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Intel Table Set for Change: Focus, Frugality, ...And Fabless? Upgrade to Hold Rating | Target Change January 21, 2020 NORTH AMERICA | Semiconductors

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Intel Table Set for Change: Focus, Frugality, ...And Fabless? Upgrade to Hold Rating | Target Change January 21, 2020 NORTH AMERICA | Semiconductors EQUITY RESEARCH Intel Corporation (INTC) Intel Table Set for Change: Focus, Frugality, ...and Fabless? Upgrade to Hold Rating | Target Change January 21, 2020 NORTH AMERICA | Semiconductors Key Takeaway HOLD RATING Share loss, a transistor transition disaster, changing of the mgmt guard, and a CEO bonus (FROM UNPF) that inflects with the stock in the low $60s tell us the table is set for change at INTC. We PRICE $59.60^ increase our price target to $64 assuming that the company divests memory (Focus) and MARKET CAP $264.2B cuts OpEx (Frugality). Fixing its manufacturing or moving to a Fabless model potentially PRICE TARGET (PT) $64.00 (FROM $40.00) addresses our share concerns, but we assess a low probability of either... for now. UPSIDE SCENARIO PT $85.00 DOWNSIDE SCENARIO PT $45.00 Focus = $5 to the Stock. We estimate that divesting the memory business could add $0.16 of EPS, 200bps to gross margins, 260bps to op margins, and 1.0x to the P/E ^Prior trading day's closing price unless otherwise noted. multiple due to $2.3bn in higher annual capital return and focusing on core story. FY Dec Frugality = $12 to the Stock. Based on its sales level, we estimate that INTC's SG&A USD 2018A 2019E 2020E should be between 1.7% and 6.5% of sales. At the midpoint (4.2%) vs. INTC's current EPS 4.58 4.60 3.80 levels of 8.5%, we estimate an incremental $0.63 of EPS, 430bps to op margins, and 1.0x FY P/E 13.0x 13.0x 15.7x to the P/E multiple due to $2.5bn in higher annual capital return. *EPS changes reflect lower estimates and change from GAAP to non-GAAP estimates Fabless = $19 to the Stock (Low NT Probability). We estimate that if INTC sold its factories at book value, and transitioned to a fabless model that enabled it to close the Chart 1 - INTC Stock Price 90 New Base Case @ $64 transistor gap with AMD in servers, it could increase EPS by $0.74 due to a lower share assuming high probability of restructuring $19 80 EPS: $4.61; P/E: 13.8x EPS +$0.74 count and expand P/E multiple by 2.0 turns due to $6.6bn in higher annual capital return. FCF - $18.2bn 70 P/E +2.0x $12 60 EPS +$0.63 $5 P/E +1.0x Timing. We see three catalysts that set the table for dramatic change in 2020-21: 50 $46 EPS +$0.16 Bull Case @ $85 P/E +1.0x Fabless Model 40 Base Case - ex EPS: $5.50 P/E: 15.5x 1) Changing of the Guard: over the past six years, 10 long-standing senior execs with 30 Restructuring @ $46 FCF: $24.7bn 23-to-42 years of experience have left Intel, while more recently at least a half-dozen Price ($) Stock INTC 20 EPS $3.80 new seniors have joined - largely from fab-lite/less backgrounds. Similarly, 39-year Intel 10 P/E 12x 0 veteran and Board Chairman, Andy Bryant (~69 yrs old), indicated that he would not stand ng Divest - ex - Fabless Move to Move Memory for re-election after serving his current term through May 2020. SG&A Discipline Base Case Base . Restructuri Source: Jefferies, company data 2) 10nm Delay and Pending Market Share Crisis. Intel's 10-12 quarter delay of its 10nm transistor means for the first time in decades INTC has ceded transistor leadership in The 4th Tectonic Shift in Computing the industry, which we think will lead to 1,000-2,000bps of share loss in 1-to-2 yrs. 10nm Enigma 3) CEO Bonus Plan, indicates a performance bonus of $30m kicks in should INTC's stock hit $62 for 30 days, which scales to $180m at a $95 stock price by Jan 30, 2024. FCF and Capital Return Handbook - 2018 A Fabless INTC: Sacrilege, or Inevitable? It looks like INTC's 10nm server MPU is at least Mark Lipacis * Equity Analyst one full year behind AMD, and we expect INTC to lose 2,000bps of server share to AMD (415) 229-1438 over the next two years. Because the cost to run a server MPU (includes power to both [email protected] operate and cool the server) can exceed its price, a company that falls far enough behind Vedvati Shrotre * may not be able to give its MPUs away for free, so if INTC doesn't fix its manufacturing Equity Associate problems fast, it may be splitting the MPU market 50/50 with AMD before long. A deal (415) 229-1574 where INTC sells its fabs and outsources to TSMC is difficult to imagine politically, but it [email protected] looks like INTC's transistor lead is lost for good, and a fabless INTC would be positioned Natalia Winkler, CFA * to both stem share loss and turn itself into a cash flow and capital return machine. We Equity Associate assess a low probability near term, but will monitor developments closely. (415) 229-1511 [email protected] Please see analyst certifications, important disclosure information, and information regarding the status of non-US analysts on pages 26 to 31 of this report. * Jefferies LLC / Jefferies Research Services, LLC EQUITY RESEARCH Intel Corporation (INTC) INTEL (INTC) The Long View | Scenarios Estimates Base Case USD 2018A 2019E 2020E Rev. (MM) 70,848.0 70,956.0 67,112.0 • Management divests memory and streamlines SG&A expense. Previous • INTC continues to face secular challenges with a shift Consensus EPS 4.58 4.62 4.66 in computing’s center of gravity away from x86 to parallel processing. Previous 4.39 4.46 • Share loss to AMD in desktop and server and NVDA in EPS datacenter. Q1 0.87 0.89A 0.99 • Decline in PC unit shipments. • 2020 EPS: $3.80; P/E FWD: 16.8; Price Target: $64 Previous Q2 1.04 1.06A 0.97 Upside Scenario Previous • Base Case plus moves to a fabless model. • Corporate PC refresh cycle. Q3 1.40 1.42A 0.98 • Design wins in datacenter for parallel processing and Previous accelerator products (Xeon Phi, Nervana, Altera). Q4 1.28 1.24 0.87 • Better OpEx management improving margins. • AMD mis-executes. Previous • 2020 EPS: $5.50; P/E FWD: 15.5x; Price Target: $85 FY Dec 4.58 4.60 3.80 Previous Downside Scenario • Reaccelerating decline in PC unit TAM. Valuation • Continued share loss to AMD, NVDA, XLNX and homegrown solutions from hyperscale players. 2018A 2019E 2020E • Mis-execution of manufacturing process technology P/Rev 3.7x 3.7x 3.9x transitions. EV/Rev 3.9x 3.9x 4.1x • Gross margin compression due to under-utilization. • Valuation compression associated with lower growth FY P/E 13.0x 13.0x 15.7x outlook. *EPS changes reflect lower estimates and change from GAAP to non-GAAP estimates • 2020 EPS: $3.00; P/E FWD: 15x; Price Target: $45 Market Data | Investment Thesis / Where We Differ 52-Week Range: $60.97 - $42.86 • We argue there is a tectonic shift in computing toward a parallel model, and as the incumbent with dominant Total Entprs. Value $276.3B share, we think INTC has the most to lose. Avg. Daily Value MM (USD) 1,153.47 • Our "4th Tectonic Shift in Computing" thesis argues Float (%) 98.1% that parallel processors will take share from x86 MPUs in the data center going forward. We also expect AMD will take x86 server MPU share from INTC in the data center. | Catalysts • Breakthroughs in manufacturing process technology or chip design. • Corporate PC refresh cycles. • Design wins for its parallel co-processor (Xeon Phi) or artificial intelligence products (Nervana, Movidius). • Adoption and ramp of 3D XPoint memory. • Design wins in Networking products for virtualized network appliances. January 21, 2020 2 Please see important disclosure information on pages 26 - 31 of this report. EQUITY RESEARCH Intel Corporation (INTC) Table of Contents Section 1: Executive Summary.......................................................................................... Pg 4 Section 2: Timing - INTC Set-up for Change....................................................................... Pg 6 Section 2.1: 10nm Delay + Share Loss.................................................................................................. Pg 8 Section 2.2: Management Change - Changing of the Guard................................................................ Pg 9 Section 2.3: CEO's Bonus Plan.............................................................................................................. Pg 10 Section 3: EPS P/E Add Stock Opportunity........................................................................ Pg 11 Section 3.1: Focus - Divest Memory...................................................................................................... Pg 13 Section 3.2: Frugality - Drive SG&A Discipline...................................................................................... Pg 15 Section 3.3: Fabless - Shift to Fabless Model...................................................................................... Pg 17 Section 3.4: Estimated Impact of Implementing All Three Scenarios................................................ Pg 19 Section 4: Capital Return Framework................................................................................ Pg 20 Section 5: Financials........................................................................................................ Pg 23 January 21, 2020 3 Please see important disclosure information on pages 26 - 31 of this report. EQUITY RESEARCH Intel Corporation (INTC) Section 1: Executive Summary INTC Has Secular Challenges. Our upgrade to Hold notwithstanding, we continue to believe that Intel faces the secular challenges that we outlined in our 2017 note "The 4th Tectonic Shift in Computing," namely that the center of gravity in computing is drifting away from x86 both at the edge (to IoT devices from PCs and cell phones) and in the data center (to parallel processing architectures). Since the new computing devices are not centered on x86, Intel is simply becoming less relevant. Unfortunately, Intel has compounded these secular challenges by fumbling its long-standing transistor lead. The Intel transistor execution machine that used to deliver a new transistor every eight quarters like clockwork, two years ahead of everyone else in the industry, is a shadow of its former self. The transition to 14nm took 11 quarters, and the transition to 10nm took close to five years - and the 10nm version of its server MPU likely won't ship in volume before 4Q2020, at least a full year behind AMD.
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