Intel Valuation Project

Valuation and Value Creation Final

Consulting Project

Intel Strategy for Maximizing Long-Run Value

April 23, 2016

Executive Summary

Intel Corporation operates in the semiconductor industry as a mature, vertically integrated chip

designer and manufacturer. Their long-term presence in this industry, combined with a

reputation for quality and innovation has allowed them to gain and maintain market share in

target markets for more than twenty years. However, the transition away from PC’s to mobile

devices has allowed competitors to enter the market, and Intel has stumbled in their attempt to

pivot their strategy to address this critical new market. Our discounted cash flow model

accurately predicts Intel’s share price of $31.97 within a small margin of error of only 11 cents.

After carefully analyzing for key value drivers and sensitivity we are able to provide

recommendations to increase the share price by 21% to $38.58 per share. Our recommendations

focus on reducing costs and optimizing efficiency in the following areas: R&D, Capital

expenditures and asset utilization, and SG&A - primarily marketing.

Strategic Overview

The consumer market is changing rapidly as mobile devices have become a normal part of our

lives over the past decade and demand for PCs is declining. Intel has not optimized in this market

and is adopting new strategies. Intel’s recent reorganization, which included reducing workforce

by 11%, signals its goal of growing in the Data Center and Internet of Things segments of the

market to advance cloud computing and B2B platforms (see Exhibit 1). New market entrants

attracted by high profit margins are increasing and technological change is an ongoing necessity.

In Exhibit 2 we detail Porter’s 5 Forces showcasing Supplier Power as being low due to the shear

volume Intel commands in the market. Consumers have Mixed Power since the there are few

alternatives, however the move towards mobile devices is cause for action. Competitive Rivalry

is high since low cost design model uses foundry manufacturers to undercut the market and large

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consumers are beginning to vertically integrate forcing Intel to keep prices low. The Threat by

New Entry is low since Entry still requires heavy investment in R&D and up front capital.

Financial Analysis

Advanced Micron (AMD), Intel’s biggest rival, dwarfs Intel threefold in terms of 2015 sales

($16B vs. $55B). As a large, well established franchise, Intel is closely tied to the overall market

performance and has a Beta of 1.05 (see Exhibits 3 and 6). Micron is noticeably more volatile to

market forces. In 2015, Intel Corporation saw a slight decline in performance and share price

from $33.04 to $31.02 for 2014 to 2015, which is expected given close tie to market performance

and the 2015 S&P500 decline of 2.7%. The more volatile competitor suffered a share price

decline of 62% for the 2015 year. Intel’s core performance and financial strength is detailed in

Exhibit 4. Intel’s Quick Ratio shows it has sufficient cash to meet current liabilities 2 times

over, and we see little variance in ratios between 2013 to 2015. However, there was a significant

increase in its Debt to Equity Ratio (D/E) between 2014 and 2015 of 11% points to 32%. Intel

acquired long term debt of close to $8 billion in 2015 to further grow and expand development in

the cloud computing and business development offerings. The DuPont method was used to

disaggregate Return on Equity (ROE), highlighting driving factors for Intel’s performance.

Micron has a ROE of 21.82% compared to Intel of 18.42%, which is due to Micron managing its

assets more effectively in terms of converting assets to sales and funding assets with more debt.

Intel is more effective in terms of operating efficiency with a higher net profit margin for 2015

over its competitor. The same is reflected again in the Operating Return on Investment (ORI)

with Intel’s 3 year low at 13.3% being nearly a full percentage point higher compared to

Micron’s ORI at 12.4%. Intel is more capital intensive and relies on scalability to meet

consumer demand as compared to Micron.

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Valuation

A discounted cash flow method was used to value Intel enterprise at $31.89 per share (see

Exhibit 7). Intel’s current share price (as of close on 4/21/16) is $31.97 per share. The 52-week

historical prices have ranged from $24.87 to $35.59 per share, with beta of 1.05. The current

value of Intel’s shares being less than 5% different than our valuation model provides a platform

for sensitivity analysis and projections. Intel’s WACC is 7.72%, Intel’s cost of debt was

calculated by using the 2015 annual statement and using a weighted average of all debts which

mature post 2020 (see Exhibit 8). Estimates provided by Value Line, a 3rd party analysis and

forecasting company, are used to estimate key value drivers for 2016 and 2017 and project a

target range for 2019 and 2021. This final estimate was used as the 2020 value in our value

driver analysis. Value Line offers direct information regarding sales, operating margins, tax

rates, net working capital, capital spending, and depreciation. Exhibits 9 summarizes the

projections estimates, and Exhibit 10 shows how the projections for key value drivers change

over time.

Full Valuation Model:

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Analysis of the Company's Value Drivers

Capital Structure: WACC was estimated over a range of D/E by finding the unleveraged beta

and re-leveraging to account for the varying degrees of financial risk. As an approximation, the

cost of debt was assumed constant across the range of D/E evaluated (see Exhibit 11). WACC

was highly insensitive to changes in capital structure as shown in Exhibit 12. As a result,

varying leverage is not an effective lever for increasing shareholder value through reducing the

WACC. Specifically, increasing D/E to 100% from baseline of 13%, a 7.4x increase in debt,

only results in a decrease in the WACC of 0.18%.

Sensitivity Analysis of Various Value Drivers: As shown in Exhibit 13, a sensitivity analysis

was performed across a range of -20% to +20% of baseline for numerous inputs to determine

sensitivity of that input to cash flows and ultimately the equity valuation. The valuation of Intel

was highly sensitive to COGS and moderately sensitive to R&D Expenses. Net Fixed Assets, and

SG&A Expenses which are our strategic focus to improve value for Intel.

Strategy for Increasing Shareholder Value

A significant reduction in COGS would be difficult to achieve since raw materials are mainly

commodities and overseas production for older products is already optimized. Intel’s newer

innovations require manufacturing expertise and high intellectual property not found abroad.

Research and development investment is critical for Intel to remain competitive, however,

partnering with academia and broader industry consortiums can reduce R&D costs while

continuing to innovate. Samsung, IBM, and Micron are already part of consortiums to share

early R&D costs. Partnering with suppliers to push innovation down the supply chain can cut

costs. Sharing internal data and fostering collaboration can reduce R&D burden. By adopting

these two strategies, it was estimated that Intel could save approximately 5% from its Other

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Operating Expenses, which are primarily R&D.

There may be some opportunity to consolidate and globalize production, but the opportunities

are seen as small. As the foundry model of chip production becomes more common, vertically

integrated companies will need to compete with the foundry companies. This means that

efficiency and utilization of capital assets will become a critical consideration. Reductions of

3% in Net Fixed assets costs beginning in 2016 can be realistically achieved.

Finally, SG&A may be reduced significantly by reducing costs associated with advertising.

Although Intel relied heavily on advertising to build market share to its current level, it now

relies more on its established relationships with computer and smartphone manufacturers and the

quality and reputation of its products to generate sales. It is recommended that Intel reduce

advertising costs by 25% to $1.35B beginning in 2016 from $1.8B in 2015. This equates to a

5.7% decrease in SG&A expenses from 2015 levels.

Exhibit 14 estimates the improved cash flows and shows an improvement of greater than 12%

for each year. By making these three strategic changes, the discounted cash flow method results

in a valuation of $38.58 per share, an increase of approximately 21% from the baseline valuation

and the current share price (see Exhibit 15).

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Summary and Conclusion

Intel Corporation enjoys market leadership in two business segments that are continually

evolving. High profit margins and aggressive competitors such as Micron call for increased

improvement to stay competitive and continue to add long term shareholder value. Intel is

reorganizing operations and funding capital expenditures with an increase of $8 billion in debt.

Our sensitivity analysis and projections are able to demonstrate that increasing the valuation per

share by 21% is feasible, elevating current per share price from $31.97 to $38.58. Cost

reductions can be achieved by creating synergies with academia and research partners to lower

R&D. Operational efficiencies can be improved from data sharing with suppliers and improving

manufacturing to lower costs and improve cash flow. Finally, marketing expenses can be

significantly reduced, leveraging technology and manufacturing expertise and established

relationships and reputation to continue to maintain market share.

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Exhibits

Exhibit 1: Market Landscape

Exhibit 2: Intel - Porter’s 5 Forces

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Exhibit 3: Share Price & Market Comparison

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Exhibit 4: Competitive Ratio Analysis

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Exhibit 5: Return on Equity & Operating Return on Investment

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Exhibit 6: WACC Calculation Inputs and Results

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Exhibit 7: Discounted Cash Flow Valuation

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Exhibit 8: Cost of Debt

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Exhibit 9: Value Driver History & Forecast

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Sales growth rate 23.79% -1.22% -1.19% 6.00% -0.92% 6.33% 4.49% 3.15% 3.15% 3.15%

COGS / Sales 37.49% 37.85% 40.20% 36.26% 37.35% 37.97% 37.16% 36.53% 35.90% 35.26%

S, G, & A / Sales 14.20% 15.68% 16.35% 15.62% 14.33% 15.47% 15.07% 14.76% 14.45% 14.14%

Other operating expenses / Sales 15.94% 19.02% 20.13% 20.65% 23.03% 22.03% 21.34% 20.81% 20.27% 19.74%

Operating margin 32.37% 27.44% 23.32% 27.47% 25.29% 24.53% 26.43% 27.90% 29.38% 30.86%

Tax rate 27.21% 26.01% 23.72% 25.93% 19.65% 25.00% 26.00% 28.00% 28.00% 28.00%

Cash / Sales 33.52% 32.53% 31.10% 34.15% 34.73% 30.24% 32.82% 36.68% 40.43% 44.07%

Accounts receivable / Sales 6.76% 7.19% 6.80% 7.92% 8.65% 8.00% 7.50% 7.00% 6.50% 6.00%

Inventory / Sales 7.59% 8.87% 7.92% 7.65% 9.33% 9.03% 8.59% 8.41% 8.24% 8.08%

Accounts payable / Sales 5.47% 5.67% 5.63% 4.92% 3.73% 4.23% 4.73% 5.23% 5.73% 6.23%

Net working capital / Sales 42.39% 42.92% 40.18% 44.81% 48.98% 43.04% 44.18% 46.86% 49.44% 51.93%

Net fixed assets / Sales 43.75% 52.46% 59.63% 59.49% 57.55% 57.69% 59.39% 63.47% 69.27% 76.83%

Other assets / Sales 46.13% 55.57% 62.78% 64.37% 64.93% 66.22% 67.55% 68.90% 70.28% 71.68%

Change in Other Assets / Sales 0.00% 9.44% 7.21% 1.59% 0.56% 1.30% 1.32% 1.35% 1.38% 1.41%

Exhibit 10: Chart of Key Value Drivers Over Time

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Exhibit 11: WACC Scenario Analysis

Exhibit 12: Impact of Debt to Equity Ratio on WACC

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Exhibit 13: Sensitivity Analysis for Various Value Drivers

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Exhibit 14: Estimate of Cash Flows

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Exhibit 15: Valuation Model based on Intel Adopting Recommendations

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References

Slideshare (2016). Retrieved fron http://www.slideshare.net/sofi_smith/intel-15053501 on

April 19, 2016.

Intel Corp. (2015). 2015 Annual Report. Retrieved from http://www.intc.com/annuals.cfm on

April 10, 2016.


April 10, 2016.


April 10, 2016.


April 10, 2016.

Micron Technologies. (2015). 2015 Annual Report. Retrieved from

http://investors.micron.com/annualMeeting.cfm on April 10, 2016.

House, A. (April 2016). Value Line Report - Intel Corp. Retrieved from Northeastern Library

portal on April 10, 2016

Scrudato, R.J. (April 2016). Value Line Report - Micron Technologies. Retrieved from

Northeastern Library portal on April 10, 2016

Trahan, E. (2016). FINA 6216 Lecture Notes. Northeastern University. Boston, MA.

Statista (April 2016). Retrieved from http://www.statista.com/statistics/263567/employees-at-intel-since-2004/ on April 23,2016.

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Intel Valuation Project