Valuentum Exclusive Analysis for the Discerning Investor

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Image Source: Intel Corporation – Second Quarter of Fiscal 2020 IR Earnings Presentation

By Callum Turcan

On October 20, Intel Corporation (INTC) and South Korean-based SK Hynix announced a major transaction that will reshape the global NAND flash memory market. For reference, NAND flash memory is used in smartphones, personal computers, and other digital devices. Intel will receive $9.0 billion in cash that will be paid out in two phases, assuming everything goes as planned. In return, SK Hynix is receiving “Intel NAND memory and storage business, which includes the NAND SSD business, the NAND component and wafer business, and the Dalian NAND memory manufacturing facility in China” though Intel will retain its Intel Optane business, which caters to both the data center and personal computer markets.

Deal Overview

The deal will unfold in stages. First, Intel and SK Hynix aim to receive the necessary government approvals by late-2021. Once the relevant government entities sign off on the transaction, Intel will sell its NAND SSD operations (includes related IP and the transfer of employees) and the associated Dalian NAND memory manufacturing facility (located in the Chinese city of Dalian) to SK Hynix for $7.0 billion in cash. Additionally, final closing activities are expected to occur in March 2025, which will involve Intel selling its IP relating to manufacturing and design processes involving NAND flash wafers to SK Hynix while also transitioning its R&D employees and Dalian fab workforce over to SK Hynix in return for $2.0 billion in cash. Until final closing activities are completed, Intel will continue to produce NAND flash wafers at its Dalian Memory Manufacturing Facility while retaining the related IP.

For SK Hynix, the company will become the second largest player in the NAND flash memory market according to the WSJ which cites data from the market research firm TrendForce. Please note that in economic terms, the NAND flash memory market is incredibly volatile (as an important aside, NAND flash memory is considered “non-volatile” on an functional basis because it can retain data without power, unlike DRAM which requires power to retain memory) and companies operating in this space tend to experience large swings in their earnings. For Intel, the company intends to reinvest the cash infusion into developing its more promising offerings (meaning offerings that cater to markets supported by secular growth tailwinds) that are geared towards AI, semi-autonomous/fully-autonomous vehicles, and 5G networking solutions.

We are fans of this deal because it will allow Intel to pivot towards more consistently lucrative opportunities where it has competitive advantages. To stay competitive in the NAND flash memory market, a firm needs to prioritize investments in that space (R&D, new manufacturing facilities), and that is something Intel would find hard to do going forward given its various business segments. Additionally, scale is required in this business and competing with industry leader Samsung Electronics Co (SSNLF) is no easy task. Within the press release announcing the news Intel noted:

For the six months ended June 27, 2020, NAND businesses represented approximately US $2.8 billion of the revenue for Intel’s Non-volatile Memory Solutions Group (NSG) and contributed approximately US $600 million to NSG operating income.

During the first half of fiscal 2020 (period ended June 27, 2020), Intel generated $39.6 billion in GAAP revenues and $12.7 billion in GAAP operating income, indicating that this deal will only take a slice out of its financials as things stand today. Intel’s Data Center Group (‘DCG’) division posted 43% year-over-year sales growth in the fiscal second quarter, with its revenues reaching $7.1 billion, as the ongoing coronavirus (‘COVID-19’) pandemic accelerated the shift towards cloud-computing operations at enterprises, governments, and other entities around the globe. That dynamic led to a sharp increase in demand for data centers which in turn supported demand for Intel’s DCG offerings.

Concluding Thoughts

We continue to like shares of Intel as a holding in both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios. Our fair value estimate for Intel sits at $61 per share. Though Intel is facing significant hurdles, one of which we will cover in just a moment, we view its long-term growth trajectory as one that is quite promising.

The biggest hurdle holding Intel back right now is uncertainty over how management plans to position Intel to produce next-generation semiconductors (which we covered in great detail here), something that in our view could easily be remedied by having Intel turn to third-party foundries such as Taiwan Semiconductor Manufacturing Company Limited (TSM) known as ‘TSMC’ in shorthand. Most of Intel’s competitors use third-party foundries, and TSMC is considered the best in the business given its ability to produce 7-nm chips (the firm has produced over 1 billion “defect-free” 7-nm chips). When Intel reports its earnings later this week, we will be looking out for commentary on that situation and will keep members informed on any key updates.

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Related: SFTBY, TSM, SSNLF, SCWX, SPY, VOD, CHA, CHL, CHUFF, ERIC, NLOK

Other: VLUE, SMH, FTXL, SOXX, TDIV, DEEP, JHMT

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Callum Turcan does not own shares in any of the securities mentioned above. Apple Inc (AAPL), Cisco Systems Inc (CSCO), Intel Corporation (INTC), and Microsoft Corporation (MSFT) are all included in both Valuentum’s simulated Best Ideas Newsletter and Dividend Growth Newsletter portfolios. Alphabet Inc (GOOG) Class C shares and Facebook Inc (FB) are both included in Valuentum’s simulated Best Ideas Newsletter portfolio. Oracle Corporation (ORCL) is included in Valuentum’s simulated Dividend Growth Newsletter portfolio. AT&T Inc (T) is included in Valuentum’s simulated High Yield Dividend Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.