Intel Stock Evaluation

February 11, 2006

Holdings

	11-Feb
1	F
2	NBG
3	PCLN
4	NKE
5	BA
6	VRSN
7	SNP
8	CAT
9	INTC
10	C
11	CA
12	FNF
13	MS
14	TKC
15	HMC
16	CRYP
17	X
18	AAPL
19	COP
20	ACH

Performance of Individual Stocks For last 3 months:

11-Feb
FNF	-5.28%
COP	-6.53%
CAT	25.81%
NKE	-2.47%
BA	11.46%
VRSN	-0.84%
SNP	32.42%
PCLN	-6.99%
JNJ	-3.65%
C	-3.23%
CA	-6.97%
F	5.06%
MS	9.59%
TKC	22.50%
HMC	6.59%
CRYP	-2.80%
X	43.48%
AAPL	9.38%
NBG	20.91%
ACH	43.80%

Total Increase (Decrease) since last quarter: 9.61%

Additions: INTC

Subtractions: JNJ

Commentary: The acquisition of Intel[i]:

Intel has had its troubles recently, and these have been well publicized. Chief among these is that AMD, a major competitor, is taking away market share. Nonetheless, Intel is a reasonable acquisition at this time, as I will try to explain:

Basic Stats:

Stock Price (Feb 11, 2006)	21.67
Market Capitalization	$126 billion
P/E (ttm)	14.5
P/E (average earnings last 3 years)	17.3
BV of Equity	$36 billion
Tangible BV of Equity	$32 billion
Adjusted BV of Equity w/ research asset	$53.84

First, it is important to understand Intel from a book value perspective. In general, this makes Intel look unattractive as an investment opportunity, because the company does not offer a very fat margin of safety. The company has a market cap of $126 billion, or almost 4 times its tangible book value. Yikes! Also, it is important to note that the company has made no significant addition to the Book Value of its equity over the last few years. In fact, the book value of equity that was reported in 2000 was about $1 billion more than the one reported for the end of 2005. Since the ability of a company to grow the book value of its equity is a prime proxy for the soundness of the investment in such a company, Intel seems like a dud.

However, one thing that Intel does not put in its balance sheets is the effect of research and development on its asset base. It is reasonable to assume that Intel can convert some of its R&D activity into future earnings, so Intel has a latent ‘research asset’ that is not showing up in its financial statements. I have tried to quantify the research asset in the following table. I assume a straight line amortization of R&D expenditures over a 7 year lifespan:

Year	R&D Expenses ($bn)[ii]	Value of Resarch Asset ($bn)
2005	5,145	$17.84
2004	4,778	$16.48
2003	4,360	$15.14
2002	4,034	$13.85
2001	3,796	$12.53
2000	3,897	$11.09
1999	3,111	$9.14
1998	2,509	$7.67
1997	2,347	$6.54
1996	1,808	$5.32

Source: 2005 10-K

So, by this calculation $17.84 billion in assets is not showing up in the balance sheets. Of course, if I lengthen the depreciation time above 7 years, I increase the value of the research asset, and if I decrease it below 7 years, I decrease the value. However, if a 7 year amortization estimate is a reasonable way to account for Intel’s R&D activity, then the company could be considered to have a book value of $53.84 billion, or a market cap that is a discount of only 2.3x to the book value of equity. This looks OK, though not spectacular. Also, including the research asset, Intel’s book value of equity has increased about $5 billion since 2000, or an increase of roughly 12%. Again, not great, but better than the a drop of 3% that we were seeing before.

However, what makes Intel a buy right now is the growth in its earnings and revenues, combined with the fact that the market has been willing to pay a high multiple to earnings for companies such as Intel. The following is a simple model that I made looking at future revenue and earnings growth. I have assumed a conservative 9% per year growth in revenues, and an after tax margin of 20 percent.

			Operating				After Tax Margin	YoY Revenue Growth	Net Income	Market Cap at 18x Earnings ($bn)	% Profit on Current Purchase[iii]	Compunded ROI
	Net Revenue		Income		Net Income
2015		91915.26					20.00%	9.00%	18383.0524	330.89	182.62%	10.95%
2014		84325.93					20.00%	9.00%	16865.1857	303.57	158.93%	11.15%
2013		77363.24					20.00%	9.00%	15472.6474	278.51	137.04%	11.39%
2012		70975.45					20.00%	9.00%	14195.0894	255.51	116.79%	11.69%
2011		65115.09					20.00%	9.00%	13023.0178	234.41	98.04%	12.06%
2010		59738.61					20.00%	9.00%	11947.7227	215.06	80.68%	12.56%
2009		54806.07					20.00%	9.00%	10961.2135	197.30	64.59%	13.27%
2008		50280.8					20.00%	9.00%	10056.1592	181.01	49.66%	14.38%
2007		46129.17					20.00%	9.00%	9225.83412	166.07	35.80%	16.53%
2006		42320.34					20.00%	9.00%	8464.068	152.35	22.92%	22.92%
2005	$	38,826	$	12,090	$	8,664	22.31%	13.50%	8,664
2004	$	34,209	$	10,130	$	7,516	21.97%	13.50%	7,516
2003	$	30,141	$	7,533	$	5,641	18.72%	12.62%	5,641
2002	$	26,764	$	4,382	$	3,117	11.65%	0.85%	3,117
2001	$	26,539	$	2,256	$	1,291	4.86%	-21.31%	1,291
2000	$	33,726	$	10,395	$	10,535	31.24%	14.76%	10,535
1999	$	29,389	$	9,767	$	7,314	24.89%	11.86%	7,314
1998	$	26,273	$	8,379	$	6,068	23.10%	4.80%	6,068
1997	$	25,070	$	9,887	$	6,945	27.70%	20.26%	6,945
1996	$	20,847	$	7,553	$	5,157	24.74%	N/A	5,157

If Intel can stay on this course and attain a P/E ratio of 17 or higher within 5 or 6 years, then this will be a reasonable investment. Of course, if Intel is unable to do this, things could get a little bit ugly. However, including the research asset into the balance sheet, I think Intel should have a decent cushion to protect its stock price from plummeting much lower from a book value perspective.

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