Intel Cut to Hold at Paribas; ARM Camp Can Take Quarter of Server Market by 2020

By Tiernan Ray

Shares of chip giant Intel (INTC) are down 29 cents, or 0.9%, at $32.16, after Jerome Ramel with Exane BNP Paribas this morning cut his rating on the shares to Neutral from Outperform, writing that ARM Holdings (ARMH) is making more inroads to Intel's server chip franchise than he had expected.

Writes Ramel, "One year ago we argued that ARM would make few inroads in PC/servers and Intel few inroads in Wireless. Things have changed."

Server makes up a very large share of Intel's profit, as he points out with a chart:

He is "now turning more positive on ARM's chances in servers and believe it can grab a 25% unit share by 2020."

The downgrade follows a big presentation by Intel last Thursday regarding new developments in its server-chip lineup, which many analysts found encouraging.

Ramel maintains an Outperform rating on ARM stock. Of the relative stock performance of the two, Ramel writes, "Over the last year, while both stocks have de-rated for likely different reasons, Intel has outperformed ARM on a relative basis."

"We believe this could reverse over the next 12 months for the reasons we describe in this report as well as due to a strengthening of the smartphone market."

Ramel cuts his Intel estimates, starting with this year, on the impact in profit, and he cuts his price target to $35 from $40.

The maturation of software, writes Ramel, has finally allowed ARM servers to be competitive, and there's demand for a second source:

Our industry contacts indicate there is a strong demand for another source for server chips. ARM's value proposition has been consistent, in that it offers a lower price and power consumption vs Intel server chips. What has changed, in our view, is that only now does the software ecosystem allow volume orders of ARM-based server chips. Another driver is China's intention to develop its own semiconductor industry for national security reasons – a goal that will push China towards non-Intel solutions. Finally, we are seeing a broadening of the customer base engaging with ARM servers outside of Cloud/HPC vendors and into Telco and financial companies.

Mind you, this is going to take time, with Cavium (CAVM) and Applied Micro Circuits (AMCC), two of the most prominent ARM-based chip vendors, shipping very low volumes initially:

The ARM-based server ramp-up will likely be slow. While we expect Applied Micro and Cavium server revenues to double this year and into 2017, this is off a very low base. Although we now project 25% (vs 10%) unit server share by 2020, this adds only c.USD46m in incremental royalties, i.e. c.3% of revenues and c.5% of EBIT. Independently of this, ARM remains our top pick based on 64-bit and octa-core royalty tailwinds in the ST coupled with share gain in new segments such as server/networking/automotive in the LT. Further, consensus has grown too bearish on smartphones. [...] Applied Micro and Cavium are now on the cusp of revenue ramp-up from ARM-based servers. Initial revenue, although small, has been realised and is forecast to ramp-up through 2016 and into 2017. QCOM and Broadcom are also developing ARM-based server chips but these wont ramp-up until 2018.

This is going to eat into Intel's profits more than it helps ARM or its partners initially, he reckons:

The server story is key for Intel as we expect it to derive 90% of its revenues and EBIT growth from servers over 2015-2018. This is a clear example of disruption and is likely to offer an asymmetric risk/opportunity. We model a slight positive for ARM as we expect servers to represent about 3% of total 2020 revenue or 5% of EBIT, i.e. 5% of EPS. In contrast, for Intel we have cut our 2018 EPS by 16% just on the server impact (we have also lowered our PC assumptions, a 9% 2018 EPS cut). We see too much risk for Intel with competition in servers coming from AMD, the new platform named Zeppelin, and ARM's partners such as Applied Microcircuits, Cavium, Qualcomm, Broadcom, AMD. We are downgrading Intel to Neutral with a new TP of USD33 vs USD40.

He now models Intel's server division, the "data center group," making $18.1 billion revenue this year, down from a prior $18.2 billion estimate, and $19.3 billion next year, down from a prior $20.3 billion estimate.

Ramel cuts his operating profit estimate for Intel to $14.4 billion and $15.8 billion, for 2016 and 2017, respectively, from prior estimates for $15.6 billion and $18.7 billion. That trims his EPS projections to $2.27 and $2.45 from $2.45 and $2.89.

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