Why Intel's Data Center Group Grew Double Digits in 2017

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Chip giant Intel's (NASDAQ: INTC) data center group (DCG) is expected to be the company's main growth engine in the years ahead. Indeed, at the company's investor meeting last February, the company explained how its strategy would be a "data center first" one.

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DCG isn't Intel's largest business by either revenue or profit -- that honor still goes to its client computing group (CCG) business -- but it's the company's second-largest business and, unlike CCG, has strong long-term growth prospects.

During the first three quarters of 2017, Intel's DCG saw year-over-year revenue growth of below 10%. For some context, Intel's stated long-term revenue growth goal for the business is 10% (or better) compounded annually.

In the final quarter of 2017, Intel's DCG saw 20% year-over-year revenue growth. Not only was this better than expected, it led to full-year DCG growth of 11% -- well ahead of the company's expectation of high-single-digit revenue growth for the year.

Moreover, thanks in part to the big boost in revenue, the profitability of this segment improved dramatically as well, with operating profit growing by about $1.1 billion year over year to $3 billion.

Let's go over what drove those results.

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A surge in enterprise server sales

Intel's DCG business sells to three main types of customers: cloud service providers, enterprise and government, and communications service providers.

Generally speaking, sales to cloud service providers are strong because cloud computing, in general, is strong. Intel's sales to communications service providers have also been robust because such companies are shifting away from chips designed for specific functions ("fixed function") toward more general-purpose processors, such as the ones that Intel provides.

However, sales to enterprise customers have been sluggish in recent years, thanks in no small part due to the shift away from companies building and maintaining their own data centers on-premises and toward customers outsourcing their data center needs to major cloud service providers.

In effect, the trend that fuels Intel's sales to cloud service providers is the same one that's hurting its traditional enterprise server sales.

Last quarter, though, Intel saw a surge in enterprise server chip sales. According to the company's earnings presentation, revenue within DCG's enterprise and government sub-segment were up 11% year over year.

The increase, Intel CEO Brian Krzanich said, was due to the company's enterprise and government customers buying the company's latest Xeon Scalable processors and, particularly, buying higher-end processors within that product family .

Some good news and some bad news

The good news for Intel is that the better-than-expected enterprise and government results within DCG helped propel DCG's financial results.

The bad news is that revenue spike is almost certainly going to prove temporary -- and Intel knows it.

When analyst John Pitzer asked CFO Robert Swan about the below-seasonal guidance that Intel gave for the first quarter of 2018, Swan said that the company expects "more normalized enterprise [server processor]" growth in the quarter.

In response to another, related question, Swan said that Intel is "not anticipating enterprise growth to stay at these levels as [it goes] into [2018]."

This is the smart thing for Intel to do in providing financial forecasts -- it's better to bake in achievable expectations and potentially surpass them than to assume that an abnormally strong performance in a historically problematic business in one quarter represents a fundamental change in the trend line.

So, I think it's unreasonable for investors to expect another quarter in which DCG grows another 20% year over year, and I'm glad that Intel is explicitly cautioning investors to keep their expectations in check.

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Ashraf Eassa owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool has a disclosure policy.