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Morningstar | We’re Not Thrilled With Intel’s Seemingly Consolation CEO Pick Bob Swan; No Change to $65 FVE

On Jan. 31, Intel completed its long-awaited CEO search by removing the interim tag from Bob Swan and promoting him to the permanent position. We were surprised by the move as Swan himself had reportedly said he didn’t want the job permanently. CNBC reported that Intel was close to selecting another candidate as CEO that ultimately did not work out, implying Swan was a second choice at best. Swan’s pre-Intel experience features a stint as an operating partner at private equity firm General Atlantic, director on Applied Materials’ board, and CFO at eBay. We are somewhat skeptical of Swan’s finance-oriented background (similar to former Intel CEO Paul Otellini) and non-Intel background. That said, we concede the latter could be refreshing for a chipmaker at a crossroads with growth in core PC and server segments waning and new growth vectors such as artificial intelligence and automotive still nascent, with competition in abundance. Juxtaposed with peers such as Nvidia CEO Jensen Huang and AMD CEO Lisa Su, both engineers, Swan seems somewhat out of place. Shares of both competitors rose as Intel’s stock fell 2% on the news, though the elimination of the CEO uncertainty should bode well for Intel shares going forward. We are maintaining our $65 fair value estimate for wide-moat Intel and continue to see an attractive margin of safety. Nevertheless, we will heavily scrutinize Swan’s moves going forward through the lens of assessing whether investments are superfluous or pragmatic as well as cost-cutting endeavors and potential business impact.

Todd Underwood, vice president of finance will serve as interim CFO as Intel commences an internal and external search for a permanent CFO. Intel’s business has been firing on all cylinders during Swan’s interim stint as CEO, recording 13% revenue growth for 2018. However, we note much of this outperformance came off the seeds planted by his predecessor, Brian Krzanich. More recently, Intel’s $15.5 billion capital expenditures plan for 2018 likely supports the 10-nanometer ramp, expanded capacity in 14-nanometer, and expansion plans in Oregon R&D center.

Recently, Israeli Finance Minister Moshe Kahlon noted Intel applied for a grant of $1 billion from the government for a new fab in Israel that would cost $11 billion. We note the firm’s initial 10-nm ramp is occurring in Israel. Although these plans highlight Swan’s confidence in Intel’s manufacturing future and competitiveness, we remind investors Otellini signed off on Intel’s Fab 42 in Arizona that has been sitting as an empty shell for nearly a decade before the firm recently began filling it with equipment for what we anticipate will be Intel’s 7-nm node. Per Robert Palmer (former CEO of Digital Equipment), “building semiconductors is like playing Russian roulette. You put a gun to your head, pull the trigger, and find out four years later if you blew your brains out.” Only time will tell how these potential expansionary moves will fare for Intel.

Staying in Israel, Intel has reportedly made a $5.5 billion to $6.0 billion cash/stock bid to buy Israeli-based Mellanox Technologies, which implies a 30% premium. Mellanox sells networking products with InfiniBand and Ethernet technologies for interconnects. As Intel looks to grow its share of total data center spend and as data transfer is a growing bottleneck, this deal could make sense. Over the past year or so, both Xilinx and Microsoft have been linked to acquiring Mellanox. With Intel still digesting its $15.3 billion Mobileye and $16.7 billion Altera deals, among a host of other tuck-in acquisitions such as Nervana, we don’t believe now is the right time to pursue another sizable acquisition, particularly for a relatively modest sales contribution (Mellanox’s 2018 revenue was $1.09 billion, up 26% year over year). Nevertheless, we note Intel has its own Omni-Path interconnect solutions, with this reported bid likely implying its technology is subpar to that of Mellanox.