The Intel Corporation Margin Fallacy

By Markets Fool.com

I was reading Paul McLellan's take on a recent piece by Jean-Louise Gassee about Intel and its mobile efforts. McLellan notes that if Intel had actually won the Apple chip supply deal all of those years ago, Intel would today enjoy an incremental $5-$10 billion in revenue but at lower gross profit margins than the company's core microprocessor business.

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"Whether Wall Street would treat this as good or bad is unclear," McLellan writes. "They love Intel's margins."

As an Intel stockholder, I would view this as extremely good. Allow me to explain why.

All I care about is profits
It is true that Intel tends to operate in businesses in which it can command a very high gross profit margin percentage; the company's target corporate gross margin range of 55% to 65% very clearly shows this. However, as a stockholder, all I really care about is how much operating profit selling a particular product line nets me.

In the table below, I have listed the revenue, gross profit margin percentage, and operating profit of two semiconductor companies (the names of which I'll reveal shortly). One company has a very high gross profit margin percentage, while the other has a lower gross profit margin percentage.

Company

A

B

Annual revenue in last fiscal year ($billions)

20.1

1.732

Gross profit ($billions)

9.463

1.185

Gross profit margin %

47.1%

68.4

Operating expenses

2.411

0.710

Operating profit ($billions)

7.054

0.476

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Source: Company reports

Company A saw a gross margin percentage of 47.1% in its last fiscal year while Company B saw a gross margin percentage of 68.4%. However, due to substantially higher revenues and relatively low operating expenses as a percentage of revenue, Company A makes a lot more money than Company B.

So, which business would investors expect to be worth more? Company A with the lower gross profit margins but much higher operating profit, or Company B with higher gross profit margins but lower operating profit? Well, Company A is Taiwan Semiconductor , which sports a market capitalization of $111.76 billion as of writing, while Company B is Altera , which has a market capitalization of $11.28 billion.

Clearly there is far more to delivering shareholder value than the gross profit margin; total profit is by far the more relevant number, and even relatively low gross margin business can be very lucrative at the right revenue levels.

Going back to Intel
Let's suppose that Intel were selling $7.5 billion of lower margin mobile processors atop its core PC and datacenter businesses to Apple -- the midpoint of McLellan's estimate. Further, let's assume 45% gross profit margins on these parts -- well below Intel's current gross profit margin. I'm going to assume no change to current R&D/SG&A spending with the addition of this business since Intel is already spending massive amounts on mobile.

Intel, per current guidance, is on track to generate about $55.8 billion in revenue at 63% gross profit margin; operating profit is expected to be $15.41 billion. If Intel had the hypothetical Apple business, then, with the assumptions above, it would be on track to generate $63.3 billion in sales and rake in $18.785 in operating income.

As an investor, I'd take $18.79 billion in operating profit over $15.41 billion any day of the week, and I think most Intel investors would agree with me.

The article The Intel Corporation Margin Fallacy originally appeared on Fool.com.

Ashraf Eassa owns shares of Intel. The Motley Fool recommends Apple and Intel. The Motley Fool owns shares of Apple and Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.