A Spinoff Is Bad News for This Chip Giant

Intel (INTC) has been struggling to figure out how to right the ship...

For a while, the chipmaker tried to do everything in the semiconductor space.

It had a design business, where it researched and designed new semiconductor chips. And it had a fabrication business, where it actually manufactured the chips.

Back in 2021, the fabrication business was struggling. It wasn't big enough to fulfill manufacturing orders on behalf of other companies, so it only made Intel-designed chips.

That meant it had huge competition from chip foundries like Taiwan Semiconductor Manufacturing (TSM). Taiwan Semiconductor could fulfill manufacturing orders for chips designed by other companies... and it could do so at a much cheaper cost.

Intel's management considered getting rid of the manufacturing unit. That way, it could focus on design and let another fabricator make the chips.

But management decided to go in the exact opposite direction instead...

Over the past two and a half years, Intel has spent billions of dollars expanding its manufacturing capacity so that it could compete with Taiwan Semiconductor. It built chip fabrication plants all over the world, including several in the U.S. and Europe.

However, it seems Intel may have bit off more than it can chew...

Earlier this month, the company announced that it's now planning to spin off part of its fabrication business – its Programmable Solutions Group ("PSG").

The PSG division manufactures reconfigurable chips, which can be programmed for specific uses after production. Mostly, they're manufactured for the defense and telecom industries.

According to the announcement, PSG should begin operating as a standalone business in January 2024, with an initial public offering expected over the next two to three years.

Overall, Intel CEO Pat Gelsinger believes this strategic move will allow the company to refocus on its larger design and manufacturing projects. He also claims that it will unlock more value for shareholders.

While this sounds like a smart move for the company, it may just mean that Intel is scrambling for cash...

As we'll explain today, Intel is pursuing this spinoff from a place of weakness. That's bad news for Intel investors... and it's a sign of what's to come for plenty of other companies.

Intel may be more on the defensive than the offensive...

You see, when interest rates are high – as they are today – companies need to get creative to raise cash.

They don't want to refinance their debt at higher rates... and sometimes they can't because it'd be too expensive.

This often leads companies to start panic selling their own businesses.

Typically, companies will start by selling off smaller parts of their business that won't disrupt the main business when they're gone. They can then use the proceeds to pay down debt or reinvest in better opportunities.

There are genuine positives to this spinoff strategy. However, sometimes it's simply out of desperation...

And that seems to be the case for Intel today.

We can see this by looking at the company's Credit Cash Flow Prime ("CCFP") analysis. The CCFP helps us compare a company's obligations with its cash position and expected cash earnings.

In the chart below, the stacked bars represent Intel's obligations each year through 2029, including this year. We then compare these obligations with the company's cash flow (the blue line) as well as its cash on hand at the beginning of each period (the blue dots).

Intel has substantial debt and obligations piling up in the next few years.

Take a look...

As you can see, Intel doesn't have enough cash flow to cover all of its obligations in any of the next seven years. And it barely has enough cash on hand for the next four years.

On top of that, it doesn't have room to refinance its debt at higher rates. So the spinoff is likely Intel's way of raising cash to try and get a handle on its obligations...

That's a red flag for investors... Not only does it suggest Intel is out of financing options, it means the company may have to keep sacrificing parts of its business to stay afloat.

The CCFP also shows that Intel spends a lot on research and development (R&D). As is the case with all semiconductor companies, Intel needs to spend on R&D to keep up with innovation in the tech sector. But by selling parts of its business, the company now loses access to the R&D it paid for.

That could hurt Intel's future growth and earnings potential for years to come.

Shrinking in a high-growth industry is a horrible sign...

Semiconductors are at the forefront of technological innovation today – especially with the ramp up in artificial intelligence and machine learning.

Intel should be riding this chipmaking wave and expanding its capabilities... yet, it's struggling to pay its bills. Worse, it's selling off moneymaking assets and valuable R&D investments.

This is a screaming red flag for Intel... and it's a huge warning sign for the broader economy. If companies as big as Intel have their backs against the wall, this is bound to be a widespread issue.

We don't expect Intel's situation to turn around any time soon. And this is likely a risk for plenty of other companies out there.

Keep an eye out for prominent spinoffs. Some companies may be selling parts of their business just to stay alive...

Regards,

Rob Spivey
October 17, 2023