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Wary Investors Question Intel's Newest Farm Team

But the company says its plunge into the server-farm business is a logical offshoot of what it does best: running plants with military efficiency.

SAN FRANCISCO -- Analysts and investors who have cheered Intel's (INTC) - Get Intel Corporation (INTC) Report expansion from microprocessors to communications chips are worried the chip giant will have trouble with its latest foray: a bid to become an operator of Internet data centers.

In 1997, when Intel moved into embedded processors by buying the StrongARM technology from

Digital Equipment

, and again this year, when it moved to enter the communications chip market with its planned purchase of

Level One Communications

(LEVL) - Get Level One Bancorp, Inc. Report

, Wall Street welcomed the news.

But since April, when Intel announced its plans to set up a server-farm business, the general consensus has been the area seems too far afield of Intel's core business. Intel is building three data centers this year at a cost of between $50 million and $100 million each. The data centers are giant facilities that run the Internet backbone for small and medium-sized businesses by keeping thousands of servers constantly humming. It's a service-oriented sector that has little to do with Intel's strong suit, manufacturing.

"It seems when companies diversify away from their core business, they have problems," says David Risgard, managing director of

North Star Asset Management

, which is long Intel. "It's a whole different mentality ... that they will need. I'd rather see them continue to buy communications chips."

Eric Linser, portfolio manager with

Rosenblum Silverman Sutton

, says Intel's entry into such a service-related industry makes him nervous. "It's an entirely different operating model," he says. "It doesn't make sense to me."

As far as Intel is concerned, being the backbone for other companies' Internet and e-commerce operations is a logical offshoot of what the company does best: building huge plants and operating lots of equipment that needs constant maintenance. "We have a lot of experience in building chip factories around the world," says spokesman Robert Manetta. "To make chips, you have to be really precise."

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Intel has achieved precision in building plants because it operates under a "copy exactly" practice: Each plant that makes a particular product is built exactly the same. This way, if a quake on the San Andreas fault shuts down Intel's California operations, production of Pentium chips can be shifted almost instantly to other Pentium factories around the world. That backup system is similar to the structure of Web-services companies that have far-flung data centers.

On Tuesday, Intel said it made a $200 million investment in

Williams Communications

, a maker of the fiber-optic networks that will connect its server farms. And it already owns


, a Seattle start-up that helps small and medium-sized businesses create e-commerce sites. iCat will be able to funnel these businesses to the Intel farms, Manetta says.

"We obviously wouldn't get into it unless we thought we could make money off of it," Manetta says. It took several years for the company's networking business to get off the ground, he points out, and now it generates some $1 billion a year in revenue. But the company will not say when it expects the profits from its server farms to trickle in.

U.S. Bancorp Piper Jaffray

analyst Ashok Kumar, who rates Intel stock a strong buy, says the profits will be secondary to Intel's ability through its server farms to showcase Intel-based hardware and the applications that run on them. Piper Jaffray is not an underwriter of Intel.

Still, some analysts wonder how profitable Intel could be in the service-related industry. "It's interesting," says

Morgan Stanley Dean Witter

analyst Mark Edelstone. "But they haven't laid out the economic model." Morgan Stanley is an underwriter of Intel.

Not all money managers are leery of Intel's latest attempt to move away from chips. Toby Levitt of

Albion Management Group

believes the risks are small and the potential rewards great in the server-farm business. "It they don't succeed, it's not that big a deal, and if they do, it opens up a new source of revenue for them," he says.