© 2011 Karthik Ethirajan, all rights reserved

Emerging Market and Cloud Momentum Propel Revenues; Reiterate $25 Target

Q2 results beat expectations. Strength in emerging markets and cloud build out in mature markets

helped Intel achieve $13.0 billion in revenues, up 1% sequentially, and beat consensus estimate of

$12.82 billion. EPS was $0.54 beating consensus by $0.03. Net income was $3.0 billion down 7%

sequentially but in line with seasonality. Gross margin of 61% came slightly below guidance due to

higher start-up costs and flat ASP.

Increase in capital spending and R&D proportional to expanding TAM. Capex forecast jumped up by

$300 million to $10.5 billion for 2011. A large percent of capex is going to building new factories for

14nm process and adding forward reuse capabilities, retrofitting older factories to handle newer

processes should demand surge. R&D and MG&A forecast increased by $500 million to $16.2 billion to

address newer markets such as Ultrabooks and Tablets, while expanding the portfolio of server

products.

Q3 guidance calls for a sequential 7% upside in revenues despite lowering PC growth to 8-10% for

2011. Q3 revenue forecast is $14.0 billion and improved gross margin target of 64%. Revenue growth is

in part due to the seasonal upside seen in buying during the second half of the year. Gross margin

improvement factors in higher volume and driving down the cost curve. ASP will remain flat.

INTC valuation will be lackluster until PC forecasts are reconciled and new markets begin to take root.

We view fair value for INTC as $25, or 9.3x our EPS estimate of $2.68 for 2012.

© 2011 Karthik Ethirajan, all rights reserved

Overview

Q2 results beat expectations

Company reiterated strong demand and TAM growth in emerging markets and that of enterprise

products in mature markets, partially offset by softening consumer demand in mature markets. China

contribution is greater than 50% of revenues. Channel revenues, a proxy for emerging market growth,

grew by 17%. Reduction in channel inventory also signaled an uptick in emerging market demand.

Revenue set a new record, $13.0 billion, which is 21% higher than a year ago and up 1% sequentially.

Net income of $3.0 billion was down 7% sequentially and EPS was down 4% sequentially at $0.54. The

gross margin was 61%, 0.8 points below Q1. Although benefited from lower Cougar Point impact costs

(200 basis points), margin was impacted by higher 22nm start up costs (150 basis points) and higher

platform costs (150 basis points).

Revenues from the two key business groups, PC Client Group and Data Center Group declined quarter

over quarter, although in line with seasonality. Other Intel architecture group revenue climbed 21%

sequentially to $1.4 billion in large part due to Infineon revenue of $601 million for the quarter. Other

segments in the general embedded markets also grew nicely between 20-50% on a sequential basis. In

the Data Center Group, units in the storage market were up 48% year over year. Enterprise network

revenue was up 40% year over year.

Increase in capital spending and R&D proportional to expanding TAM

Our view is that emerging market is going to be a volume play. Capturing value here will require placing

huge capacity bets. Intel’s forecast for capital spending increased by $300 million to $10.5 billion for

2011. A large portion of this spend is going towards building new factories for the 14nm process and

retrofitting existing factories to handle new processes if a sudden capacity expansion is needed.

Ensuring adequate capacity is essential to monetizing process technology leadership.

Intel spent about $2 billion in R&D in Q2. R&D spend is targeted towards developing platforms for new

growth vectors for Intel such as Ultrabooks, Tablets and Smartphones, and expanding its current

product portfolio on the enterprise side. These initiatives are critical in keeping a check on the rate of

cannibalization from Tablets and share gains by the ARM camp.

Q3 guidance calls for a sequential 7% upside in revenues despite lowering PC growth to 8-10% for

2011

Intel guided Q3 revenues to be $14.0 billion with an improved gross margin target of 64%. That is an

increase of 7% and 3.4 points respectively from Q2 to Q3. Growth projections are roughly in line with

seasonality. We expect the gross margin to improve sequentially as the 22nm start up costs and 32nm

© 2011 Karthik Ethirajan, all rights reserved

ramp up costs come down during the second half of 2011. Further, Intel guided that higher unit volume

will positively impact Q3 gross margin by 100 basis points.

ASP has remained flat from Q1 to Q2 and the trend is expected to continue into Q3. Neither a richer mix

of products nor the Sandy Bridge ramp (20% faster than other products) has helped the ASP situation.

Two thirds of the product mix in client PCs is the i3, i5 and i7Core products. Sandy Bridge makes up

more than half of those Core products.

Intel revised down the PC growth rates from low double digits to 8-10%, citing weakness in Netbooks

demand. Laptops and desktops are still expected to grow at low double digits for 2011.

INTC valuation will be lackluster until PC forecasts are reconciled and new markets begin to take root.

Upbeat PC growth forecast from Intel will take a couple of quarters to be ratified by the rest of the

industry. Likewise, Intel’s Ultrabook initiative and mobile strategy also need similar timeframes before

their successes can be assessed.

Meanwhile, we view fair value for INTC as $25, or 9.3x our EPS estimate of $2.68 for 2012.

Investment Thesis

Intel’s core business in PC and server is helped by growth in emerging markets and build out of cloud in

mature markets. Intel is starting to reap the benefits of its process leadership. Some new markets such

as enterprise networks and embedded market holds promise, while mobile and new consumer markets

remain elusive.