How Will Intel Stock Be Impacted by Amazon’s Homegrown Chips?

Amazon's entry into the server market is a concern that should be monitored, but it's not a reason to sell Intel stock yet

Chip maker Intel (NASDAQ:INTC) has dealt with numerous competitive threats over the past several decades. None of them did much damage to Intel stock, since INTC ultimately prevailed over all of those threats. After all, as of this writing, Intel stock is trading just a few percentage points below its post-Dot Com Bubble highs.

But Intel is about to face a threat it has never dealt with before. This threat is arguably bigger, stronger, and more relentless than any other threat with which it has ever contended. The new threat is Amazon (NASDAQ:AMZN).

According to a report from The New York Times, Amazon is building its own data center chips which will directly rival Intel’s data center chips. Amazon stock traded higher on the news, while many bearish articles came out regarding Intel’s growth prospects in the wake of the report.

The bear thesis on Intel stock makes some sense at this point, as does the bull thesis on Amazon stock. Amazon is the largest data center operator in the world, and Intel’s data center business is its main growth engine. As a result, if Intel loses Amazon as a customer, or worse yet, Amazon starts selling its data center chips to other cloud players, the positive catalysts that support Intel stock could significantly weaken, while AMZN stock could have more positive catalysts.

But that doomsday scenario is too unclear, too unrealistic, and too far in the future to mean much today. So while Amazon’s entry into the chip market is a cause for concern for owners of INTC stock, it isn’t a reason to sell Intel stock yet.

Amazon’s Entry Is a Cause For Concern

There’s no doubt about it. Amazon’s entry into the chip market is somewhat worrisome for owners of Intel stock. If a certain doomsday scenario unfolds, Intel stock would drop by a large amount.

Amazon has been expanding into new markets for many years. At first, Amazon stock was only supported by the company’s e-commerce business. Then, the company built its own cloud data centers, and eventually created Amazon Web Services from those data centers. As a result, AMZN subsequently became the leading cloud player in the world.

Now AMZN is trying to enter offline retail, digital advertising, logistics, and chips. All of these efforts are boosting AMZN stock and hurting the stocks of the companies Amazon is attacking.

In a bear-case scenario for INTC, Amazon will develop its own chips and completely ditch Intel as a supplier. That would be a meaningful, negative development for Intel stock.

About a third of Intel’s revenues are generated by its data center business, and essentially all of the company’s growth is generated by that business.

Moreover, AMZN controls about a third of the public-cloud sector. Thus, reasonably speaking, Amazon could represent anywhere between 5% and 10% of Intel’s total revenues (AMZN doesn’t account for more than 10% of INTC’s top line, per Intel’s latest 10-K filing). If the company’s growth segment loses that much revenue, Intel stock would be negatively impacted.

Meanwhile, in a doomsday scenario, Amazon will develop its own chips, completely ditch Intel as a supplier, and start selling its own chips to other cloud players. Or, in another doomsday scenario, other cloud giants will follow in Amazon’s footsteps by building their own chips, too. In either case, because the cloud market is so top-heavy (the top five players control the lion’s share of this market), Intel stock could be badly hurt over the long-run.

All in all, owners of INTC stock should be concerned about Amazon’s decision to enter the chip market. AMZN is a ruthless company with a disruptive history. Naturally, then, Amazon’s progress in this market should be monitored closely by both owners of INTC stock and owners of AMZN stock.

But I’m Sticking With Intel Stock

Having said all that, the bear case and doomsday scenarios for Intel stock won’t, in all probability, play out.

The New York Times piece strongly implies that Amazon isn’t necessarily building its own chips to take market share from Intel. Instead, the implication is that AMZN is building its own chips to gain bargaining leverage over Intel on future chip orders.

That makes sense. It is highly unlikely that Amazon, after just a few years of working on chips as a side gig, has created chips of comparable quality to that of INTC, which has been working on chips on a full- time basis for decades. So AMZN likely doesn’t want to replace all of its Intel chips with its own chips . Instead, Amazon just wants to pay less for high-quality Intel chips.

In this base-case scenario, Intel stock won’t be impacted all that much. Its margins will drop because it will sell some chips to AMZN at a discount. But Intel’s margins should remain healthy and stable, and the growth of its data center group should remain strong.

As long as this remains the case, INTC stock, which trades at a rather anemic forward price-earnings ratio of ten, should perform well. And, as for Amazon stock, it has enough growth potential without chips to support the long-term bull thesis on AMZN.

The Bottom Line on INTC Stock

Amazon’s entry into the chip market should worry owners of Intel stock. But the doomsday scenario is far-fetched and exceedingly unlikely to play out anytime soon. As a result, the core bull thesis on Intel stock remains intact, and investors should buy INTC.

As of this writing, Luke Lango was long INTC stock and AMZN stock. 


Article printed from InvestorPlace Media, https://investorplace.com/2018/12/how-will-intel-stock-be-impacted-by-amazons-homegrown-chips/.

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