Business Valuation Report for Intel Corporation

Prepared for:

Prof. John Stowe MFE 6220 - EQUITIES Department of Economics Ohio University

April 30, 2015

Melih Komuscu, MFE Program Student

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TABLE OF CONTENTS PAGE

Description of the Project ……………………………………………….……..…………………… 3

Information Sources ………………………………………………………….……..……………….. 3

Business Summary …………………………………………………………….………..…………….. 3

Associated Business Risks ………………………………………………………………………….. 6

Business Valuation Approaches and Methods …………………..………………………… 8

Judgment of the Valuation Results ……………………………………..………………………. 15

References …………………………………………………………………………..…………………….. 16

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List of Tables

Figure 1. Annual Revenue

Figure 2. Annual net Income

Figure 3. Annual Earning Per Share

Figure 4. Annual EBITDA

Figure 5. Annual Free Cash Flow

Figure 6. Historical Values of the Adjusted Close Shares for Intel Corporation

List of Tables

Table 1. DDM Value with a Single Holding Period

Table 2. Gordon Growth Model for Dividend Valuation

Table 3. Two-Stage DDM Model

Table 4. FCFF and FCFE Valuations for the Intel’s Shares

Table 5. Residual Income Valuation for the Intel Shares

Table 6. Summary of the Market Multipliers

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1. DESCRIPTION OF THE PROJECT

The purpose of this project report is solely to provide an independent valuation opinion in

order to assist investors who plan to buy Intel Corporation stock. As such, this restricted

valuation report is intended for use by individuals and investors only. Intel Corporation designs,

manufactures and sells computer components and related products.

2. INFORMATION SOURCES

During the valuation process I have reviewed the business financial statements and financial

data, which have been provided by the financial various sources, including Morningstar, Yahoo

Finance, and NASDAQ. It was assumed that these financial statements are true and accurate. I

also accessed the financial statements released by the Intel Corporation itself.

3. BUSINESS SUMMARY

Intel Corporation was founded in 1968 and is based in Santa Clara, California. The Intel

Corporation designs, manufactures, and sells advanced integrated digital technology, primarily

integrated circuits and semiconductors, for industries such as computing and communications.

It is the world's leading semiconductor producer and has been leading the industry since the

inception of the personal computer. The company also offers a wide range of technological

products for data processing, data storage and wired network connectivity products. It

develops and manufactures mobile communications components and offers software products

for endpoint security, network and content security, risk and compliance, and consumer and

mobile security. The company sells its products primarily to original equipment manufacturers,

original design manufacturers, and industrial and communications equipment manufacturers in

the computing and communications industries. The Intel also invests significantly in research

and development (R&D) and this high R&D funding has allowed Intel to maintain its leadership

position in the semiconductor industry.

Intel Corporation is the world's largest semiconductor chip maker, based on revenue. In

accordance with recently published financial statements, Intel Corporation has Current

Valuation of 146.33 B. This is 46.32% higher than that of the Technology sector. The total

revenue of the company in 2014 was 55.8 billion, a 6 percent increase over the 2013 earnings.

Total revenue of the company for the last quarter of 2014 was reported as 14.7 billion, a % 1.3

percent decline compared to the Q3 earnings of 2014. Net income of the company in 2014 was

11.7 Billion, nearly a 22 percent increase over the 2013 income figures. On March 12, 2015,

Intel lowered its 1Q15 revenue forecast due to “softer-than-expected demand for business

desktop PCs.” Lower-than-estimated inventory levels across the PC supply chain also

contributed to the lower revenue outlook. As a result of lower revenue expectations, Intel’s

share declined by 4% during early part of March 2015. In 1Q15, Intel’s (INTC) CCG (Client

Computing Group) segment reported revenue of $7.42 billion—a decline of 8% on a year-over-

year basis. Reduction in the global PC shipments, partially due to slow refreshment of Microsoft

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(MSFT) Windows XP, was kept responsible for this segment’s negative growth. Macroeconomic

and currency fluctuations, especially in Europe (EZU), contributed to the decline as well.

Financial statements of the company for 2014 fiscal year indicate a 10.61% return on assets

while the return on equity resulted in 20.51%. Earnings per share in Q4 of 2104 was $2.31, a 22

percent increase over the Q3 of 2013’s earning figure.

Following charts present some figures for the financial status of the Intel Corporation’s. The

company’s revenues are growing in recent years despite fluctuations. The net income of the

company peaked in 2011, declined slightly in the following 2 years but then picked again in

2014.

Figure 1. Annual Revenue

Figure 2. Annual net Income

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Revenue (in billions) 38,826 35,382 38,334 37,586 35,127 43,623 53,999 53,341 52,708 55,780

0

10,000

20,000

30,000

40,000

50,000

60,000

Revenue (in billions)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Net Income (in billions) 8.66 5.04 6.97 5.29 4.36 11.46 12.94 11 9.62 11.7

0

2

4

6

8

10

12

14

Net Income (in billions)

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Figure 3. Annual Earning Per Share

Figure 4. Annual EBITDA

Figure 5. Annual Free Cash Flow

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Earning Per Share (in dollars) 1.42 0.87 1.2 0.93 0.79 2.06 2.46 2.2 1.94 2.39

0

0.5

1

1.5

2

2.5

3

Earning Per Share (in dollars)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

EBITDA (in billions) 17.22 12 13.97 12.31 10.75 20.68 23.88 22.48 20.88 23.89

0

5

10

15

20

25

30

EBITDA (in billions)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Free Cash Flow (in billions) 9 4.84 7.62 5.72 6.65 11.48 10.19 7.85 10.02 10.22

0

2

4

6

8

10

12

14

Free Cash Flow (in billions)

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As reflection of the net income, the earnings per share was highest in 2011, and then increased

again after two years of slight drops. A similar trend was observed with the EBITDA figures. On

the other hand, free cash flow figures of the company were more stable during 2013 and 2104

after a sharp decline in 2012.

Figure 6. Historical Values of the Adjusted Close Shares for Intel Corporation

As seen in the above figure, share prices of the company characterized by small fluctuations

between 2005 and 2010, with an exception of s sharp decline in 2009. The prices have been in

rising trend since that drop and are standing around 32$ currently.

4. ASSOCIATED BUSINESS RISKS

As any other company investing in technological products, the Intel Corporation also faces

certain business risks since it operates in highly competitive industries. As stated in previous

section, any decline in PC shipment will impact the revenues adversely. The cyclical industry in

which Intel operates will cause its profitability to fluctuate regardless of how successful it is in

tailoring its processors to new markets. Failure to anticipate and respond to technological and

market developments could damage its ability to compete. At the same time, demand for its

products is highly variable. In recent years, the company experienced declining orders in the

traditional PC market segment, which has been negatively impacted by the growth in ultra-

mobile devices such as tablets and smartphones. In other words, increasing demand for tablets

and smartphones can adversely can affect the PC market, resulting in less demand for

computer chips. Similarly, the semiconductor industry has deeply cyclical trends. Demand in up

cycles is so high that chip manufacturers have trouble keeping up. Similarly, if electronic sales,

particularly PC sales, are slow, demand for chips can plunge. The fact that the semiconductor

industry is more impacted by the notion of consumer demand more than corporate demand,

0

10

20

30

40

50

60

Shar

e P

rice

(in

do

llars

)

Historical Adj Close Shares for Intel

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also adds to the overall volatility. The analysts think that any bad strategy by Intel will lead to

AMD capturing market share in the PC market.

Any prolonged delay in process technology by Intel would allow other semiconductor

manufacturers to overwhelm Intel’s lead and or even surpass it. In general terms, the risk

factors that the Intel Corporation can face can be summarized as follow. Those risk factors can

influence financial performance of the company to some extent.

Changes in product demand may harm financial results and are hard to predict

Failure to anticipate and respond to technological and market developments could harm

its ability to compete

Changes in the mix of products sold may harm financial results

Global operations subject us to risks that may harm results of operations and financial

conditions

Failure to meet production targets, resulting in undersupply or oversupply of products,

may harm its business and results of its operations

Having difficulties obtaining the resources or products it needs for manufacturing,

assembling and testing its products, or operating other aspects of our business, which

could harm its ability to meet demand and increase its costs

Changes in product demand, and changes in customers’ product needs, could negatively affect

competitive position of the company and may reduce its revenue, increase its costs, lower its

gross margin percentage, or may even require to write down its assets. In order to be

competitive with its rivals, the Intel Corporation maintains a successful R&D effort, develop

new products and production processes, and improve its existing products and processes ahead

of competitors. Although the R&D efforts are critical to success of the company, the R&D

investments may not generate significant operating income or contribute to its future

operating results for several years and such contributions may not meet its expectations or

even cover the costs of such investments. The company may be unable to develop and market

new products successfully, and the products it invests in and develop may not be well received

by customers.

The risks described above are business-related risks. Surely, there are other risks associated with macro-economic conditions and political situation. Among the macro-economic risks, inflation, reductions in economic growth, or recession, can be counted while the political risks may involve restrictions on access to markets, confiscatory taxation, and expropriation of assets.

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5. BUSINESS VALUATION APPROACHES AND METHODS

The valuation part consists of following sections;

Explanation/justification of assumptions (discount rates, growth rates, CF’s)

DDMs, a single-stage one and a two-stage one

FCFF valuation and FCFE valuation

Residual Income valuation

Valuation based on market multiples

Summary judgment of value

5.1.Explanation and Justification of Assumptions

The procedures employed in the valuation section include actual data for the Intel Corporation

from Morningstar and Nasdaq and some assumptions as well. The input data and assumptions

also vary based on the valuation method and will be explained where necessary.

Based on the data given in Morningstar and Nasdaq, I made the following assumptions.

1. The projected yield of dividends: %3

2. Current dividend per share: $0.90

3. Upcoming dividend: $ 0.24

4. 5-year dividend growth forecast: %10.19, and then % 8 for the next 3 years

5. Required Return on equity: %13.26

5.2.Discounted Dividend Valuation

5.2.1.DDM Value with a Single Holding Period

Table 1. DDM Value with a Single Holding Period

If an investor wishes to buy a share of stock of Intel and hold it for one year, the value of that

share of stock today would be V0 = $31.39. The expected share price of $34.31 is nearly %10

higher than this figure.

DDM Value with a Single Holding Period

Expected price per share in one-year P1= 34.41

Expected Dividend per Share D1= 1.14

Required Rate of Return r= 13.26 0.1326

V0 31.39

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5.2.3.Gordon Growth Model

Table 2. Gordon Growth Model for Dividend Valuation

The market price of $32.46, or approximately 8 percent, more than the Gordon growth model

intrinsic value estimate of $30.11. The Intel Corporation appears to be slightly overvalued,

based on the Gordon growth model estimate.

5.2.4DDM Two-Stage Model

Table 3. Two-Stage DDM Model

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The INTEL appears to have a dividend policy of recognizing sustainable increases in the level of

earnings with increases in dividends, keeping the dividend payout ratio within a range of 40

percent. Considering the different growth rates, Two-Stage DDM model seems a better choice

for the valuation process. It is forecasted that current dividend of $0.90 will grow by 10 percent

approximately per year during the next 4 years. Thereafter, the growth rate will decline to 9

percent and remain at that level indefinitely. At the end of the year 5, the stock price is

expected to rise to $46.76 per share. If we buy the stock as long as it is below $33.95, a 10

percent increase in dividend will ensure us a 13 % return on our investment.

5.3.FCFF and FCFE valuations

For the valuation, following inputs from the Intel Report were used, and some assumptions were made where necessary. • Sales are $55,870 million • Sales will grow at 6% annually for five years, and then at 4% annually thereafter • EBIT is 15,995 million and is %28.6 of the sales • Interest expense is $192 million and will increase proportionately with sales • Depreciation expense is $8,549 million and will increase proportionately with sales • Gross investment in plant and equip will be 40% of the increase in sales • New investment in working capital will be 11,711 million and will increase 5 percent each year • Net borrowing will be 20% of the new investment each year. • The corporate income tax rate is 25.9% • The before - tax cost of long-term debt is 5.0% • The equity beta is 0.95, risk-free rate is 4.0%, and equity risk premium is 9% (12.36 % in Intel Report) • There are 4,736 million outstanding shares

Here, I tried to find the FCFF and FCFE from the EBIT, using the formula given below.

FCFF= NI+ NCC + Int (1-Tax rate )- FCInv - WCInv

and

FCFE= NI+NCC-FCInv – WCInv + Net borrowing

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Table 4. FCFF and FCFE Valuations for the Intel’s Shares

Given the above data, Intel Corporation can use free cash flows to manage its capital structure

to finance its new investments and borrowings. The FCFF seems adequate to cover capital

expenditures. The FCFF, in part, can be used to make dividend payments to the company’s

shareholders. Moreover, since the company has high investments in fixed capital and working

capital, it will have a low FCFE and pay high dividends.

As noticed, the company’s profitability is increasing and generating high returns, and under

such a case the company would increase its net new investment in operating assets to compete

in the sector. The debt financing accompanying the new investments may also increase. While

the terminal value will stand as $34.94 at the year 6, the estimated equity value will be $42.1

with a return rate of %12.55. Since the intrinsic value of the shares ($34.83) is slightly higher

than the current share price ($32.47), the Intel shares are slightly undervalued. On the other

hand, using the $42.1 estimated equity value, Intel is overvalued. In other words, if Intel could

lower their cost of equity the share price would rise closer to the current market value.

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5.4.Residual Income Valuation

Table 5. Residual Income Valuation for the Intel Shares

Residual income (RIM) is an estimate of the profit of the company after deducting the cost of all

capital, debt and equity. The residual income model of valuation applied here analyzes the

intrinsic value of equity as the sum of the current book value of equity and the present value of

expected future residual income.

Book value per share is initially $ 2.70. Based on an ROE forecast of 12.36 percent, the ending

book value would be $ 8.11 since the dividends are paid. The intrinsic value of the share price

would be $39.99 in year 5, which correspond to a 20 percent increase. The company was

valued at more than its book value because its ROE exceeded its cost of equity.

The results indicate that the Intel earned enough to cover the cost of equity capital. As a result,

it has positive residual income and it is profitable both in accounting and economic sense.

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5.5. Valuation based on Market Multiplies (based on 27 December 2014 actual data for Intel)

Forward P/E based on the current fiscal year

P/E= Stock Price/Earnings per Share (EPS) P/E= 34.36/2.47 P/E=13.90

Price to Sales (P/S)

P/S= Share Price/Sales per Share P/S=34.36/11.80 P/S=2.91

Price to Book Value (P/BV)

P/BV= Price/Book Value per Share (PVPS) P/BV= 34.36/11.80 P/BV=2.91

Price to Operating Profit (P/OP)

Given:

Share: 4,736 million Operating Income=15,347 million

Then,

Operating Profit per share= 3.24 Share Price=34.36 P/OP= Share Price/Operating Share per Share P/OP=34.36/3.24 P/OP=10.58

Price to FCFE (P/FCFE)

Number of Shares= 4,376 million FCFE= 10,456 FCFE/Share= 2.21 Current Share (P)= 32.73 P/FCFE= 32.73/2.21 P/FCFE=14.82

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Price to Dividends (P/D)

P/D= Annual Dividend/Stock Price per Share P/D= 0.90/32.73 P/D= % 2.74

Other EV Multiples

EV/EBITDA

Given Data in Actual Figures from the Intel Reports:

Short-term debt: 1,604 Long-term debt: 12,107 Short-term Investment: 11,493 Cash & Cash Equivalency: 2,561 Trading Assets: 4,446

Total Equity= Stock price X Number of shares Total Equity: 31.49 x 4,736,000 Total Equity: 149,136,000 EV= 144,347 EBITDA=23,896 EV/EBITDA= 6.04 EV/EBITDA is 6.04, which is lower than its benchmarks (for example Technology has 10.19 value). Therefore, the company is relatively undervalued.

EV/FCFF

Given the actual data; EV= 144,347 FCFF=10,221

Then,

EV/FCFF= 14.12

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Market Multipliers Results

P/E 13.9

P/S 2.91

P/BV 2.91

P/OP 10.58

P/FCFE 14.82

P/D 2.74

EV/EBITDA 6.04

EV/FCFF 14.12

Table 6. Summary of the Market Multipliers

6. JUDGEMENT OF THE VALUATION RESULTS

In this report, a number of methods were used for the valuation of the Intel Corporation’s

based on its current and historical financial statements.

As a general comment based on the company’s financial statements, one can argue that Intel

Corp.'s net revenue, operation income, income before taxes, and net income declined from

2012 to 2013 but then increased from 2013 to 2014.

With the current data, return for equity of Intel is %20.6. For most industries Return on

Equity between 10% and 30% are considered desirable to provide dividends to owners

and have funds for future growth of the company.

Intel’s return on asset is currently %10.61. A low ROA typically means that a company is

asset-intensive and therefore will needs more money to continue generating revenue in

the future.

The calculated P/E ratio is 13.90. This is 75.28% lower than that of the Technology

sector, and 82.99% lower than that of Semiconductor - Broad Line industry.

Based on our analysis, the price to book indicator of Intel Corporation is roughly 2.91

times. This low P/BV ratio generally implies that the firm is undervalued. A ratio of 2.91

(bigger than 1.0) indicates that the firm is creating value for its stockholders.

Price to Sales ratio (P/S) for Intel is 2.91. This ratio is typically used for valuing equity

relative to its own past performance as well as to performance of other companies or

market indexes. In most cases, the lower the ratio the better it is for investors.

Therefore, the low P/S ratio puts the Intel in a very good position in terms of value of its

equity. But on the other hand, the low P/S ratio indicates a sluggish sales growth. This

price is small because Intel has a significantly higher amount of shares outstanding than

its competitors, while increasing the Price/Sales ratio.

The company’s forward P/E based on the 2014 fiscal year is 13.90. It is slightly higher

than the higher than its trailing P/E but lower than the S&P 500's forward P/E of 15.20.

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Investors therefore see more value in the company's future earnings but not as much as

they see in the market in general.

From a value perspective, we look at how much bigger the company's market

capitalization is than its latest operating profits after subtracting taxes. By this measure

Intel Corporation is priced very attractively with a total value of $156.38 billion, only

7.72 times higher than its latest quarterly net income plus depreciation.

Intel’s EBITDA is around 23.8 billion, which puts the company in a top position among

related companies in the sector.

The market price of $32.46, or approximately 8 percent, more than the Gordon growth

model intrinsic value estimate of $30.11. The Intel Corporation appears to be

overvalued, based on the Gordon growth model estimate.

I predict free cash flows into the firm to steadily increase and see this trend continuing

into the future. The FCFF seems adequate to cover capital expenditures. The FCFF, in

part, can be used to make dividend payments to the company’s shareholders.

Moreover, since the company has high investments in fixed capital and working capital,

it will have a low FCFE and pay high dividends. While the terminal value will stand as

$34.94 at the year 6, the estimated equity value will be $42.1 with a return rate of

%12.55. Since the intrinsic value of the shares ($34.83) is slightly higher than the

current share price ($32.47), the Intel shares are slightly undervalued. On the other

hand, using the $42.1 estimated equity value, Intel is overvalued. In other words, if Intel

could lower their cost of equity the share price would rise closer to the current market

value.

7. References

Equity Asset Valuation, John Wiley & Sons, Inc., 2nd Edition, 2010, by Jerald E. Pinto,

Elaine Henry, Thomas R. Robinson, and John D. Stowe. ISBN-13 9780471571439

Intel’s 2014 Annual Report

Web Sources:

o www.cfainstitute.org

o www.intel.com

o www.txn.com

o www.morningstar.com

o www.nasdaq.com

o www.yahoo.finance.com