Intel Investors May Need a Bit of Paranoia
They should be wary of the chip giant's chances to be as dominant in the next phase of computing

One of the neat things about being a technology company is that if you're one of the first to market, and you bet on the right technology, you can build yourself a near monopoly for a couple of decades. The downside is, the next technological advance can knock you off your pinnacle like ocean waves wiping surfers off their boards. If you're agile, there's always the hope of repositioning yourself to catch the next wave, as IBM switched from mainframe manufacturing to information services after the personal computer arrived. The transition is generally painful, however.

It looks as though Intel Corp., which reaped the benefits of the PC era partly at the expense of IBM, will have to perform such a feat of derring-do. For nearly 20 years it has barged along as a quasi-monopoly, manufacturing the chips that underpinned the PC revolution. But Intel's microprocessor hegemony may have only a year or two of momentum left. The giant is trying to figure out how to catch the next wave in technology without falling off its board.

The problem is that no matter what Intel invests in, it, like everyone else, is only guessing at how telecommunications, computers, software, broadband Net access, and wireless technologies are going to converge. As for Intel's stock, it may give you a nice ride over the next year or two. But it isn't safe to assume that Intel's products will dominate the next quarter century the way they did the last.

MIXED OPINION. Looking at the market right now, it might seem as though there isn't much to worry about. Intel has been a bellwether for the bull run. At 115 3/4, it's only about a dollar off its 52-week high. After a 1999 plagued by a downturn in PC sales because of Y2K fears, 2000 is shaping up to be a bumper year. Intel can't meet demand fast enough. Last year it was even able to plow $6 billion into a bundle of new networking and communications technologies in an effort to put its business back on the cutting edge.

Nonetheless, Wall Street is mixed on its opinion of the stock. Nobody doubts that the resurgence of PC sales after Y2K and the unveiling of Windows 2000 will result in a terrific year for Intel. Analysts are predicting revenue growth of up to 13% for 2000 and 15% to 18% for 2001 -- not bad for what some are calling a mature industry. The question is how to maintain growth into the next era of technological development.

The unanswerable nature of that question has led to some diverse opinions on Intel's value. Estimates range from that of S.G. Cowen & Co.'s Drew Peck, who says the stock is fairly valued at its current 113 price, to more bullish analysts such as Robertson Stephens' Dan Niles and Morgan Stanley's Mark Edelstone, who value it at 150 and 125, respectively. Morgan Stanley is predicting 2000 earnings per share of $2.90, and 2001 profits of $3.35. Last week, Robertson Stephens raised its estimate of this year's earnings from $2.90 to $3.02, and kept its 2001 estimate at $3.35. On the less-bullish end of the spectrum are Merrill Lynch's estimates of $2.37 for 2000 and $2.85 for 2001. Cowen is somewhere in the middle, with a prediction of $2.55 for this year and $2.80 for next.

FEED THE BEAST. One of the biggest hurdles Intel has to overcome in meeting the makeover challenge is its size. With nearly $30 billion in chip revenues, it's hard for the company to change direction in a meaningful way. Any new market it invests in is certain to be dwarfed by its main business. "I doubt you'll see a material contribution from any of its new businesses over the next year," says Cowen's Peck.

The problem is that even as Intel explores new directions, the need to maintain compatibility between its past products and its future ones ties it to microprocessor technology that's 25 years old. While other companies like Transmeta are skipping ahead to design chips for such software as Linux, Intel must still feed chips to the market it created. And it can't make new, advanced versions fast enough. "Execution is the danger for Intel," says Robertson Stephens' Niles. Still, he notes, "keeping up with demand is a beautiful problem to have."

If PCs were going to be the wave of the future, just defending Intel's installed base might not be such a bad plan. But technology mavens imagine advances just beyond the horizon that will turn the PC into a dinosaur in more like a decade than a millennium. They foresee some species of technology that will house video broadcasts, telephony, data transmission, interconnectivity, number-crunching, and interactivity all in one unit. Pieces of the technology already exist today, and Intel is trying to develop some of them. But trying to meet the demand for its ever-faster PC chips is giving Intel some trouble, such as the problems it had getting its chipsets to run smoothly with the new high-speed Rambus memory chips.

BACKBONE PLAY. Its recent acquisitions, twice the size of its capital expenditures last year, are all geared toward new technologies that Intel doesn't dominate. Under CEO Craig Barrett, the company has made significant investments in networking and communications processors, instead of pouring money into PC chips. "Intel wants to be the backbone of the Internet, and they are on the right track," says Sudeep Balain, senior technology analyst at Chase H&Q.

In addition to key investments such as last year's purchase of Level One, which produces communications chips that can push more information through larger-bandwidth pipes, Intel's venture capital efforts will pay off, Balain argues. The company owns bits of more than 350 software companies, with total 1999 venture capital investment hitting $1.2 billion. The properties Intel invests in are all in businesses that would enhance sales of its products, be it e-commerce, software development, or hardware development. "In a few years Intel will have its fingers in every important startup," Balain says. "It's both a way of defending its turf and getting in all the new technologies."

Critics say Intel is just bumbling around in the dark. "They haven't elucidated their networking strategy very well," says Cowen's Peck. "They invested $6 billion to acquire a hodgepodge of companies in a panic, and it's hard to discern how they fit." Some say Intel should be thinking bigger -- and bidding for companies such as rival chipmakers Broadcom and Texas Instruments.

Although analysts argue about how Intel should manage the transition away from PCs, everybody agrees that Intel has to plan for that eventuality. "It's straight out of Andy Grove's book, Only the Paranoid Survive, says Peck, referring to Intel's former CEO who made the company the king of microprocessors. "You have to be willing to eat your own young." With its expansion into networking and communications, Intel is preparing for the big gulp. Over the medium term, investors should be too.

By Margaret Popper in New York, with Andy Reinhardt in San Mateo, Calif.

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