the chip business of Altera ( ALTR), making it clear that it's increasingly putting resources behind its foundry business. Apple is currently using Taiwan Semicoductor ( TSM) as its foundry right now, and any incremental business to Intel would be a blow to Taiwan Semi, and a boon to Intel, albeit potentially at the expense of margins.

The Altera deal could pave the way for more clients to use Intel's fabs, says Deutsche Bank analyst Ross Seymore. "We believe Intel is in a position to add more foundry customers in the future as it becomes the primarily supplier of high performance logic where cost is less of a concern," Seymore wrote in a research note. He rates shares "buy" with a $26 price target.

Raymond James analyst Hans Mosesmann noted that Taiwan Semi's gross margins are in the 45% to 50% range, while Intel's are much higher. It's a major change for Intel, Mosesmann noted, signifying that "the more formal entry into the foundry business is an implicit admission" Intel will not be able to use all of its plants to build its -x86 processors, as PC demand wanes.

It's a risky business for Intel, but one its new CEO (current CEO Paul Otellini is retiring in May) will have to make if it hopes to stay relevant in a world that is increasingly passing it by.

-- Written by Chris Ciaccia in New York

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