The Exchange

Intel CEO Leaves Stock Cheap, but Will Efforts Pay Off?

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There are two ways to evaluate the tenure of Intel Corp. (INTC) CEO Paul Otellini, whose retirement next May after nearly eight years in the job and almost 40 years at the computer-chip leader was announced Monday.

Measuring the growth in Intel as a business and assessing the large cash-allocation decisions under his control, Otellini's tenure seems an unequivocal success.

As the company points out, Intel's revenue from 2005 through 2011 grew from an annual pace of $39 billion to $54 billion and increased per-share earnings from $1.40 to $2.39. The company generated a cumulative $107 billion in cash from operations under Otellini and paid out $23.5 billion in stock dividends as the quarterly dividend payout nearly tripled.

Yet deferring to the stock market's judgment, the Otellini era at Intel has appeared to be one of a well-managed retreat. Intel shares, just above $20 today, are almost 20% below where they traded on June 30, 2005, the end of the quarter when Otellini succeeded Craig Barrett as CEO.

That represents a decisive victory over Advanced Micro Devices Inc. (AMD), the PC-chip rival that has perennially stalked Intel, whose stock has been crushed from the high teens to below $2 over the same span. But set against most other relevant benchmarks — the S&P 500 index (^GSPC), the Nasdaq Composite (^IXIC), even Texas Instruments Inc. (TXN) — Intel shareholders have suffered in comparison. Most tellingly, ARM Holdings Inc. (ARMH), licenser of the key processors in ascendant mobile devices, has seen its stock surge more than 500% in that period.

Here's another "Apple Inc. (AAPL) is bigger than…" comparison to go with all the others that make the rounds: Intel's $100 billion market value — supported by $12 billion in net income - is exceeded by the cash sitting inert on Apple's books.

Viewed from the broadest possible perspective, all the stock appreciation delivered to Intel shareholders to date since its public debut in 1971 was in the books by mid-1997 when shares first reached today's quote. Of course the stock rode the late-'90s Internet bubble along with the other tech bellwethers, briefly trading above $70.

For the past decade, as Intel has continued to pour billions into research and development, making computing ever faster and cheaper, reaping billions in cash profits and prudently sharing the bounty in the form of dividends and share buybacks, the market has shrugged, insisting on valuing Intel's earnings at ever-lower multiples.

The stock's valuation, beneath 10-times projected 2012 earnings, bespeaks Intel's Old Legacy Tech identity, forever identified with plain old PCs despite the company's push into making chips for Windows-based tablets and its Ultrabooks class of sublaptops.

Since its inception, Intel has spent some $90 billion cumulatively on research and development. This has produced a nearly unmeasurable, shareholder-financed gift to world productivity. Yet is the market correct in its apparent conclusion that most of the benefits of this heroic work are either in the past or will not accrue to the portfolio values of Intel investors?

It would be wrong to simply take as a given that Intel is dead money at best and a dinosaur in decline at worst. The company continues to earn excellent returns on capital, generating double the operating income last year ($17.5 billion) as in 2007 ($8.2 billion).

R&D spending, which ran just below $6 billion each year from 2007 to 2010, was ramped up to $8.3 billion in 2011, and is running higher in 2012. The company spends more than the rest of the industry on research and increasingly complex production assets.

Its founder Gordon Moore of course popularized the Moore's Law concept that processor performance doubles through engineering progress every two years or so. This principle, which implies that engineering scale becomes a larger advantage over time, has always infused Intel's strategy and culture.

Otellini clearly hit the accelerator on core research as he prepared to retire. It's rather unlikely that Intel is using all that money and smarts to run down blind alleys or to prop up the same old PC-and-server architecture the world now views as so tired. It's far more probable that the company decided to spend heavily and under-earn in the short term in order to position its product set for the coming waves of computing platforms, and that some of these efforts will bear fruit.

Financially, Otellini struck a balance between using capital to generate future growth and disbursing it to the company's ultimate owners. Intel has repurchased 13% of its shares outstanding since 2007. Its dividend yield now stands at 4.5%. That is double the yield on Intel's own long-term corporate debt, implying that shareholders are being amply compensated for the incremental risk of owning equity.

The dividend yield, modest valuation and Intel's cash-producing ability all put a downside cushion under the shares.

There's no telling whether Intel can catch a fresh growth tailwind from the tablet and Ultrabook build-out faster than the PC economy erodes. But if that happens, you can be sure it would catch the market by surprise and have Intel shares back toward its springtime highs in the high 20s pretty quickly.

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