Intel’s data center business is struggling

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Given the strong growth of leading cloud computing companies, it’s a bit surprising how Intelit is (INTC -8.56%) data center activity carried out during the second quarter.

Intel’s enterprise customer base is far broader than cloud providers, and recession fears are beginning to impact business buying and expansion decisions. But the company did not even live up to expectations.

unexpected weakness

Intel’s data center and artificial intelligence (AI) segment generated $4.65 billion in revenue in the second quarter, down 16% year-over-year. Analyst Vivek Arya of Bank of America (BAC 1.47%) Merrill Lynch pointed out on the earnings call that this performance was nearly 25% below expectations, which was likely a key reason the stock fell around 9% on Friday afternoon.

Several factors dragged down Intel’s highly profitable data center business. First, much like what is happening in the PC market, Intel’s data center customers are adjusting their inventory levels to better reflect current market conditions. Companies selling servers don’t want to hold so much inventory of components in the face of uncertain demand, and customers using Intel’s data center chips for their own data centers might adjust their upgrade plans and expansion as the economy weakens.

Second, Intel is struggling to get its hands on the components it needs, including Ethernet and power components. Supply chain constraints are still hampering the semiconductor industry, although a drop in demand could go a long way to solving this problem.

Finally, Intel has acknowledged some runtime issues with its Sapphire Rapids data center processors. An additional step, essentially a design change, has been made to the product line as the company aims to keep “the high quality bar”, according to CEO Pat Gelsinger. Production of major Sapphire Rapids processors won’t ramp up until late this year and next year, which will push back some revenue.

For the full year, Intel has lowered its expectations for its total server-related addressable market to reflect slower growth. The company also expects to grow more slowly than the overall data center market as it rebuilds its product portfolio. Intel is the market leader, but it is under pressure from competitors’ competing products Advanced micro-systems (AMD 3.05%).

Why a turnaround is so important

Intel’s data center business is a cash cow, or at least it used to be. In 2020, for example, the data center segment generated operating profit of $10.6 billion on $26.1 billion in revenue. That’s an operating margin of about 40%.

Headwinds Intel is facing in the data center business sent operating profits tumbling in the second quarter. The segment generated operating profit of just $214 million, compared to $2.1 billion in the same period last year. This 90% drop was due to a multitude of factors, including start-up costs for advanced manufacturing nodes, investments in the product roadmap, and expenses related to pre-production of Sapphire Rapids processors.

Intel is optimistic that Sapphire Rapids will be a successful product line, but Gelsinger admitted on the earnings call that the company’s execution around it hasn’t been its “finest hour.” execution machine, adding: “We are rebuilding our execution machine”.

Intel expects its opportunity in the data center market to grow by at least a percentage of around 12% per year over the long term. Sapphire Rapids, along with ancillary products like its Arctic Sound-M data center GPU, will help it capitalize on this growth once it gets its ducks in a row.

Bank of America is an advertising partner of The Ascent, a Motley Fool company. Timothy Green holds positions at Bank of America and Intel. The Motley Fool holds positions and recommends Advanced Micro Devices and Intel. The Motley Fool recommends the following options: $57.50 long calls January 2023 on Intel and short $57.50 January 2023 calls on Intel. The Motley Fool has a disclosure policy.

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