Intel (NASDAQ:INTC)
In an unusual move, Intel (NASDAQ:INTC) secured money for new chip factories in Arizona. The move improves the chipmaker’s free cash flow but comes at a cost. My investment thesis on Intel remains bearish because the firm is overly focused on sustaining the dividend rather than addressing fundamental chip design and production difficulties.
Smart Money
Intel frequently mentions using “smart capital” to build new chip factories. The corporation describes this as capital plans to boost this business’s flexibility and help expedite and expand its manufacturing build-outs.
The smart capital strategy essentially means using government subsidies in the United States and Europe to construct local manufacturing units. Furthermore, the strategy now involves fab investment partners and the possibility of future customer commitments via advance payments for IFS and the utilization of external foundries.
Generally, a management team would be foolish not to use government incentives and other aspects of the plan to enhance a company’s financial condition. In this regard, the chipmaker inked a Semiconductor Co-Investment Program (SCIP) deal with Brookfield Infrastructure Partners (BIP).
Brookfield covers 49% of the entire project cost, while Intel sponsors 51% of the $30 billion expansion at the Ocotillo facility in Arizona. The merger is still expected to completion by the end of 2022, although Brookfield can opt out of a $250 million charge. Intel first announced plans to invest $20 billion in two new Arizona fabs in March 2021.
While Intel retains controlling ownership and operational control, Brookfield’s money is not free. The chipmaker didn’t reveal much about the funding expenses during an investor call, other than that it was higher than the cost of debt at 4.4% but lower than the cost of equity at 8.5%. The management team refused to reveal the full details of the agreement. Still, it did imply that Brookfield would get a share of the business’s cash flows based on a defined rate of return rather than 49% of earnings.
The following are Intel’s primary benefits from the agreement:
- $15 billion in adjusted FCF increase.
- EPS contributor during the build and ramp phase.
In essence, Intel saves $15 billion in upfront building expenses and appears to split initial ramp losses with Brookfield. The problem is that Intel seems required to break earnings with Brookfield throughout the productive period. The slide below from the SCIP presentation shows how Intel will produce less free cash flow throughout the fab’s manufacturing phase.
The agreement permits Intel to develop new factories, but Intel must pay Brookfield a return of $900 million at 6%. It should be noted that providing too much of a guaranteed return for the investment program might result in Brookfield receiving the great bulk of the revenues if Intel fails to catch up with TSMC and the IFS business fails to acquire traction.
Intel stated the following financial objectives through 2026 during the 2022 Investor Meeting. The firm has already reduced its near-term sales projections. Still, this SCIP should help with adjusted free cash flows in the short term, but the long-term model will see a reduction in cash flow margins due to payments to SCIP partners.
The nicest element of the transaction is that Intel can compete with TSMC on foundry size and have more capacity for the IFS plan, albeit at a high cost.
Dividend Savings
The weird news is that Intel proposes using the SCIP to save the payout and increase it in future years. In essence, the chipmaker is reducing future profits to continue paying and growing current payouts.
Nothing in the statement implies that Intel is utilizing the SCIP to match TSMC’s (TSM) expenditures in chip production capacity; instead, Intel is using the money to free up cash flow for the dividend.
The dividend has gradually increased over the previous few years, with the quarterly distribution presently at $0.365. Intel pays out $1.5 billion in cash dividends quarterly, for a total annual expenditure of $6.0 billion on the $1.46 per share yearly dividend.
By these two Arizona fabs open in 2024, Intel will have spent at least $12 billion on dividends. Without dividend payments, the chip manufacturer would not require a co-investment partner to support semiconductor foundries and share earnings.
Invest in the future or distribute present income to shareholders. Intel shareholders appreciate the dividend, but the corporation should not attempt to serve two masters. No one is satisfied when a corporation tries to serve two masters.
Takeaway
The main lesson for investors is that the SCIP assists Intel in building all additional fabs without the first cash crisis. Finally, the devil will be in the details of the agreement’s financial conditions. The chipmaker currently has enough cash to fund the dividend for the next few years. Still, such an investment partnership does not affect Intel’s competitive position. The dividend is currently being maintained at the expense of increased profitability.
Investors should continue avoiding Intel until the firm turns the business around because creating more fabs does not necessarily turn the business around.
Featured Image: Megapixl @Thetahoeguy
