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Intel: Tower Semi Acquisition Is Good For Supply Chain (NASDAQ:INTC)

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When it comes to foundries, most of us have in mind the mighty Taiwan Semiconductor Company (TSM) but, there is also Israel-based Tower Semiconductor (NASDAQ:TSEM) which is on track to be acquired by Intel (NASDAQ:INTC). News of the deal dates back to February, and more recent Discussions between the US computer chip giant and Samsung Electronics (OTC:SSNLF) in Seoul point to some form of cooperation in increasing production capacity to tackle the current chips supply chain crunch.

Now, as evidenced by Intel’s blue chart outperforming TSMC from mid-March (in the figure below) when it announced expenditures of $20 billion for the construction of two additional chip factories (called fabs) in Arizona, investors seem to be putting more trust in Intel.

INTC and TSM price % change
Data by YCharts

My objective with this thesis is to assess whether, at a price to earnings multiple of 7.33x, it makes sense to invest in Intel, and this, in light of the Tower acquisition helping the company to rapidly expand its foundry ambitions, while not forgetting the Samsung collaboration.

First, I provide a picture of the industry outlook amid supply chain constraints.

A Supply-Tainted Industry outlook

The US has the world’s top chip researchers who excel at designing sophisticated silicon used in computers, smartphones, and communications equipment with companies like NVIDIA (NVDA), Intel, and Qualcomm (QCOM) being at the forefront of AI, 5G, and Wi- Phi. It also has some of the largest chip equipment makers like Lam Research (LRCX) whose wafer fabrication machines are used by TSMC, Samsung, and others.

Moreover, there are companies including Intel, Analog (ADI), and others who manufacture chips in the US but this makes up for only 11%-12% of the total global output. With Europe accounting for another 8%- 9%, it is East Asia, mostly through countries like Taiwan, South Korea, and China, which manufacture the remaining 80%.

Normally synonymous with long-term and sustainable demand, the industry outlook for chips has been tainted by the current supply crunch, which in fact originates from the first wave of the pandemic in H1-2020 and has been detrimental to the US auto industry ever since . Furthermore, the latest Chinese lockdowns put in place as of March 26 of this year have resulted in component shortages for IT networking plays like Cisco (NASDAQ:CSCO).

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Company presentation – Intel (www.seekingalpha.com)

To address the problem of over-reliance on Asia, the US Senate approved the CHIPS For America act, aimed at providing $52 billion in subsidies for semiconductor manufacturing at the end of March. The objective of this legislation is to create a more resilient regional supply chain, which should in turn reshape the semiconductor industry itself, resulting in one where Intel with its fabs-operating experience should play a key role. However, this experience is not sufficient, and more is needed in terms of contract manufacturing expertise or having the capability to produce chips designed by fabless companies. It is at this stage, that the Tower acquisition becomes handy.

Tower’s Value Proposition

Israel-based Tower focuses on trailing edge nodes (150 nm to 300 nm) for analog devices used mostly for power management and in IoT sensors. These are used as components in a wide array of electronic devices ranging from home appliances to cars, and related shortages are hindering many sectors of the economy from being fully operational.

These trailing edge nodes are at the other end of the spectrum of the leading edge or more sophisticated process nodes like 5nm, 7nm, and 10mm which Intel primarily focuses on. Therefore, by acquiring Tower, Intel builds complementarity in its product lineup and benefits from associated revenue synergies.

In addition to the technological and financial dimensions, there is also the expertise around the semis ecosystem, namely how Intel’s sales teams should sell to fabless plays like Qualcomm and manage customer relationships as it evolves to a large contract manufacturer from manufacturing chips for its own purposes . For this matter, it currently outsources some production to TSMC and Samsung.

Consequently, with this acquisition, Intel firstly expands its semis portfolio and de facto becomes a manufacturer for clients like Broadcom (AVGO), Teledyne (TDY), Skyworks (SWKS), and many others. Second, it obtains first-hand knowledge on how to produce chips for others, as well as how to partner with chip design companies that work with end customers like automakers. Recruitment of such specialized talent in the current tight labor market is not only costly, but can take considerable time.

Third, there is also geographical expansion with Tower’s production sites in Israel (two fabs), the United States (two fabs), and Japan (three fabs). Intel’s expansion into Japanese territory bypasses TSMC’s plans to get a foothold in that country since October 2021, as the Taiwanese company which accounts for about 50% of the global chip supply has become central to resolving the shortage.

The table below shows Intel’s current and future production, test, assembly, and R&D presence in the world, which contrasts sharply with the view many people have of it as being exclusively based on the US

Intel

Table built by the author using data from (www.intel.com)

Now, Intel has planned to spend about $100 billion over the medium term in the US and Europe, putting it at par with what TSMC is spending to expand either in Taiwan or internationally. These are large amounts of money and one factor which motivates foundry spend is demand, with the semiconductor market expected to grow at a CAGR of 9.2% from 2022 to 2029.

Valuations And Key Takeaways

Still, it is important to consider the difference in costs between the US and Asia as I had elaborated in my thesis on Global Foundries (GFS) and where I had shown how government subsidies play an important role in determining fabs project feasibility, with stimulus measures being essential in view of the high Capex required. In this case, Intel’s investments in a German MegaFab (above table) should benefit from $5.5 billion as pledged by that country’s government.

Tellingly, this amount is less than the $5.4 billion Intel has paid for Tower. Now, thinking aloud, as a result of the deal, Intel could also benefit from the $3.46 billion the Japanese government is providing as subsidies to set up fab operations. For Intel, acquiring and expanding Tower’s assets in Japan are much faster than having to construct facilities from the ground up as TSMC will have to do in that country.

Talking figures, Tower’s annual income of $1.58 billion (for 2021) should add to Intel’s Foundry Services (“IFS”) revenue of approximately $900 million, making it one of the main operating segments after “Datacenter and AI” and “Network and Edge” by the end of 2022. The company can also rely on a $1 billion run rate for IFS, which should deliver about $3.5 billion of sales by 2023, representing about 4.4% of Intel’s total revenues for 2021.

Consequently, Intel’s forward price to sales multiple of 2.35x for 2023 is on the low side. Adjusting by 15.8% which is based on its undervaluation with respect to the IT sector, I obtain a P/S of 2.72x. This translates to a target of $51.9 (44.84 x 2.72/2.35) based on a share price of $44.84. The US company is also undervalued considering the price-to-earnings metric, as shown in the table below.

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Comparison with peers (www.investing.com)

As for Tower, considering the offer price of $53 per share, its stock is still undervalued by around $4-5 with respect to its share price of $48.4. In this respect, looking at regulations, given Intel’s prior presence in Israel, there has been enthusiasm from Tower’s shareholders for the deal and the company had completed the regulatory process in two jurisdictions by April 28.

Reasoning this out, the acquisition not only advances Intel IDM 2.0 strategy which lays emphasis on manufacturing capacity, but it also reinforces the company’s R&D with Tower’s design center and open foundry silicon photonics platform. Along the same lines, a collaboration with Samsung, possibly for expertise around foundry outsourcing services for leading-edge, is a positive. This may appear to be a far-fetched idea, but is feasible as with its foundry in Texas, where it manufactures logic (processor) chips for Intel, Nvidia, Tesla (TSLA), and others, Samsung just like Tower has contract manufacturing experience on American soil.

The South Korean company is also expanding production in Austin through a $17 billion investment and given the tons of materials required ranging from iron and steel castings to chip-making equipment, these companies could achieve economies of scale in the US, namely by carrying out some joint orders as inflation bites harder.

Finally, this collaboration which was discussed in person with Intel’s CEO making the trip to Seoul to meet his Samsung counterpart should not be taken lightly as it has a strong scent of geopolitics to it, and comes just after the US President visited South Korea.

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