Did Amazon Just Save Intel Stock?

It can pay to have rich friends.

This is especially true when that friend runs the largest cloud computing business in the world and you’re a computer chip maker. That is why Intel (INTC 3.31%) stocks rose after the company announced a new partnership with Amazon (AMZN 0.91%) for custom chip designs for its Amazon Web Services (AWS) subsidiary.

Intel shares rose from about $19 to $21 on the news, bucking the painful losses shareholders have suffered in recent years. Intel shares are down 70 percent from their five-year high as the company struggles to build its new foundry business and compete in the artificial intelligence (AI) era. Today, Amazon is taking a step forward and saying it will make a long-term investment in Intel’s computer chip business.

Does this make Intel stock a buy after it’s down 70% from recent highs?

Chip Design Partnerships

On September 16, Amazon and Intel announced a co-investment in custom chip design expected to cost billions of dollars. In other words, both companies agreed to pool resources to design computer chips together. Amazon will also spend $7.8 billion in central Ohio to develop data centers. It’s near where Intel is building a $20 billion semiconductor factory.

The relationship between Amazon and Intel is tightening. This makes sense for two key reasons. First, Intel is one of the largest suppliers of computer chips for AWS data centers. Amazon spends billions of dollars with Intel every year, so if they can improve their chip design, both companies stand to make money. Second, Intel has lost market share during the AI ​​boom of recent years Nvidia and Advanced microdevices.

Nvidia, in particular, is making big strides in AI and has raised its prices for customers like Amazon. Amazon likely sees this chip design partnership with Intel as a way to increase competition with Nvidia, which will hopefully drive down the costs of its computer chips. Intel can win by stealing market share back from Nvidia.

An independent foundry

Intel’s business has suffered in recent years due to its vertically integrated chip manufacturing business. Nvidia and AMD don’t make computer chips, they simply design them using software. They are made by Taiwan Semiconductor Manufacturing (TSMC), which operates what is known as a foundry business model. This company serves as a semiconductor manufacturer for many parties, but never competes directly with its chip design customers. TSMC has amassed a large share of the semiconductor manufacturing market and has taken the crown from Intel as the most advanced developer in the entire sector.

A few years ago, Intel began planning to build its own foundry business to compete with TSMC. So far, the business has not gone well. Last quarter, revenue was $4.3 billion, flat, and the segment had an operating loss of $2.8 billion. Intel is playing the long game with the foundry business. It plans to invest tens of billions of dollars in the United States for manufacturing in places like its Ohio facility. With the CHIPS Act from the US government, you should be eligible for subsidies for these expenses.

This bet must work because these capital investments in new manufacturing facilities are burning a hole in Intel’s pocket. Free cash flow was negative $12.6 billion in the last 12 months and has turned sharply negative after being positive for decades. To return to positive free cash flow, Intel will need to acquire chip spend from its partners, such as Amazon (a current customer of TSMC) for its foundry business.

INTC Free Cash Flow Data by YCharts

Should you bet on Intel stock?

At current prices, it’s hard to value Intel stock. The company is going through a tough investment cycle and is currently unprofitable. It trades at a market cap of $88.6 billion, which looks cheap compared to its historical cash flow generation of more than $10 billion a year before its competitive struggles.

I think this partnership with Amazon is a positive development, but it doesn’t save Intel’s business and/or stock. The company has been lagging behind in the semiconductor market for several years. It is making a risky bet to switch its business to the foundry model amid this declining market share. It is unclear whether this will be successful. Meanwhile, it’s burning through more than $10 billion a year in free cash flow.

However, if Intel is successful and becomes the US version of TSMC, there is plenty of upside for the stock. TSMC is approaching a market cap of $900 billion, which is 10 times larger than Intel currently. It is not implausible for Intel to achieve this valuation if the business model transition is successful.

Investors looking to bet on Intel should make it a small position in their portfolios given the stock’s high upside and downside potential.