Why New Chip Could Bite Intel

Its new Internet handheld chip brings buzz, but will it stall the chipmaker's rebound?
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SAN FRANCISCO -- The chip isn't available yet and the products are still prototypes.

But the promise of handheld Internet gadgets, featuring


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new power-efficient Silverthorne microprocessor, was enough to make the chipmaking giant one of the stars of the Consumer Electronics Show in Las Vegas this week.

However, one aspect that has received less attention amid all the hoopla is how Intel's plan to branch out from the PC and into the consumer realm will affect its profit margins.

It's no secret that the consumer electronics market, where low prices are crucial, isn't known for rich profit margins. And Intel is still in the process of mending its profit margins, following a brutal price war with rival

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in 2007.

After seeing

its gross margin bottom out at 47% in the third quarter, Intel saw gross margins bounce back to 52.4% in the third quarter, and it's projected to hit 57% for the fourth quarter, which will be reported Tuesday.

Investors would like to see a return to the 60% level that was common in past years.

Whether the Silverthorne effort brings Intel closer towards that goal -- or might work against it -- is still unclear.

The standard playbook for chipmakers on the consumer electronics field goes something like this: Find a market with a product that's sold to a massive number of consumers, such as cell phones, and rely on a large sales volume to offset the chip's low average selling price.

Unfortunately, the mobile Internet devices in which Intel envisions using its Silverthorne chip don't meet that criteria. Right now, there's no market for those devices, as they largely don't exist, aside from


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And it's hard to imagine the first crop of these devices, expected later this year, selling in enough volume to move the revenue needle at Intel, which does nearly $40 billion a year in sales. Some analysts aren't even adding Silverthorne into their revenue model.

The good news is that Intel plans to build the chips with 45-nanometer technology, the semiconductor industry's most advanced manufacturing process. That means Intel will be able to significantly reduce its production costs, by cramming more circuits on each chip and shrinking the size of the chip die.

American Technology Research analyst Doug Freedman reckons that producing Silverthorne with 45-nanometer tools will give the chip a profit margin that's above Intel's companywide level -- even though he expects Silverthorne to sell for the relatively low price of roughly $12 a chip.

"This is one of the first times we've seen leading-edge manufacturing equipment deployed" by Intel for a consumer electronics processor, says Freedman.

Intel's past efforts at breaking into the consumer market, such as the now-divested X-scale product, relegated the chip manufacturing to older equipment. That business lost money for several years before

Intel cut it loose in 2006 .

The fact that Intel is devoting its leading-edge manufacturing equipment to the Silverthorne processor hints not only at the potential for stronger profitability, but at a stronger commitment for the effort to succeed within the company.

Of course, it's not certain that we'll ever know what Silverthorne's profit margin really is, since Intel may not break out that business's financial results.

And some observers think worrying about gross margin is premature, given the larger issue of whether Silverthorne even takes off.

"The bigger question is do you think they succeed in growing this business long term," said one chip analyst.

"The cynics aren't usually pointing to margins, because that assumes Intel succeeds."