 From theCUBE Studios in Palo Alto in Boston, bringing you data-driven insights from theCUBE and ETR. This is Breaking Analysis with Dave Vellante. Intel's big announcement this week underscores the threat that the United States faces from China. The US needs to lead in semiconductor design and manufacturing, and that lead is slipping because Intel has been fumbling the ball over the past several years. A mere two months into the job, new CEO Pat Gelsinger wasted no time in setting a new course for perhaps the most strategically important American technology company. We believe that Gelsinger has only shown us part of his plan. This is the beginning of a long and highly complex journey. Despite Gelsinger's clear vision, his deep understanding of technology and execution ethos, in order to regain its number one position, Intel we believe will need to have help from partners, competitors and very importantly, the US government. Hello everyone and welcome to this week's Wikibon Cube Insights powered by ETR. In this Breaking Analysis, we'll peel the onion on Intel's announcement of this week and explain why we're perhaps not as sanguine as was Wall Street on Intel's prospects and we'll lay out what we think needs to take place for Intel to once again become top gun and for us to gain more confidence. By the way, this is the first time we're broadcasting live with Breaking Analysis. We're broadcasting on theCUBE handles on Twitch, Periscope and YouTube and going forward we'll do this regularly as a live program and we'll bring in the community perspective into the conversation through chat. Now you may recall that in January, we kind of dismissed analysis that said Intel didn't have to make any major strategic changes to its business when they brought on Pat Gelsinger. Rather, we said the exact opposite. Our view at the time was that the root of Intel's problems could be traced to the fact that it was no longer the volume leader because mobile volumes dwarf those of x86. As such, we said that Intel couldn't go up the learning curve for next gen technologies as fast as its competitors and it needed to shed its dogma of being highly vertically integrated. We said Intel needed to more heavily leverage outsourced foundries, but more specifically, we suggested that in order for Intel to regain its volume lead, it needed to, we said at the time, spin out its manufacturing, create a joint venture with a volume leader leveraging Intel's US manufacturing presence. This we still believe with some slight refreshes to our thinking based on what Gelsinger has announced. We'll talk about that today. Now specifically, there were three main pieces and a lot of details to Intel's announcement. Gelsinger made it clear that Intel is not giving up its IDM or integrated device manufacturing ethos. He called this IDM 2.0, which comprises Intel's internal manufacturing, leveraging external foundries and creating a new business unit called Intel Foundry Services. It's okay. Gelsinger said we are not giving up on integrated manufacturing. However, we think this is somewhat nuanced. Clearly Intel can't, won't and shouldn't give up on IDM. However, we believe Intel is entering a new era where it's giving designers more choice. This was not explicitly stated. However, we feel like Intel's internal manufacturing arm will have increased pressure to serve its designers in a more competitive manner. We've already seen this with Intel finally embracing EUV, extreme ultraviolet lithography. Gelsinger basically said that Intel didn't lean into EUV early on and that it created more complexity in its 10 nanometer process, which dominoed into seven nanometer. And as you know, you know the rest of the story and Intel's delays. But since mid last year, it's embraced the technology. Now, as a point of reference, Samsung started applying EUV for its seven nanometer technology in 2018 and it began shipping in early 2020. So as you can see, it takes years to get this technology into volume production. The point is that Intel realizes it needs to be more competitive and we suspect it will give more freedom to designers to leverage outsource manufacturing. But Gelsinger clearly signaled that IDM is not going away. But the really big news is that Intel is setting up a new division with a separate P&L that's going to report directly to Pat. Essentially it's hanging out a shingle and saying, we're open for business to make your chips. Intel is building two new fabs in Arizona and investing $20 billion as part of this initiative. Now, while Intel has tried this before earlier last decade, Gelsinger says that this time we're serious and we're going to do it right. We'll come back to that. This organizational move, while not a spin out or a joint venture, it's part of the recipe that we saw as necessary for Intel to be more competitive. Let's talk about why Intel is doing this. Look at lots has changed in the world of semiconductors. When you think about it back when Pat was at Intel in the 90s, Intel was the volume leader. It crushed the competition with x86 and the competition at the time was coming from risk chips. Now when Apple changed the game with iPod and iPhone and iPad, the volume equation flipped to mobile and that led to big changes in the industry. Specifically, the world started to separate design from manufacturing. We now see firms going from design to tape out in 12 months versus taking three years. A good example is Tesla and it's deal with arm in Samsung. And what's happened is Intel has gone from number one in foundry in terms of clock speed, wait for density, volume, lowest cost, highest margin to falling behind. TSMC, Samsung and alternative processor competitors like NVIDIA and ARM. Volume is still the maker of kings in this business. That hasn't changed and it confers advantage in terms of cost, speed and efficiency. But ARM wait for volumes we estimate are 10x those of x86. That's a big change since Pat left Intel more than a decade ago. There's also a major chip shortage today. But you know, this time it feels a little different than the typical semiconductor boom and bust cycles. Semiconductor consumption is entering a new era and new use cases emerging from automobiles to factories to every imaginable device, piece of equipment, infrastructure, silicon is everywhere. But the biggest threat of all is China. China wants to be self-sufficient in semiconductors by 2025. It's putting approximately $60 billion into new chip fabs and there's more to come. China wants to be the new economic leader of the world and semiconductors are critical to that goal. Now there are those that poo poo the China threat. This recent article from Scott Foster lays out some really good information, but the one thing that caught our attention is a statement that China semiconductor industry is nowhere near being a major competitor in the global market, let alone an existential threat to the international order in the American way of life. I think Scotty is stuck in the engine room and can't see the forest of the trees. Wake up. Sure, you can say China is way behind. Second example, NAND. Today China is at about 64 3D layers, whereas Micron they're at 172. By 2022 China is going to be at 128. Micron is going to be well over 200. So what's the big deal? We say talk to us in 2025 because we think China will be a parody. That's just one example. Now the type of thinking that says, don't worry about China and semis reminds me of the epic lecture series that Clay Christensen gave as a visiting professor at Oxford University on the history of and the economics of the steel industry. Now if you haven't watched this series, you should. Basically Christensen took the audience through the dynamics of steel production and he asked the question, who told the steel manufacturers that gross margin was the number one measure of profitability? Was it God? He joked. His point was when new entrants came into the market in the seventies, they were bottom feeders going after the low margin, low quality, easiest to make rebar sector. And the incumbents, they pulled back and their mix shifted to higher margin products and their gross margins went up and life was good. Until they lost the next layer and then the next and then the next until it was game over. Now, one of the things that got lost in Pat's big announcement on the 23rd of March was that Intel guided the stream below consensus on revenue and earnings. But the stock went up the next day. Now when asked about gross margin in the Q and A segment of the announcement, yes, gross margin is A, if not the key metric in semis in terms of measuring profitability. When asked Intel CFO George Davis explained that with the uptick in PCs last year, there was a product shift to the lower margin PC sector and that put pressure on gross margins. It was a product mix thing and revenue because PC chips are less expensive than server chips was affected as we're margins. Now we shared this chart in our last Intel update showing spending momentum over time for Dell's laptop business is from ETR. And you can see in the inset, the unit growth in the market data from IDC. Yes, Dell's laptop business is growing. Everybody's laptop business is growing. Thank you, thank you COVID. But you can see the numbers from IDC, Gartner, et cetera. Now, as we pointed out last time, PC volumes had peaked in 2011 and that's when the long arm of Wright's law began to eat into Intel's dominance. Today arm wafer production, as we said is far greater than Intel's. Well, you know the story. Here's the irony. The very market that conferred volume advances to Intel PCs has had a slight uptick last year, which was great news for Dell, but according to Intel, it pulled down its margins. The point is Intel is loving the high end of the market because it's higher margin and more profitable. I wonder what Clay Christensen would say to that. Now, there's more to this story. Intel's CFO blamed the supply constraints on Intel's revenue and profit pressures. Yet AMD's revenue and profits are booming. So are TSMCs. Only Intel can't seem to thrive when there's this massive chip shortage. Now let's get back to Pat's announcement. Intel is for sure going forward, investing $20 billion in two new US-based fabrication facilities. This chart shows Intel's investments in US R&D, US CapEx and the job growth that's created as a result, as well as R&D and CapEx investments in Ireland and Israel. Now we added the bar on the right-hand side from a Wall Street Journal article that compares TSMC CapEx in the dark green to that of Intel in the light green. You can see TSMC surpassed the CapEx investment of Intel in 2015 and then Intel took the lead back again and in 2017 was hanging on in 2018, but last year TSMC took the lead again and appears to be widening that lead quite substantially, leading us to our conclusion that this will not be enough. These moves by Intel will not be enough. They need to do more. And a big part of this announcement was partnerships and packaging. Okay, so here's where it gets interesting. Intel, as you may know, was late to the party with SOC system on a chip and it's gonna use its packaging prowess to try and leapfrog the competition. SOC bundles things like GPU, NPU, DSUs, accelerators, caches on a single chip. So better use of the real estate, if you will. Now Intel wants to build system on package which will disaggregate memory from compute. Now remember today, memory is very poorly utilized. What Intel is gonna do is to create a package with literally thousands of nodes comprising small processors, big processors, alternative processors, ARM processors, custom silicon, all sharing a pool of memory. This is a huge innovation and we'll come back to this in a moment. Now as part of the announcement, Intel trotted out some big name customers, prospects, and even competitors that it wants to turn into prospects and customers. Amazon, Google, Satya Nizella gave a quick talk from Microsoft to Cisco. All those guys are designing their own chips as does Ericsson. And look, even Qualcomm is on the list, they're a competitor. Intel wants to earn the right to make chips for these firms. Now many on the list like Microsoft and Google, they'd be happy to do so because they want more competition. And Qualcomm, well look, if Intel can do a good job and be a strong second source, why not? Well one reason is they compete aggressively with Intel, they probably don't like Intel so much but it's very possible. But the two most important partners on this slide are one, IBM, and two, the US government. Now many people are gonna gloss over IBM in this announcement but we think it's one of the most important pieces of the puzzle. Yes, IBM and semiconductors. IBM actually has some of the best semiconductor technology in the world. It's got great architecture and is two to three years ahead of Intel with power 10. Yes, power. IBM is the world's leader in terms of disaggregating compute from memory with the ability to scale to thousands of nodes. Sound familiar? IBM leads in power density, efficiency and it can put more stuff closer together. And it's looking now at a 20X increase in AI inference performance. We think Pat has been thinking about this for a while and he said, how can I leapfrog system on chip? And we think he thought and said, I'll use our outstanding process manufacturing and I'll tap IBM as a partner for R&D and architectural chops to build the next generation of systems that are more flexible and performant than anything that's out there. Now look, this is super high end stuff. And guess who needs really high end massive supercomputing capabilities? Well, the US military. Pat said straight up, we've talked to the government and we're honored to be competing for the government slash military chip boundary. I mean, look, Intel in my field is going to have to fall down into face not to win this business. And by making the commitment to foundry services we think they will get a huge contract from the government as large perhaps as $10 billion of more to build a secure government foundry and serve the military for decades to come. Now Pat was specifically asked in the Q&A section is this foundry strategy that you're embarking on viable without the help of the US government kind of implying that it was a handout or a bailout. And Pat, of course, said all the right things. He said, this is the right thing for Intel independent of the government. We haven't received any commitment or subsidies or anything like that from the US government. Okay, cool, but they have had conversations and I have no doubt and Pat confirmed this that those conversations were very, very positive that Intel should head in this direction. Look, we know what's happening here. The US government wants Intel to win. It needs Intel to win and its participation greatly increases the probability of success. But unfortunately, we still don't think it's enough for Intel to regain its number one position. Let's look at that in a little bit more detail. The headwinds for Intel are many. Look, it can't just flick a switch and catch up on manufacturing leadership. It's going to take four years and lots can change in that time. It tells market momentum as well as we pointed out earlier is headed in the wrong direction from a financial perspective. Moreover, where is the volume going to come from? It's going to take years for Intel to catch up for arms if it ever can. And it's going to have to fight to win that business from its current competitors. Now I have no doubt it will fight hard under Pat's excellent leadership. But the Foundry business is different. Consider this, Intel's annual CapEx expenditures, if you divide that by their yearly revenue it comes out to about 20% of revenue. TSMC spends 50% of its revenue each year on CapEx. This is a different animal, very service oriented. So look, we're not pounding the table saying Intel's worst days are over. We don't think they are. Now, there are some positives and showing those on the right hand side. Pat Gelsinger was born for this job. He proved that the other day. Even though we already knew it, I have never seen him more excited and more clear headed. And we agree that the chip demand dynamic is going to have legs in this decade and beyond with digital edge AI and new use cases that are going to power that demand. And Intel is too strategic to fail and the US government has huge incentives to make sure that it succeeds. But it's still not enough in our opinion because like the steel manufacturers, Intel's real advantage today is increasingly in the high end, high margin business. And without volume, China is going to win this battle. So we continue to believe that a new joint venture structure is going to emerge. Here's our prediction. We see a triumvirate emerging in a new joint venture that is led by Intel. It brings x86, that volume associated with that. It brings cash, manufacturing products, R and D. It brings global resources so much more than we show in this chart. IBM as we laid out brings architecture, it's R and D, it's longstanding relationships, it's deal flow, it can funnel its business to the joint venture, as can of course parts of Intel. We see IBM getting a nice licensed deal from Intel and or the JV and it has to get paid for its contribution. And we think it'll also get a sweet deal in the manufacturing fees from this Intel Foundry. But it's still not enough to beat China. Intel needs volume and that's where Samsung comes in. It has the volume with ARM as the experience and a complete offering across products. We also think that South Korea is a more geographically appealing spot in the globe than Taiwan with its proximity to China. Not to mention that TSMC, it doesn't need Intel. It's already number one. Intel can get a better deal from number two Samsung and together these three we think in this unique structure could give it a chance to become number one by the end of the decade or early in the 2030s. We think what's happening is our take is that Intel is going to fight hard to win that government business, put itself in a stronger negotiating position and then cut a deal with some supplier. We think Samsung makes more sense than anybody else. Now finally, we want to leave you with some comments and some thoughts from the community. First, I want to thank David Floyer. His decade plus of work and knowledge of this industry along with this collaboration made this work possible. His fingerprints are all over this research in case you didn't notice. And next I want to share comments from two of my colleagues. The first is Sarbjeet Johal. He sent this to me last night. He said, we are not in our grandfather's compute era anymore. Compute is getting spread into every aspect of our economy and lives. The use of processors is getting more and more specialized and will intensify with the rise in edge computing, AI, inference and new workloads. Yes, I totally agree with Sarbjeet and that's the dynamic on which Pat is betting and betting big. But the bottom line is summed up by my friend and former IDC mentor Dave Michela. He says, this is all about China. History suggests that there are very few second acts, you know, other than Microsoft and Apple. History also will say that the antitrust pressures that enabled AMD to thrive are the ones, the very ones that starved Intel's cash. Microsoft made the shift because its PC software cash cows proved impervious to competition. The irony is the same government that attacked Intel's monopoly now wants to be Intel's protector because of China. Perhaps it's a cautionary tale to those who want to break up big tech. Wow, what more can I add to that? Okay, that's it for now. Remember, I publish each week on wikibon.com and siliconangle.com. These episodes are all available as podcasts. All you gotta do is search for breaking analysis podcasts. You can always connect with me on Twitter at dvolante or email me at david.volante at siliconangle.com. As always, I appreciate the comments on LinkedIn and in Clubhouse, please follow me so that you're notified when we start a room and start riffing on these topics. And don't forget to check out etr.plus for all the survey data. This is Dave Vellante for theCUBE Insights powered by ETR, be well and we'll see you next time.