How Intel Plans to Transform Its Business

Intel  has been able to keep its position as the largest semiconductor company in the world for many years. In a volatile industry, the legendary chipmaker kept its business strong by constant innovation. Its advanced chip-design capabilities, huge research and development budget, and visionary management were essential success factors.

Unfortunately, even a company as innovative and R&D-focused as Intel can make mistakes. By focusing on the PC, Intel missed the smartphone revolution. The market for mobile chips is now dominated by Qualcomm . Moreover, challengers specialized in manufacturing chips for tablets, such as ARM Holdings  may be eating into Intel's PC chip sales. As a result, Intel has not seen meaningful top-line growth since 2012. Can Intel transform its business?

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New cash cows in the making
In the most recent quarter, Intel's PC client group saw a 3.5% decrease in sales. The good news is that the company is aware of its heavy exposure to a dying PC industry and has taken major steps to change the composition of its revenue.

A potential new cash cow could be found in server chips. Intel's data-center business is growing at a healthy rate. For example, according to the latest earnings release, storage revenue was up 20%, and cloud revenue was up 40% year to year.

Another promising source of growth can be found in the tablet market, which according to IDC, currently consists of about 227 million units a year. The company recently introduced a new model of Atom chips, named Bay Trail, which by the end of November will be included in 10 tablets and hybrids. Android tablets equipped with Bay Trail could be introduced at very attractive price points, around $150 per device, the company says.

However, capturing market share in the tablet world won't be an easy task. ARM has specialized in this segment by designing battery-saving, low-power chips, which are perfect for tablets. Moreover, so far ARM's business model has also proven more successful. Unlike Intel, which under a vertically integrated business model controls every production stage, ARM makes no chips of its own. ARM designs chip technology that other companies, from Qualcomm to Apple, license and manufacture. This allows ARM to focus on the most profitable part of the business.

Slow progress in mobile
In its latest earnings call, Intel showed investors that catching up with ARM in the tablet world is going to be a long journey. Despite strong efforts to promote Bay Trail, its other architecture segment, which includes both mobile and tablet business units, saw a $100 million decrease in sales when compared with 2012.

Intel is also challenging the mobile market. So far, progress has been slow. Big clients in this market, such as Apple, have already optimized their software based on ARM hardware. A transition from ARM to Intel technology would be very expensive for most handset manufacturers.

The smartphone semiconductor segment is Qualcomm's territory. Qualcomm specializes in designing wireless technology for small devices. The company recently increased its quarterly revenue by an astonishing 35% and saw 172 million chip-unit shipments in the third quarter of 2013. There are also plenty of growth opportunities left, because Qualcomm occupies only a small portion of the tablet market, below Intel. To capture more share, Qualcomm is constantly upgrading its Snapdragon processor line. It says its new chips will appear in 200 smartphones and tablets.

Finally, Intel could find a new cash cow in developing semiconductors needed for everyday objects -- from cars to household appliances -- to be connected to the Internet, what some refer as "the Internet of things," a technological paradigm where all objects in the world are equipped with machine-readable identifiers that allow them to be connected to networks. According to Cisco's CEO, this market could be worth $14 trillion. ABI Research, on the other hand, predicts more than 30 billion devices will be wirelessly connected to the Internet of things by 2020. By recently announcing a low-power Atom chip, the Bay Trail-I, which could be used to build these connected products, Intel became an early mover.

Final Foolish thoughts
Intel faces increasing competition in the tablets market, a dying PC industry and low margins in the smartphone world, where it needs to catch up with Qualcomm and ARM. The good news is that by now, the company is well-aware of the fact that revenue diversification -- finding new cash cows -- remains crucial.

The bad news is that, according to the latest earnings call, the journey to a new Intel will be long. The bottom line is that due to its innovative culture and high R&D budget, the company has plenty of value, but the nature of its issues make its stock attractive only to patient investors.

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Adrian Campos has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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