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Intel's Strong Growth in Data Centers Dashed

Over the last year, the largest companies in cloud computing have burned through billions of dollars building data centers to accommodate all the businesses moving data to the cloud. Spending by Google, Amazon, Microsoft and others has resulted in robust growth for Intel, which holds around 98 percent market share in the computer processors used in servers.

But many of these companies have started slashing orders, the company said. They are trying to get through inventory accumulated over the last year before buying more. Intel recently reported its fourth quarter earnings, which showed signs of slowing revenue. Growth in the company's cloud business slowed from 50 percent in the third quarter to 24 percent in the fourth quarter of 2018.

“The cloud business is going to continue to grow,” Navin Shenoy, vice president and general manager of Intel's data center business unit, said on an analyst conference call last week. "There's no doubt about that." But he cautioned that "there is some lumpiness to the business, and there are periods where people build and then there are periods where people consume."

Robert Swan, Intel’s chief financial officer, said the weakness will continue in the current quarter, dragging down growth. In the first quarter, the Santa Clara, California-based company forecasts sales of $16 billion, down from $16.1 billion in the first quarter of 2018. Intel also projected sales growing one percent to $71.5 billion in 2019. The company has not grown that slowly since 2015.

Server chip sales increased 9 percent in the fourth quarter to $6.1 billion. Growth fell from 26 percent in the third quarter as the spending surge evaporated. At the same time, shipments of server chips jumped 10 percent. Intel's server chips, which can cost thousands of dollars, also increased slightly in price. Intel's Xeon processors perked up around 5 percent in average selling price. 

The slowdown cast a shadow over Intel's first full year of more than $70 billion in sales. Revenue rose 13 percent over the last year to $70.8 billion even though they fell short of the company's estimates. Intel reported annual growth of 9 percent in the fourth quarter, bagging $18.7 billion of revenue and $5.2 billion of profit. The results, however, also fell short of Intel's $19 billion forecast.

Intel may be dependent on data centers to grow, but the company's biggest business is still personal computers. Last year, the client computing business boasted $37 billion of revenue, an increase of around 9 percent annually. Intel's chips are inside nine out of every 10 personal computers. In contrast, Intel's data center revenue totaled $23 billion in 2018, up 13 percent from 2017.

In the fourth quarter, Intel sold $9.8 billion of personal computer chips, up 10 percent over the last year despite shipments declining. According to Gartner, global shipments of personal computers slumped 4.3 percent in the fourth quarter due to uncertainties around political and economic conditions. But average selling prices rose because of an ongoing chip shortage, Swan said.

Intel's challenges stem from more than dwindling demand in data centers. Shrinkage in global smartphone sales has impaired Intel's earnings, Swan said. Global trade tensions cut also cut into the company's business in China, the largest market for semiconductors. Cloud computing companies in China are tightening their belts, too. Memory prices are also cooling down, eroding profits.

Demand slowed for Intel's cellular modems in the fourth quarter. Business has been booming since Intel started supplying the chips to Apple in 2016. And today, every iPhone is shipped with Intel inside. In the third quarter of 2018, Intel's modem business jumped 131 percent. But in the fourth quarter, growth plummeted to 45 percent, resulting in $200 million less revenue than it projected.

Intel is also struggling to prevent its largest competitor in computer chips, Advanced Micro Devices, from eating into its market share. Last year, Intel said that chips based on its latest 10-nanometer node would be delayed for another year, sparking concern that the company had lost its manufacturing edge. Intel said that the processors will be inside personal computers by the end of 2019.

That has given AMD a golden opportunity. The company plans to start shipping 7-nanometer processors produced by TSMC in the second quarter. TSMC's 7-nanometer node is about as advanced as Intel's 10-nanometer process, according to industry analysts. Intel is also under pressure from Nvidia, which is building graphics accelerators that threaten to marginalize Intel's silicon in servers.

Intel is trying to move past the difficulties. Intel's latest line of server chips, Cascade Lake, is designed to protect against the Meltdown and Spectre security vulnerabilities that stunned the technology industry last year. The chips are also capable of running artificial intelligence algorithms—a process called inferencing—more efficiently. Graphics chips are often used to train those algorithms.

Last month, the Silicon Valley company said it would start adding on to manufacturing plants in the United States and abroad in 2019. The move follows an effort in recent months to combat shortages of chips used in its core markets of personal computers and data centers. Intel said that the added capacity would allow it to respond to future supply shortages up to 60 percent faster than today.

Intel bumped capital spending last year to $15.2 billion, up from forecasts of $14 billion, in an attempt to smooth over the shortages. In recent months, Intel has focused on producing processors with higher margins for data centers and desktops instead of cheaper chips. The shortage should end in the second quarter, Swan said. Capital spending in 2019 is projected to be $15.5 billion, he said.

But the highest priority is hiring Intel's next chief executive. Swan took over after Brian Krzanich was forced out of the company last year for running afoul of policies that prevented him from having a relationship with another employee. But Swan's appointment was never supposed to be a permanent. The search for his replacement has been going on for half a year now.

Swan has said he doesn't want the job permanently. "The board continues to evaluate candidates for what I believe is the biggest and best open job on the planet," he said on the analyst conference call. "They are proceeding with a sense of urgency, while also ensuring that they make the right choice." He added: "In the meantime, we will not be distracted by the void."

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