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Posted 1/17/2005
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Intel's 'turnaround' will run aground
The improvements shown in the latest quarter aren't sustainable; here's why. And, yes, Im short the stock.
By Bill Fleckenstein
It's the New Year, and I'd like to begin with an "old" theme: Intel, as an investment, is on borrowed time.
Regular readers just might have heard that before. And for newcomers to The Contrarian Chronicles, please see my Oct. 18 column, "Intel: All risk and no reward."
Before Intel (INTC, news, msgs) reported its fourth-quarter results, I knew that the quarter was not going to be a problem. That doesn't mean I understood why the company was indicating they were going to be doing so well in the fourth quarter, because I did not and I do not. Nevertheless, in light of everything I had been hearing, I did not expect Intel to have a problem in the fourth quarter.
But I bought Intel January 2006 puts recently because I think Intel's problems will be severe this year. I still believe they're producing too many parts for the level of end demand, and they're going to have to shut down some production. I believe that competition from Advanced Micro Devices (AMD, news, msgs) is going to be a real problem this year, and that will become clear once Dell (DELL, news, msgs) finally endorses AMD. And, I believe that the PC market is weak and getting weaker.
The cents that come from consensus
I also recognize that, in order to get paid, I need other people to come to my conclusion about Intel, which is why I opted to buy plenty of time with my January 2006 put position. My plan had been: Once Intel announced its quarter, to expand my position (my outright short position is very small) if the stock rallied on the company's waxing poetic (which it did), or if the stock declined because Intel started to get realistic (which it did not).
Intel's inventory enigma
Much was made of the fact that Intel whittled down its inventory. I spent a good deal of time trying to piece together their cost-of-goods-sold with the decline in inventories and the year-on-year increase in revenues. But I couldn't make the numbers tie out.
In a similar fashion, I cannot make Intel's revenues for the quarter tie out with the lackluster data we've seen from Best Buy (BBY, news, msgs), Circuit City (CC, news, msgs) and market-researcher NPD -- or any other circumstantial PC information I've been able to pull together.
In short, at least by my reckoning, the top line doesn't tie, and the numbers under the hood don't tie.
Fred Hickey looks under the hood
They also don't tie for my good friend Fred Hickey of the High-Tech Strategist, who, as I'm sure most folks know, is the best tech analyst by a mile. As Fred and I went through these numbers last Tuesday night, Fred correctly pointed out that in the past, when things had not tied out or when Intel was saying something that didn't fit with everything else, they paid for it the next quarter. In a brilliantly worded e-mail to me, he summed up his thoughts as follows:
More about Intel on MSN Money
"Early in 2004, when you and I were worried about the inventory buildup (as it was clearly a problem), Intel wasn't worried. Then in mid-year, Intel had an epiphany: They had an inventory problem (which led to the surge in cost-of-goods-sold and plunging margins, just as we had predicted). Now they're telling people on the conference call that they think they're a little light on inventory.
"This gibberish is from a company that had a very bad sales quarter in Q3 (which they didn't forecast) and then a very good sales quarter in Q4 (which they also didn't forecast). I can't think of another company that preannounces more often (both up and down). They've been the patron saint of bad forecasting for at least a decade. Why anyone puts any credibility into their forecasts is beyond me. And then to take their forecasts and apply it to the rest of the semiconductor industry -- even though it contradicts every data point we can find -- is sheer lunacy."
Looking askance at sustainable strength
Following up on what Fred had to say, what really matters is: Do you think the quarter that Intel had is sustainable? And do you think that Intel is telling you the whole truth and nothing but the truth about what's going on? It's no surprise that I don't think Intel's quarter is sustainable, nor do I think they're telling us everything that one might like to know about their inventory, cost-of-goods-sold, etc.
It is conceivable to me that they wrote down inventory in the third and fourth quarters. You can try to back into that by looking at the cost-of-goods-sold. This line item is up about $1 billion-plus year-over-year when the incremental sales should only put it up about $450 million, plus or minus. So, there is a large bulge of $600-$700 million in that quarter.
Similarly, in doing the math last quarter, I saw that their cost-of-goods-sold bulged by around $300 million, which at the time I thought was a write-off. On its call Tuesday night, Intel said that these changes were not caused by write-offs. Whether that's literally true or a function of semantics, I don't know, nor will we ever know.
The whiff of write-off
Another astute analyst friend of mine summed up the aforementioned $600 million to $700 million this quarter and $1 billion over the two quarters -- which he concluded was a write-off -- as follows:
"How can Intel write off between $600mm and $1bb of inventory, and then say their inventory position is lower than they would like it to be? Well, they can say whatever they want. But at the end of the day, the earnings call is also a 'sales' call. I think they're pulling a John Chambers special to preserve the notion of tightness in the market (aided and abetted by production snafus in certain parts) that's leading to double ordering, and potentially firmer pricing as well. Why they do this, I don't know, because it will always go the other way and make things worse ( la Q3 2004), but maybe they want to send Barrett out on a high note. . . ." (CEO Craig Barrett plans to retire in May.)
A 'revival' rings hollow
Back to the bottom line: One can choose to think this is the start of a big-time turnaround in Intel, the semiconductor-capital-equipment industry, the PC industry and chips at large. Or one can decide that this is some sort of anomaly that doesn't fit with anything else (recognizing that Intel has had anomalous quarters in the past). And in fact, Intel is one of the few companies I know that has preannounced both positively and negatively in the same quarter. As Fred noted, they are notoriously bad forecasters and not a good barometer.
I have made my bet with the Intel LEAPs I own and my Intel shorts, as well as my short in other chip stocks. My strong belief is that, by the time the first quarter is over, we'll see that however it occurred, the fourth quarter of 2004 was a complete outlier for Intel and that they are indeed on borrowed time. That is my view and I'm sticking to it.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money. At the time of publication, Bill Fleckenstein was short Best Buy, short CDW Computer, short Intel and long Intel puts.
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