Intel: Should Have Kept Gelsinger (Rating Downgrade)

Summary:

• Intel Corporation’s abrupt removal of CEO Pat Gelsinger raises concerns about the company’s direction and execution of its turnaround strategy, prompting a downgrade to sell.
• Gelsinger’s vision for AI PC sales and new chip architecture was crucial, but with his departure, the bull thesis appears weakened.
• Intel’s valuation metrics, while seemingly cheap, reflect significant challenges ahead, including poor forward revenue growth and high restructuring charges.
• The frequent CEO turnover and board missteps over the past decade have left Intel without clear direction, making the stock risky at this time.

Co-authored by Noah Cox and Brock Heilig.

Investment Thesis

Intel Corporation (NASDAQ:INTC) shares are up roughly 5.6% since the last time I covered the chipmaker over the summer, originally on the back of what the street thought was the company finally starting to execute its turnaround. While I had downgraded my view on the stock at the time to a hold, I also noted that the company could be close to pulling off its turnaround.

At the time, it appeared like there was evidence (albeit somewhat painful for shareholders) that former CEO Pat Gelsinger was doing the right things and was going to orchestrate a successful turnaround.

But in a surprising move earlier this week, Gelsinger was pushed out as CEO of the chipmaker, which was an odd move, given the numerous votes of confidence Gelsinger had recently received from some Intel board members.

The departure of Gelsinger shows me that Intel’s board really does not know which direction they want the company to go in. Intel is now about 3 and a half years into the very deep plan that Gelsinger had installed. He previously noted that he had “bet the whole company” on this new plan, and on a new chip manufacturing architecture. For him to abruptly be forced out gives me a lot of skepticism about the company and what its future holds.

With this, I am downgrading my view on shares to sell. I think the worst thing the company could have done in this situation was change strategy.

Why I’m Doing Follow-Up Coverage

As I mentioned before, shares are up but have trailed the market since the last time I wrote about the chip company in August. I think a large reason why there were any gains after the poor earnings performance over the summer was mainly supported by the market being hopeful that Gelsinger was in the process of completing a successful turnaround.

But now that Gelsinger is out, this is a fundamental game changer. Unfortunately, I’ve gotten progressively more bearish on the company throughout this year as the turnaround strategy failed to live up to expectations.

As I discussed in my research from August, when I downgraded from a strong buy to a hold, I thought there was a little bit of a silver lining that I saw in the company. At the time, I thought the main silver lining was around AI PC sales. Since then, we’ve not seen these sales materialize for the industry as a whole.

With AI PC sales not materializing and Gelsinger out, this is why I’m doing follow-up coverage — to show that most of what supported the bull thesis now appears to be gone.

Why Pat Gelsinger Was Pushed Out

While Intel is just now experiencing the effects of under-investment and changing industry trends, it’s actually quite possible that the events that triggered this decline started well over 15 years ago. Going back to 2007, Intel missed the mobile chip boom with the release of the iPhone.

This prompted Apple to go with Samsung for chips for the first few years that iPhones were on the market before Apple eventually rolled out its own homegrown chip. Apple later dropped Intel as the supplier for their Mac lineup as well.

Intel also unfortunately missed the evolution of server technology from CPUs to what NVIDIA Corporation (NVDA) CEO Jensen Huang calls “Accelerated Computing” or GPU technology.

With Intel boxed out of the accelerated computing revolution, not a leader in mobile chips, and also out of MacBooks, this leaves PC chip sales as one of their biggest remaining product lines. AI PC sales have not taken off like many (including myself) have hoped this year.

This led Intel to book a revenue decline of 6.2% in Q3, compared to the year-ago 3rd quarter. It also reported nearly a $0.46/share adjusted net loss, which missed analysts’ expectations of a loss of $0.02 by a significant margin.

In essence, Gelsinger was asked to leave because the company was doing too little too late to adapt to new industry trends from a product execution standpoint. Earlier in the year, Gelsinger (and management) was banking on AI PC sales to help finance the turnaround. This was noted in the Q1 Call:

Within client, we are defining and leading the AI PC category. IDC indicates the overall PC market is now expanding. And as stated earlier, as standards emerge and applications begin to take advantage of new AI-embedded capabilities, we see demand signals improving, especially in second half of the year helped by a likely corporate refresh -Q1 Call.

Now these sales are not coming to fruition.

What’s Next?

Intel is clearly at a turning point. Earlier this week, David Zinsner (Executive Vice President and Chief Financial Officer) and Naga Chandrasekaran (Executive Vice President and Chief Global Operations Officer) joined a conference call with Industry analysts on December 4th to discuss the steps going forward for the company.

Intel is getting ready to release a new 18A node for semiconductor manufacturing, which is expected to be ready for production in 2025. The two Intel executives spoke about the potential that this new node could bring to the company.

…we are progressing, Chandrasekaran said.

There are several milestones that we have met and there are still many milestones ahead for the technology development. And if I wear my technology development hat for a minute, there’s always challenges when you’re introducing new technology and there’s ups and downs. But what I would say is there’s nothing fundamentally challenging on this node. Now it is about going through the remaining yield challenges, defect density challenges, continuing to improve it, improving process margin and getting it ramped. Will there be challenges? There will be, but I think we are progressing.

Zinsner was clear in the call that the company does intend to keep its core strategy intact, regardless of who comes in as the new CEO.

…the Board was pretty clear that the core strategy remains intact, Zinsner added.

We still want to be a world-class foundry. We want to be the Western provider of leading-edge silicon to customers and that remains our goal. But we also understand that it’s important for the number one customer of foundry to be successful in order for foundry to be successful. And so the Board wants to also put emphasis on execution around the product side of the business to make sure that the foundry business remains successful.

These pieces of commentary are helpful for someone who used to be an investor in the company. But this commentary doesn’t solve the core issue for the business: the company needs a profitable core venture to finance the expansion of the 18A side of the business.

And with AI PC sales not living up to investor expectations, I think this is where the flaw in the strategy is. Based on management commentary, it appears that the board still likes the strategy, they were just not satisfied with Gelsinger’s execution.

The reason I believe they should have kept Gelsinger is because (as the WSJ reported) this was his vision. So while the company as a whole has bought into the vision, removing the visionary (even if you think they are not executing at the speed you want to) is not usually the right move. Gelsinger, by the time this vision had come to fruition this year, had become the face of the vision. It’s difficult to recover from this when installing a new CEO. I think this is why the stock has sold off since his departure on Sunday.

Valuation

While Intel shares appear cheap on a forward price-to-sales ratio and on a forward price-to-book ratio, I think this is justified. The company currently has a forward price-to-sales ratio of 1.70, which is 47.56% lower than the sector median of 3.25.

Meanwhile, the chipmaker’s forward price-to-book ratio is at an even greater discount to the sector median. Intel sits at a forward P/B ratio of 0.88, compared to the sector median in this area at 4.41. This is an 80.06% discount to the sector median. Seeking Alpha gives this an A+ grade.

A big reason this forward Price/Book ratio is low could be based on the billions in restructuring charges the company has taken over the last 12 months. Investors likely believe charges like these will continue going forward.

With this, forward revenue growth is expected to be poor, I think the company is looking at a year of anemic growth. The sector median for forward revenue growth is 5.64%, but Intel is currently estimated to come in at -3.93% forward revenue growth. This is over two full percentage points worse than its five-year average of -1.84%.

With this, I think Intel’s forward price-to-sales ratio should decline another 25% from here, considering the fact that the company is in a tough position (18A will be capital intensive and AI PC sales are not supporting the business). This would result in an additional 25% downside.

Bull Thesis

While Gelsinger was key to the strategy (and I think he will be difficult to replace) the biggest bull thesis for the company is that they find a new CEO with a great vision that helps them orchestrate a successful turnaround.

Intel is trying to operate quickly in this area.

Effective immediately, former ASML CEO Eric Meurice and Microchip Technology CEO Steve Sanghi are set to join Intel’s board, according to CNBC.

Eric and Steve are highly respected leaders in the semiconductor industry whose deep technical expertise, executive experience and operational rigor make them great additions to the Intel board, interim Executive Chairman Frank Yeary said.

Obviously, we still don’t know who will be the next CEO of Intel (some analysts think Gregory Bryant would be a great candidate), I don’t think knowing the CEO yet is Intel’s biggest problem.

Intel has had immense CEO turnover over the last decade or so (first Brian Krzanich, then Bob Swan, Gelsinger, and now a person to be named later), I think the real issue is some members of the Intel board. Intel will now have 4 CEOs in 10 years. As I mentioned earlier, Intel has had 15 years of effective missteps when we take a step back.

That is not just one CEO’s fault. That is the fault of the company’s board (in my opinion) for not picking high-quality CEOs when they are needed. So while I welcome the addition of some new board members who have real industry experience, I am not sure if this will be enough on its own to pick the maverick CEO they will need to finish the turnaround plan.

Takeaway

Intel has arguably had too much CEO turnover in the last 10–15 years, which has left the company without direction (and a series of missteps have left them missing a key series of chip innovations).

The company is once again at a turning point, left having to pick its fourth CEO in the last decade. While Intel is very cheap from a valuation standpoint, I don’t see this as a sign that shares (and the company) are in an opportune position. I think it rightfully reflects the fact that the company has a handful of serious challenges ahead. I am personally not optimistic. For now, I think Intel is a sell.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Noah Cox (main account author) is the managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.

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