CHIPS Act – The Investment Journal

It accounts for 70% of the country’s GDP.

Consumer spending.

Makes sense. Healthy consumers are obviously necessary for a healthy economy.

But good health isn’t always apparent on the surface. Trouble can be quietly developing under the surface.

Like the heart disease candidate whose arteries are filling with plaque. They may look perfectly fine… until they’re lying on the ground clutching their chest.

Today’s economy is something like that.

Last October, the BEA announced that real GDP rose at an annualized rate of 2.8%.

That is an impressive number.

To take it at face value (much like the Fed has been insisting we do) you’d have to say that the economy, and consumers in particular, are doing just fine. So have another piece of cheesecake.

The reality underlying the situation, however, isn’t so good.

A Shift in Buying Preference

In a broadly healthy economy, a rising GDP should lift all boats. (Or most anyway.) You expect to see retailers posting great numbers across the board. Blood is pumping through those arteries.

But that’s not what has been happening. And it hasn’t been happening for some time…

All the way back in November 2022, the Wall Street Journal reported:

“Walmart gains more shoppers” sounds like good news. But article reported strains in the consumer sector:

The country’s largest retailer by revenue said Tuesday that households continue to face pressure from rising food prices, and lower-income shoppers are eating into savings.

Inflation was still roaring at the time and CPI for that month came in at 7.1%. And you’d expect that kind of news from lower-income shoppers. But what you might not expect…

During the most recent quarter, households earning $100,000 or more helped push Walmart grocery sales higher, executives said.

Sales data had indicated that higher-income consumers had begun to trade down searching for bargains. When inflation begins to reach the middle to upper income brackets, stress is beginning to build.

Still, with prices soaring over 7% annually, it’d be reasonable to argue that most households would be looking to save a buck or two.

But now with inflation “well on track back to 2%,” if you believe the Fed, things should be shifting back to normal. But they’re not.

In fact, they’re going in the opposite direction…

The Trade Down Continues

This November Walmart released its earnings. Not only did they beat revenue and earnings estimates, they raised their forward guidance.

In particular, management noted…

While average transaction growth slowed, customers are buying more at each visit, driving ticket sizes. A lot of that growth was driven by upper-income households making $100,000 a year or more as increasingly more affluent households trade down. That cohort made up roughly 75% of share gains for the quarter.

Two years later, the $100K and up cohort is still shopping at Walmart. And they’re doing it more and more.

This suggests clear strains in the economy. In a recent webinar, Goldman Sachs noted:

Our focus on the webinar centers around discussing high-end and low-end consumers trading down. This phenomenon occurs as macroeconomic headwinds mount, including elevated inflation and high interest rates due to backfiring ‘Bidenomics.’ More importantly, trading down occurs when incomes don’t keep up with inflation or when purchasing power decreases.

So the trade down phenomenon itself is suggesting trouble. But there’s more…

The bargain hunting isn’t carrying across the board.

Target, who released their earnings the same day as Walmart, missed everywhere with their stock dropping 21% on the news.

This suggests that the trade down to discount stores isn’t even widespread. (Even Dollar General collapsed on its latest earnings report.)

The bottom line: The trade down and concentration of retail customers suggests they’re taking a seriously defensive position as economic conditions become more and more uncertain.

Could be tough times ahead.

It’s a legacy that’ll likely end up being studied in grad school business books for years to come.

But whether it’s a story of success or failure remains to be seen.

In its 50-plus year history, Intel has gone from the world’s dominant semiconductor chip producer to verging on the edge of failure.

Not necessarily a reputation you like to hang your hat on.

In our last post, we said the government tends to make bad decisions when it comes to ~~spending~~ investing your money. Early this year, Intel put in and received the promise of a big chunk of Chips Act money to help build new fabrication and research facilities in Arizona.

If only $20 billion were the solution to all Intel’s problems.

The Big Arizona Bet

By way of a little background, Intel has committed to building two state-of-the-art fabrication plants (known as “fabs”) in Chandler, Arizona that will employ the company’s latest chipmaking process known as “18A.”

That number describes a 1.8 nanometer-class chip that would effectively compete with the 2nm and 3nm chips currently produced by Taiwan Semiconductor Manufacturing (TSM) — the world’s biggest contract fab.

Intel’s plan is to further compete with the likes of TSM by splitting their business into design-side and the manufacturing-side entities. CEO Pat Gelsinger explained In a recent company memo:

A subsidiary structure will unlock important benefits. It provides our external foundry customers and suppliers with clearer separation and independence from the rest of Intel. Importantly, it also gives us future flexibility to evaluate independent sources of funding and optimize the capital structure of each business to maximize growth and shareholder value creation.

Some prospective customers have taken note.

Amazon Web Services recently cut a deal with Intel to co-invest in a custom chip design based on the 18A platform for its servers. The deal was “a multi-year, multi-billion-dollar framework,” according to the press release.

On paper, this all sounds like a step in the right direction. Except the road ahead is anything but smooth. Fortune recently reported:

Meanwhile, costs for Intel’s planned Arizona fabs and two more in Ohio have soared past initial projections. The Arizona plants, which Intel is counting on having online in 2025, have been hit by construction delays.

Which has impacted the availability of $20 billion from the Chips Act:

In March it was awarded $8.5 billion in direct CHIPS funding and $11 billion in loans. But the money is tied to Intel hitting certain construction milestones, and it has yet to receive any funds.

And if that wasn’t enough…

And in September, Reuters reported that Broadcom, which makes networking and radio chips, had tested Intel’s process and concluded it was not yet ready for full production.

According to the WSJ: “Intel’s manufacturing arm is money-losing and hasn’t gained strong traction with customers other than Intel itself since Gelsinger opened the factories to outside chip designers three years ago.”

Completing the business split and getting the new fabs into production are critical for Intel’s future success.

White Knights to the Rescue?

Just two weeks ago, rival chip manufacturer Qualcomm approached Intel to discuss a possible takeover.

Intel’s stock popped. Qualcomm’s took a hit.

That’s because the deal would be a major financial stretch for QCOM.

The deal would be valued significantly above the amount of cash Qualcomm has on its balance sheet and would require taking on significant debt or diluting the company’s shareholders. This deal is viewed as a longshot at best.

Not long after the Qualcomm news broke, Apollo Global Management approached Intel with another offer to support their turnaround efforts:

Bloomberg reported, citing sources familiar with the matter, that Apollo recently proposed an equity-like investment of up to $5 billion to Intel’s management. The people said Intel execs were mulling over the proposal. There were no definite, as the investment could change or fall apart.

And there’s more good news coming from the government…

The Biden-Harris Administration announced today that Intel Corporation has been awarded up to $3 billion in direct funding under the CHIPS and Science Act for the Secure Enclave program. The program is designed to expand the trusted manufacturing of leading-edge semiconductors for the U.S. government.

This is a DoD targeted program that’s separate from the other $20 billion that’s stuck in limbo.

Can They Be the Comeback Kids?

Intel has a history of being on the wrong side of industry trends. (Like when it opted not to provide Apple with chips for its iPhone and ignored its GPU division as Nvidia was making inroads into the AI trend.)

Yet there’s always hope to right the ship.

Meta managed to do it — with a disciplined program of slashing costs and refocusing on its core business — after a disastrous investment in the metaverse that cost them three-quarters of their market cap in a little over a year.

But can Intel?

Given their history in the chip business, they’ll certainly be a stock to watch…

There’s something to be said for government investments…

They’re stupid.

Nearly every foray into industrial policy by a government ends up creating serious unintended consequences.

But that doesn’t mean they’ll stop trying.

This latest government go-round involving the tech industry will likely be no different.

Launching a Giveaway Program

Quick story… When global governments shut down the world during the pandemic, the US became painfully aware of just how dependent its economy was on foreign production of certain key materials. One notable dependency was in the semiconductor segment.

The shortage that followed sent shockwaves through multiple industries that relied on access to these tech components.

In the face of this realization, the government did what it does best.

It threw money at the problem.

In 2022 the Biden Administration (in cahoots with the US Congress) passed something called the Chips Act. The White House assured us that this $280 billion handout would:

…accelerate the manufacturing of semiconductors in America, lowering prices on everything from cars to dishwashers. It also will create jobs – good-paying jobs right here in the United States. It will mean more resilient American supply chains, so we are never so reliant on foreign countries for the critical technologies that we need for American consumers and national security.

In addition to targeting semiconductor manufacturing capability in the US, it would fund R&D in various “leading edge” technologies. (In other words, technologies that don’t have a viable commercial market of their own.)

One of the first to step up to the trough was the former heavyweight champion of the chip industry — Intel.

_{Source: CNBC}

According to the article:

Intel said it would spend its CHIPS Act funds on fabs and research centers in Arizona, Ohio, New Mexico and Oregon. The company previously announced plans to spend $100 billion on U.S. programs and facilities. Intel has announced a plan to catch up in leading-edge manufacturing by 2026.

Intel’s Ohio fab will cost more than $20 billion and Intel said it is expected to start production in 2027 or 2028. Intel is also expanding manufacturing operations in Arizona and New Mexico. Intel says the projects will create jobs for 20,000 people in fab construction and 10,000 people in chip manufacturing.

The company’s stock popped on the news.

Spending Down a Black Hole?

But that was six months ago. And oh how things have changed.

Early last month, Intel released a disastrous Q2 earnings report. Revenues missed expectations and resulted in a $1.6 billion net loss. EPS came in at $0.02 vs a $0.10 expectation.

The company announced it was suspending the dividend it’s been paying since 1992.

And now rather than creating tens of thousands of jobs, they announced they would be laying off 15,000 beginning this year.

The company’s stock is down over 60% year to date.

Intel Corp. (INTC) Year to Date.

_{Source: Barchart.com}

Intel CEO Pat Gensler said, “Our revenues have not grown as expected — and we’ve yet to fully benefit from powerful trends, like AI. Our costs are too high, our margins are too low.”

That may be the scariest statement of all.

For all intents and purposes the AI boom has been fueling the market since late 2022. If they’ve missed the bus for the past two years, it’s hard to imagine how they plan to catch up.

Intel has a bit of a history of being on the wrong side of industry trends. (Like when it opted not to provide Apple with chips for its iPhone.)

There’s always hope to right the ship. (Meta managed to do it after a disastrous investment in the metaverse.) But right now, Intel is nowhere near equipped to spend $100 billion on anything.

And given all this, is this where the government should be spending $20 billion of your money?