Intel Gets a Helping ARM

Second, Intel announced that LG Electronics will be a new foundry customer for the 10-nanometer internally developed chips for its phones. This has negative repercussions for Qualcomm, which counts LG as an important customer. The news isn’t especially shocking, however, as LG was long rumored to be building its own processor business, and we anticipate that ongoing vertical integration will weigh on Qualcomm’s chip business.

Finally, Mark Bohr, Intel’s head of process architecture, said Intel will not be using ASML’s ASML advanced extreme ultraviolet lithography for the 10-nanometer process, and the technology isn’t ready for the 7-nanometer node, either. This is consistent with our thesis for ASML, as we don’t expect extreme ultraviolet to be a major factor in semiconductor manufacturing until the 7-nanometer process. Even though ASML’s share price dropped following the news, we continue to view the narrow-moat company as significantly overvalued.

Physical IP licenses from ARM allow Intel’s customers to deploy ARM’s physical IP in their manufacturing processes and lead to royalties over the course of the process life. We believe the ARM ecosystem will benefit from bringing Intel’s manufacturing expertise into the fold, as foundries pursuing Moore’s Law face numerous challenges in progressing to advanced process nodes. This move is also consistent with our view that foundry offerings represent a good way for Intel to leverage its expertise and utilize excess capacity, especially as it faces a declining PC market. This doesn’t change our fair value estimate for ARM Holdings, which represents the SoftBank offer price.

With its foundry agreement, LG is following a trend carved out by Apple and later Samsung and Huawei: internally designing processors in lieu of using those sold by the likes of Qualcomm. It remains unclear the extent to which LG will use its own chips, but we surmise the firm will limit its initial rollout to certain phones and tablets while continuing to use Qualcomm chips for its marquee devices. As a result, we are not altering our fair value estimate for Qualcomm; the shares trade a modest discount and may be appealing to investors.

On the basis of Intel’s rumored design win for a portion of modems used in the next iPhone, we speculate Intel’s relationship with Apple in the smartphone space may be in its early innings. The ARM licensing deal and LG business could lead to future business with Apple, should Intel be able to exhibit adequate yields on its 10-nanometer process. This may lead Apple to dual-source future iPhone chips with TSMC and Intel. This would represent significant exposure to the smartphone space, which Intel has been seeking for years, and also an acknowledgement from a premium smartphone maker that could lead to further foundry business.

We continue to believe the market has priced in overly ambitious expectations for the EUV lithography pioneered by ASML, and we still see multiple patterning as the chief method for continued pursuit of Moore’s Law over the next few years. The latter requires significant deposition and etch equipment, provided by the likes of Applied Materials AMAT, Lam Research LRCX, and Tokyo Electron. Intel’s announcement supports our view, and we believe EUV will be ultimately utilized for a few layers at the 7-nanometer node.

Intel is currently trading above our fair value estimate, so we recommend prospective investors remain on the sidelines for now.