Intel Goes to War on Two Fronts

Intel‘s (NASDAQ:INTC) fourth-quarter earnings report highlighted the challenges it faces in its core business as well as the difficulty of breaking into the booming mobile market. Coming late to a party dominated by ARM (NASDAQ:ARMH), Qualcomm (NASDAQ:QCOM), Nvidia (NASDAQ:NVDA), Samsung and others makes that job much tougher. The earnings report, which showed net income for the quarter at $2.5 billion (down from $3.4 billion in the same quarter the previous year), and the resignation late last year of CEO Paul Otellini underscore the impact of being so slow to react to tech’s mobile transformation.

At this year’s Consumer Electronics Show, Intel laid out plans for its next-generation computer chips (code named Haswell) and its PC roadmap through 2014. And while you may wonder what PCs have to do with Intel’s mobile problem, if things go according to Intel’s plan, the two could actually be convergent — at least in the tablet market, which is currently seen as the big threat to computers.

Indeed, tablets are Intel’s enemy No. 1 at the moment. They may have many limitations as a business tool (they lack physical keyboards, they don’t run the most popular software applications and they have a small display), but they’re cheaper, much more portable and are being snapped up by consumers and businesses. Tablets like Apple’s (NASDAQ:AAPL) iPad are a big part of the slowdown in PC sales.

When Apple launched the MacBook Air in 2008, not many in the Windows PC camp considered it much of a threat. Although the ultraportable notebook was incredibly small and light (for the time), it was underpowered, jettisoned components like an optical drive, wasn’t upgradable and started at $1,799. Apple didn’t give up and relentlessly improved the MacBook Air, expanding the lineup to include multiple models. Sales took off.

Intel responded with its 2011 Ultrabook initiative, designed to allow PC manufacturers to better compete against Apple. Yes, Intel also supplied the CPUs in those MacBook Airs, but the chipmaker has a vested interest in keeping Windows PCs competitive. With new Intel Ivy Bridge processors, Windows-based Ultrabooks were expected to account for 40% of consumer laptop sales by the end of 2012.

Hewlett-Packard (NYSE:HPQ), Dell (NASDAQ:DELL) and other PC makers gave it their best shot, but ultraportable sales came nowhere near Intel’s expectations. With only 10.3 million sold in 2012, Ultrabooks came out to less than 1% of total PC laptop sales for the year.

That’s partly why Intel’s announcement at CES 2013 — actually more of a pronouncement — caught many off guard. To qualify for the Ultrabook branding, any notebooks equipped with Intel’s Haswell processor must be touchscreen-enabled. Despite poor sales so far, that “Ultrabook” designation still matters because without Intel’s stamp of approval, an ultraportable risks being viewed as substandard.

This requirement stomps on PC makers’ turf — dictating not just the CPU, but display technology and core functionality as well — but it’s probably for their own good. And there hasn’t been much of a backlash yet.

On the surface, Intel’s edict sounds like it could be a problem for manufacturers. Adding technology with a touchscreen display (including a requirement to support Intel’s wireless display technology) could increase costs, which then either eats into profits or gets passed on to consumers. On the cost front, Intel says to expect Ultrabook prices to start at the $599 by the end of next year as component prices come down with mass production. That’s good for consumers.

I think Intel has performed a master stroke of strategizing. The specs on the Haswell CPU look good and promise to double Ultrabook battery life, hitting the 10+ hours that tablets are capable of. Add touch display and Microsoft’s (NASDAQ:MSFT) new Windows 8 operating system — which was designed around a tablet-like touch experience — and Ultrabooks get a lot more compelling.

An Ultrabook can be used as a regular laptop with no penalty, but with that touchscreen and Windows 8, it offers a user experience that Apple’s MacBook Air simply can’t match.

An Ultrabook that weighs 2 pounds, doubles as a tablet and is a fully functioning PC running Windows 8 with a keyboard and all-day battery life makes you wonder what the point of a tablet is, especially for business users. Even at the $799 suggest price for Lenovo’s Intel Core i5-powered Yoga 11s convertible (one of many new Ultrabook convertibles announced at CES), the case for buying an Ultrabook instead of a tablet is strong. In comparison, Microsoft’s Surface RT tablet costs $719 by the time you boost storage to 64GB and add the touch cover for typing.

Goosing the Ultrabook market in an attempt to take on tablets while hopefully increasing Windows PC sales is one thing, but Intel isn’t giving up on mobile. It’s continuing its efforts to break into the market. At CES it unveiled a new Atom Z2420 (dubbed Lexington) mobile chip for low-cost smartphones intended for emerging markets.

That doesn’t mean Intel is leaving premium smartphones and tablets to ARM. The giant also introduced new Clover Trail and Bay Trail processors aimed at high-end smartphones and tablets.

We knew Intel had an uphill fight against established mobile CPU makers. We also knew Windows PC makers were taking it on the chin from tablets, while watching Apple eke out gains in the PC market. By continuing to push its own chips for mobile uses, while reinventing the Ultrabook as a viable tablet alternative, Intel is playing both sides. And it’s looking stronger as a result.

As of this writing, Brad Moon didn’t own any securities mentioned here.

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