Intel may have little choice in big manufacturing bet

Intel Corp's decision to spend $13 billion in 2013 to develop and build future manufacturing technology has not gone down well on Wall Street but it may be necessary if it wants to stay on top of rivals in coming years.

Intel Corp's decision to spend $13 billion in 2013 to develop and build future manufacturing technology has not gone down well on Wall Street but it may be necessary if it wants to stay on top of rivals in coming years.

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The top chipmaker's shares slumped nearly 7 percent on Friday, a day after executives said the company would increase 2013 capital spending from an already dizzying $11 billion.

Some analysts decried the move, saying adding new capacity should be far from Intel's mind in a waning personal computer market. Increased spending may further pressure margins and leave Intel with even more idle capacity if PC sales keep falling.

But others believe that Intel's top priority must be maintaining its technological edge, a costly but necessary endeavor that may even pay off in the long run with market share gains. Moving up the technology ladder can also deliver cost savings, helping safeguarding Intel's margins as it tries to catch up to rivals in smartphones and tablets.

"That's the bet they're making and they're all in," said Sanford Bernstein analyst Stacy Rasgon. "If you stop, TSMC (2330.TW) and Samsung (005930.KS) close the gap - and you're toast."

Of Intel's $13 billion capex this year, $2 billion will go toward expanding a fabrication plant, or fab, in Oregon where engineers will work on a long-term plan to manufacture microchips on silicon wafers measuring 450 mm - about the size of a large pizza.

The other $11 billion goes toward more immediate improvements in Intel's manufacturing technology, letting it build chips over the next two or three years with features measuring just 14 nanometers, and then 10 nm. The narrower the features, the more transistors can fit on a single chip, improving performance.

The newest fabs currently use 300 mm wafers, about the size of a vinyl record. Moving up in size will make room for more than twice as many chips to be etched on each, leading to cost savings.

Lowering costs will be a serious priority for Intel as it ventures into the tablet and phone markets, where chips sell for much less than in the PC industry. Intel, which has yet to make meaningful progress in mobile, stresses that its most advanced fabs have the lowest cost per chip produced.

"One of reasons why Intel is so aggressive on capital spending is to maximize the chances it has of protecting its gross margins as it moves into smaller and lower priced CPUs," Longbow Research analyst JoAnne Feeney said.

Spending Spree

Intel is not the first tech company to worry Wall Street with aggressive long-term investments whose payoffs are difficult to estimate.

Investors in the past have criticized Amazon.com Inc (AMZN.O) for splurging on costly warehouses and other shipping facilities, investments that eventually paid off and contributed to rich stock valuations.

While the size of Intel's capex increase alarmed investors, the chipmaker since 2011 has been spending heavily. Intel normally pours 12 to 16 percent of its revenue into capex, but spending has been closer to 20 percent in the past two years and will probably be higher this year, Feeney estimated.

The costs of developing the new technology to use 450 mm fabs are so high that just a few companies, such as Intel, Samsung Electronics (005930.KS) and Taiwan's TSMC, are expected to have the scale to make the jump worthwhile. Building 450 mm plants from the ground up is expected to cost $10 billion or more.

It's not just a matter of creating bigger silicon wafers. Most of the high-tech equipment - sold by the likes of Applied Materials (AMAT.O) - used in chip manufacturing has to be redesigned as well.

The transition from 300 mm to 450 mm is so expensive and complicated that the world's biggest chipmakers and tool makers are collaborating to establish new standards and timing new technology.

Intel made a $3 billion strategic equity investment last year in chip equipment supplier ASML (ASML.AS) to help fund the development of future lithography tools for 450 mm fabs, a move followed by rivals Samsung and TSMC.

Intel's Oregon plant will lead the effort to produce chips on 450 mm wafers, with other larger Intel plants upgraded in the future, Chief Financial Officer Stacy Smith told Reuters on Thursday.

Rasgon said Intel's long-term investments in manufacturing will mean more pressure on its margins over the next few years, but that its spending will help ensure it remains a major player in the chip industry over the next decade - though there's no guarantee.

"If there's any company I can look at five years from now, they'll be here and they'll be really successful at whatever they're doing. But I don't know what they'll look like," Rasgon said.