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Intel Surges, But Some Risks Remain

By Hal Plotkin
Silicon Valley Correspondent

Semiconductor analysts still favor Intel Corp.’s {INTC} stock, even after this week’s big run-up, but some of them also warn of potential risks down the road.

On Monday, Lehman Brothers’ analyst Dan Niles touched off a buying spree in Intel shares after he published an upward revision to his earnings expectations for 2000 to $3.10 a share from $3.07 and for 2001 to $3.60 a share from $3.50. Niles’ report also reiterated his firm’s “buy” recommendation and $175 price target on the stock.


Five-day stock performance chart for INTC

In his report, Niles wrote that he based his upward revision on his projection of an increase in Intel’s average selling prices brought about by strong demand, as well as the company’s growing manufacturing capacity.

“We now believe that Intel can produce 10 to 15 percent more processors quarter over quarter in both Q3 and Q4,” Niles wrote. “Manufacturing is the key to Intel’s earnings, and we believe it is finally starting to hum. The mix is also richer towards high-end Pentium III’s versus [lower end] Celeron [chips].”

Other analysts tracking the stock agree with Niles about the short-term prospects for the firm, but some of them also say there are new risks associated with the stock’s newfound higher valuation.

“I’m actually quite gratified to see some of our competitors move their numbers up to where we were a few weeks ago,” says Charles Boucher, an analyst with Bear Stearns in New York. “It’s a nice validation.”

Boucher also has a ‘buy” rating on the stock, though his 12-month price target comes in somewhat lower, at $160, a price level that he says would bring the stock to a price-to-earnings ratio about 45 times his expected 2001 earnings.

“I liked it a lot better at $90 than I do today,” Boucher adds. “The valuation is starting to get within spitting distance of a reasonable level. So you need to be a little more aware of some of the risk factors.”

And what are those risk factors?

They include heightened competition from arch rival Advanced Micro Devices Inc. {AMD}, new competition in the mobile-computing space from start-up Transmeta Corp. and worries about a possible stumble during the introduction of Intel’s forthcoming Willamette processor because of its reliance on memory chips designed by Rambus Inc. {RMBS}, which are more costly and not yet as widely available as currently standard memory chips.

Sudeep Balain, an analyst with Chase H&Q in San Francisco, also has a “buy” rating on Intel’s stock, with a 12-month price target of $175.

But he says Advanced Micro’s stock is the better buy at the moment.

“We think AMD is the much better value now,” Balain says, noting that the stock has been trading at a P/E of about 17 this past week.

Balain’s 12-month price target of $150 for Advanced Micro would bring the stock up to a P/E of about 27, still way below most analysts’ forward-looking P/E for Intel’s stock, which range from about 42 to 46.

“Intel is certainly the dominant player today,” Balain says. “But you only have two players in a $35 billion [annual] market. There is room for both players to succeed moving forward. We just think AMD is the better bargain of the two.”

Balain says that 30 percent of Advanced Micro’s business now comes from sales of flash memory chips, which are used in a variety of devices, including cell phones and information appliances.

“AMD is locking in long-term flash sales agreements with customers such as Nortel Networks Corp. {NT}, Siemens AG {SMAWY}, Nokia Corp. {NOK} and Cisco Systems Inc. {CSCO},” Balain says. “It puts them in a very strong position.”

Boucher acknowledges that Advanced Micro is giving Intel the biggest run for its money in the long rivalry between the two firms, now that both companies are selling microprocessors that are fully competitive on both features and price.

But Boucher says that Intel should be able to protect and extend its market lead over Advanced Micro over the long run.

“AMD is enjoying their moment in the sun with their Athlon [microprocessor],” Boucher says. “But they need to find a road map that will let them compete with Intel, and that is going to be very difficult. Intel’s research-and-development budget this year is greater than AMD’s total revenues. I just don’t see how AMD will keep up.”

Looking a little further down the road, there are also concerns that Intel may be hurt in the emerging mobile-computing space by new low-power chips produced by Silicon Valley start-up Transmeta Corp.

Earlier this month, Gateway Inc. {GTW} said it would use chips from Transmeta to power the new mobile Internet appliances it plans to produce in partnership with America Online Inc. {AOL}

Intel executives have also targeted the very same market but are now facing an entirely new competitor.

“Transmeta is certainly a threat over the short term, at least on the low end, no question,” Balain says. “But longer term, I really don’t see it as that big a threat. Intel’s sees what’s happening and is taking the steps necessary to compete.”

Earlier this week, for example, Intel announced a new mobile version of its Pentium III microprocessor that runs on about half the power of previous versions. More energy-efficient Intel chips are said to be in the company’s development pipeline.

Transmeta officials, however, claim that the company’s low-power Crusoe chip requires only about one-third the power of Intel’s latest offering. That means portable devices made with Transmeta chips could last up to three times longer without needing fresh batteries than those that contain chips made by Intel.

That is, at least until Intel catches up.

“What you need to remember, though, is that as far as information appliances go, it’s not a zero-sum game,” says Ashok Kumar, an analyst with U.S. Bancorp Piper Jaffray in San Francisco. “Information appliances are an accretive market.”

Companies such as Transmeta, Kumar says, are helping to create an entirely new market, rather than slicing off market share from Intel. Kumar also says Intel’s prospects, unlike Transmeta’s, don’t hinge on the company being an early leader in the nascent information-appliance market.

“The market for information appliances is still embryonic at this point,” Kumar says. “It pales in comparison to the 160 million PCs sold worldwide this year.”

Perhaps the biggest potential cloud hanging over Intel moving forward, however, has to do with the planned introduction of the firm’s new, more-powerful 1.0 GHz Willamette microprocessor, which is slated to hit stores later this year.

Although the chip is drawing raves in high-performance computing circles, some say consumer demand for Intel’s Willamette chip could be slowed by the current requirement that it be used only in systems containing more powerful memory chips designed by Rambus.

While there has been some movement by memory chip makers toward the Rambus design in recent weeks, leading PC makers have balked at paying higher prices for the new, more-powerful memory chips, as compared with previous memory-chip technology, which is now a low-cost commodity item.

“The Rambus chips still cost three to four times as much as DRAM [chips],” says Quinn Bolton, semiconductor device analyst at CIBC World Markets in New York. “There could be a delay for Intel if it sticks with Rambus only.”

For that reason, Bolton says that he expects Intel will make alternatives available for the Willamette microprocessor that will allow PC manufacturers to use the older, less-expensive and more widely available memory-chip sets.

Bolton has a $150 12-month price target on Intel’s stock. But he says the stock could easily move past that mark if the introduction of Intel’s Willamette microprocessor proceeds smoothly later this year.

“We’re very bullish on Intel, particularly when we get into the second half [of this year],” Bolton adds.

“Intel’s valuation is getting up there,” Boucher says. “But we do think the stocks in the semiconductor sector deserve a premium, with the biggest premium going to the stocks of companies whose products have high proprietary content.”

“Intel really defines the high end of that spectrum,” Boucher adds.

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