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Thursday, March 16, 2017

Intel + Mobileye: Strategic Sense, Financial Nonsense

Mike Smitka
Prof of Economics, Washington and Lee University

Cars employ more and more processing power, from chips that handle keyless entry and kick-to-open functions to engine controls and now ADAS (Advanced Driver Assist Systems). Someday there may even be autonomous vehicles, requiring GPUs (graphics processing units) to interpret sensor data and powerful CPUs to run the algorithms. Intel has a very small automotive footprint, having been in and out of several segments over the past 3 decades, at one time making engine control modules for Ford, and buying Wind River, which had projects with BMW and Magnetti Marelli. As the computer and server markets mature needs to develop a wider footprint. At a broad level the Mobileye acquisition could serve as an entrée into the automotive sector, bringing systems capabilities for interpreting vision data that would bring instant access to most global automotive OEMs and major Tier I integrators such as Delphi.

...automakers would welcome a stronger Intel presence...

The automotive end would welcome a stronger Intel presence as well. Over the long haul, no car company wants to be tied to a single provider. Intel rivals are moving. In 2015 NXP acquired Freescale, now Qualcomm is acquiring NXP. That combination will have over $30 billion in revenue. Renasas and Infineon are out there, too, and in individual niches there are players such as NVDIA for GPUs – that ADAS thing – and infotainment systems. Major automotive players would love to have another strong player that they can pull into development projects.

One challenge is execution: Intel has $60 billion in revenue, Mobileye perhaps $300 million. By reputation Intel tends to swallow up small companies, but not digest them and spread their know-how into the larger organization. Selling into the automotive footprint is not easy, with long lead times, complicated and very idiosyncratic test requirements (your cell phone won't work if it's been out in the desert sun, or put through engine compartment vibrations for a month). Mobileye knows how to do that, and could ease Intel's reentry. They also understand the software and data flows in a vehicle system; selling a stand-alone chip is an uninteresting business. Intel needs to add value by bringing to the table a palette of software tools and interface capabilities that let it provide systems-level solutions. Thus it is important that Mobileye not be split up and spit out. The deal has it remaining a subsidiary based as now in Israel, rather than trying to move it (which means its key personnel) to the US. Instead Intel will move people there. Automotive customers will need convincing that this arrangement isn't temporary, and Intel will have to learn how to tap Mobileye's automotive knowledge. That won't be easy.

...the acquisition makes strategic sense...

So the acquisition makes strategic sense, even if there are non-trivial barriers to successful execution.

It does not make financial sense. Rounding so as to make the arithmetic easy, Intel has a P/E of 15. To pay back the $15 billion up-front price, they thus need to generate $1 billion in profits. That won't happen immediately, so we're implicitly doing a net present value calculation. Thus we should ask whether in 2025 the acquisition will be generating $2 billion in profits. (I used a 15% discount rate; assuming Mobileye is making $100 million, this requires that profits increase at an 80% annual rate.) Now maybe that can happen. Both Intel and Mobileye have fat profit margins, so in principle the combination will need to add incremental revenue of $8-$10 billion. But reaching that level will require continuing high levels of up-front investment, call it research. Unlike with making a chip, it will also require continuing R&D, here with an emphasis on the development side of the equation. This isn't like developing a chip, where all the costs lie up front, and the profits flood in once sales commence.

...yet Intel investors should be hearing a warning BZZZ...

Furthermore, the automotive development cycle is long. For all the hoopla about autonomous vehicles, we're looking at a few hundred experimental cars on the road globally in 2020. If that goes well, work will begin on real cars that will launch in the 2025 timeframe. But they will still be high in cost, and the market uncertain. (At the rate Uber and its ilk are losing money, they won't be customers.) Volume, if any, won't come until 2030 and beyond. The holy grail that will make cars a shell for expensive software systems run on expensive hardware will remain out of reach in a timeframe relevant even for patient investors.

In contrast, ADAS is already here. What isn't known is how well received it will be as it moves downmarket. There also remain major problems with the human interface. Drivers can't zone out on the interstate while lane-keeping and adaptive cruise control are engaged, and then just pop back in when there's a warning signal. The systems have to be fail-safe, or more accurately lawyer-proof. Yes, car manufacturers can try to force a driver to keep their hands on the steering wheel. The immediate market is commercial trucking, and in that footprint Intel has already purchased Peloton Technologies (not Peloton, the exercise equipment company!). However, that segment won't generate sufficient revenue to justify the price being paid for Mobileye. In the passenger setment, the rollout of ADAS technologies has been most aggressive in Europe, which is a more technology-friendly in its regulatory and legal system. Vehicle margins in the EU are thin. The big and profitable vehicle markets are NAFTA and China. In Asia, urban congestion and aggressive (random!) driving habits make the ADAS consumer value proposition challenging: when cars move, the warning systems would be producing a constant BZZZ.

Intel investors should be hearing a warning BZZZ, too.


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