Intel's Chip Delays Cloud Picture

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SAN FRANCISCO --

Intel's

(INTC) - Get Report

strategists used to have an easy job: Time the release of new chips to ward off challenges from the pesky clone-makers like

Advanced Micro Devices

(AMD) - Get Report

.

But Intel isn't displaying that kind of clockwork efficiency in its new Merced chip for servers. In May, Intel announced to shareholders a six-month delay in the Merced because of an underestimation of its complexity. That delay is coming in tandem with a late release of

Microsoft's

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Windows NT 5.0, the operating system designed to work with Merced as Microsoft's Windows software has worked with its PC chips.

Merced is geared for the high-end server market, a high-margin El Dorado for chipmakers. Investors are nervous, though, about the delay. Each Pentium chip Intel built for PCs was two comfortable years ahead of comparable AMD offerings, but the 64-bit-Merced will enter a market for server chips where competition already exists from

Compaq

's

(CPQ)

Alpha chip and

Sun Microsystems'

(SUNW) - Get Report

SPARC chips, both of which today have 64-bit chips at speeds of 333 megahertz and 600 MHz, respectively, and which are expected to speed to at least 1 gigahertz, or one billion hertz, in time for the release of Merced (which reportedly, but not officially, will clock at 800 MHz.

IBM

(IBM) - Get Report

too has plans for a 1 gigahertz chip as early as next year. "It's a horse race," said

Dataquest

analyst Nathan Brookwood.

Intel must match such competition at a time when it is just starting to pull out of a rough patch. The company's second-quarter profits fell to 66 cents a share from 92 cents a share in the year-ago quarter as revenues dropped 2% to $5.9 billion. This quarter, with inventories down and PC-chip sales up, Intel is looking for revenues to reach as high as $6.6 billion.

Chip delays for Intel are nothing new. The original Pentium came out almost three months late in March of 1993 and with a nasty computing bug as well. The 150 and 160 MHz Pentiums each came out a quarter late. And the Klamath, or 233 MHz Pentium, was a month late. But that was back in the good days of zero competition.

Now come worries over its server chips. "Delay of the Merced is a concern. The delay of Windows NT5 is a concern," said Mike Hahn, who co-manages the $350 million

(PBTCX)

PBHG Technology & Communications fund and is long Intel. "It definitely made the Intel story less favorable."

While the price of a PC falls below $1,000, low-end servers sell for up to $10,000 each, the mid-range sell for up to $15,000, and those at the top can run well above $50,000. In 1997 it was a $49 billion market split between a handful of companies: Intel, Sun,

Digital

, IBM and

Hewlett-Packard

(HWP)

. For the server chips, Intel already dominates the low end of the spectrum and controls 40% of the midrange. The high-end, where the fattest margins lie, is up for grabs.

Originally, the Merced was supposed to hit the markets in conjunction with Microsoft's release of Windows NT 5.0. Now, not only is NT 5.0 delayed too, Intel and Microsoft are both unraveling their historically close ties. This month Microsoft announced alliances with Sun and to better integrate NT onto their chips while Intel has been trying to unify all UNIX-based software developers around the Merced.

"This normally in the business is characteristic of what people do when they don't know what is going to happen," said Max Baron, a microprocessor analyst with technology research group

Cahners In-Stat

.

The timing of Merced's release is tricky. Delays now may buy Alpha and SPARC some early market share, but a release of an inferior Merced would buy them a more lasting dominance of that market. "Merced has to be faster than Alpha," Brookwood said.

And while Intel waits on the Merced, it is working on an even faster chip called the McKinley. The release dates of the two might be so close, the McKinley could make the Merced obsolete on arrival. And to complicate matters further, Intel is expected to soon get its stopgap 32-bit Xeon chip, now at 400 MHz, to 700 MHz, within range of the Merced.

Intel's strong suit is its resources, which will keep it surging ahead as its competitors grow tired. And that is why people like venture capitalist Andrew Rappaport, a partner with

August Capital

, who has stakes in UNIX-based systems developers

Be Inc.

and Sun, believe Intel is unshakeable. "There aren't a whole lot of credible alternatives to the Merced," Rappaport said. "Windows NT is running quite nicely now on Pentium boxes and multiple Pentium boxes. Intel gets to build a microprocessor that will be in a huge percentage of boxes regardless of competition."

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