TAM Flimflam
RJ Steinhoff, CFA Investment Process
Faced with lackluster growth in its core PC and data center businesses, Intel embarked on an ambitious plan to reinvent itself as a “data-centric” company. Its ambition was to become a purveyor of technology and software for cloud, artificial intelligence, networking, 5G and Internet-of-Things devices. At its early 2017 investor meeting, to illustrate the potential of this strategic shift, Intel introduced a new total addressable market (TAM) estimate of $220 billion. This “broader market view” was contrasted against the $45 billion TAM of its old approach, geared to PCs and servers. Who would not like a nearly 5-fold increase in market size? Investors sure did—Intel’s stock rose from $36 in February 2017 to a high of $60 by the end of 2019.
Intel’s recent results indicate that its new approach has encountered serious obstacles. Q3 earnings received a poor reception from investors with shares falling over 15% since then. The company faces weak data center pricing, production problems, and stiff competition from NVIDIA, AMD, and Xilinx, leading most analysts to reduce earnings estimates for the next couple of years. Since 2017, Intel’s stock has underperformed virtually all of its chip competitors.
Intel is not alone in touting TAM estimates as a way to inspire investors. Many companies, especially those in the tech space, have increasingly focused their conversations on TAM potential. In our review of over 20,000 filings, press releases and sell-side reports of NASDAQ-listed companies over the last ten years, “TAM” mentions increased from just over 250 to more than 1,600 mentions through the end of October. TAM is not just for tech; S&P 500 filings show a 53% growth in TAM references over the last 3 years.
Intel should serve as a cautionary tale for investors enraptured by TAM projections. Many stocks, with little earnings or even revenue today, have had significant runs on TAM enthusiasm alone. Investors need to be aware of the following risks:
Competition
A large market will attract multiple competitors. In Intel’s case, NVIDIA and AMD have become fierce competitor, active in the AI, autonomous driving, and IoT spaces. Microsoft is attempting to expand its TAM in gaming by driving down the cost of consoles and offering games over the cloud instead of via traditional, high cost consoles. Apple, Amazon, and Google, not materially in the gaming space 5 years ago, are new competitors with ample war chests.
Investment
Accessing new customers generally requires large investments in new technologies, product development, and personnel. This can require significant up-front expenditures, potentially reducing short-term cash flow and hindering financial flexibility. New debt or equity may have to be issued, creating leverage issues or dilution.
Acquisitions
Expanding TAM via M&A introduces several risks. Acquired companies may not be the right cultural fit. For example, Google entered the smart home market via its acquisition of Nest. A high-profile culture clash ensued, leading to the departure of Nest executives.
Impact on Existing Business
Companies attempting to ignite growth need to stay focused on their legacy businesses, often the primary source of cash flow. With so many production problems at Intel, one has to wonder if management has spread itself too thin.
Execution
Defining the market opportunity can be easily done by a consulting firm or a newly minted MBA graduate. Executing on the plan, and navigating the above risks, requires managerial dexterity, clearly defined goals, organizational flexibility, and access to sufficient resources. Execution is where most companies drop the ball.
What’s Wrong with a Niche Anyway?
Some of the best businesses in the world focus on creating differentiated products that enjoy pricing power and customer loyalty. Naturally, as a company expands, new products or services are introduced, that capture new customers, but the core market approach remains intact. Starbucks and Nike have expanded their product lines but both remain focused on a premium customer experience. Starbucks serves over 100 million customers across its 30,000 stores around the world. That is a lot of customers, but its TAM would increase manyfold with the introduction of lower-priced menu items found at competitors like Tim Hortons and Dunkin’. However, Starbucks has chosen to focus on ways to serve its core customer better, rather than chase new ones.
Investors need to treat TAM projections skeptically. Management teams will enthusiastically describe how a product will capture hundreds of millions of customers 5 to 10 years out. Be mindful of the myriad micro and macro risks that will likely materialize between now and then. Just look at the many products and services today that did not exist just 15 years ago when companies were planning for a future that didn’t envision the iPhone, social media, cloud computing, Uber, rock-bottom energy prices, or Zoom meetings.
As investors seeking value, while trying to avoid downside risk best we can, we patiently await opportunities where TAM flimflam has been fully exposed.
RJ STEINHOFF, CFA
DIRECTOR OF RESEARCH
DISCLAIMER
The information contained herein is for informational and reference purposes only and shall not be construed to constitute any form of investment advice. Nothing contained herein shall constitute an offer, solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. Investment accounts and funds managed by Generation IACP Inc. may or may not continue to hold any of the securities mentioned. Generation IACP Inc., its affiliates and/or their respective officers, directors, employees or shareholders may from time to time acquire, hold or sell securities mentioned.
The information contained herein may change at any time and we have no obligation to update the information contained herein and may make investment decisions that are inconsistent with the views expressed in this presentation. It should not be assumed that any of the securities transactions or holdings mentioned were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities mentioned. Past performance is no guarantee of future results and future returns are not guaranteed.
The information contained herein does not take into consideration the investment objectives, financial situation or specific needs of any particular person. Generation IACP Inc. has not taken any steps to ensure that any securities or investment strategies mentioned are suitable for any particular investor. The information contained herein must not be used, or relied upon, for the purposes of any investment decisions, in substitution for the exercise of independent judgment. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. We make no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained herein. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained herein.
All products and services provided by Generation IACP Inc. are subject to the respective agreements and applicable terms governing their use. The investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. Nothing herein shall constitute an offer or solicitation to anyone in any jurisdiction where such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation.
Faced with lackluster growth in its core PC and data center businesses, Intel embarked on an ambitious plan to reinvent itself as a “data-centric” company. Its ambition was to become a purveyor of technology and software for cloud, artificial intelligence, networking, 5G and Internet-of-Things devices. At its early 2017 investor meeting, to illustrate the potential of this strategic shift, Intel introduced a new total addressable market (TAM) estimate of $220 billion. This “broader market view” was contrasted against the $45 billion TAM of its old approach, geared to PCs and servers. Who would not like a nearly 5-fold increase in market size? Investors sure did—Intel’s stock rose from $36 in February 2017 to a high of $60 by the end of 2019.
Intel’s recent results indicate that its new approach has encountered serious obstacles. Q3 earnings received a poor reception from investors with shares falling over 15% since then. The company faces weak data center pricing, production problems, and stiff competition from NVIDIA, AMD, and Xilinx, leading most analysts to reduce earnings estimates for the next couple of years. Since 2017, Intel’s stock has underperformed virtually all of its chip competitors.
Intel is not alone in touting TAM estimates as a way to inspire investors. Many companies, especially those in the tech space, have increasingly focused their conversations on TAM potential. In our review of over 20,000 filings, press releases and sell-side reports of NASDAQ-listed companies over the last ten years, “TAM” mentions increased from just over 250 to more than 1,600 mentions through the end of October. TAM is not just for tech; S&P 500 filings show a 53% growth in TAM references over the last 3 years.
Intel should serve as a cautionary tale for investors enraptured by TAM projections. Many stocks, with little earnings or even revenue today, have had significant runs on TAM enthusiasm alone. Investors need to be aware of the following risks:
Competition
A large market will attract multiple competitors. In Intel’s case, NVIDIA and AMD have become fierce competitor, active in the AI, autonomous driving, and IoT spaces. Microsoft is attempting to expand its TAM in gaming by driving down the cost of consoles and offering games over the cloud instead of via traditional, high cost consoles. Apple, Amazon, and Google, not materially in the gaming space 5 years ago, are new competitors with ample war chests.
Investment
Accessing new customers generally requires large investments in new technologies, product development, and personnel. This can require significant up-front expenditures, potentially reducing short-term cash flow and hindering financial flexibility. New debt or equity may have to be issued, creating leverage issues or dilution.
Acquisitions
Expanding TAM via M&A introduces several risks. Acquired companies may not be the right cultural fit. For example, Google entered the smart home market via its acquisition of Nest. A high-profile culture clash ensued, leading to the departure of Nest executives.
Impact on Existing Business
Companies attempting to ignite growth need to stay focused on their legacy businesses, often the primary source of cash flow. With so many production problems at Intel, one has to wonder if management has spread itself too thin.
Execution
Defining the market opportunity can be easily done by a consulting firm or a newly minted MBA graduate. Executing on the plan, and navigating the above risks, requires managerial dexterity, clearly defined goals, organizational flexibility, and access to sufficient resources. Execution is where most companies drop the ball.
What’s Wrong with a Niche Anyway?
Some of the best businesses in the world focus on creating differentiated products that enjoy pricing power and customer loyalty. Naturally, as a company expands, new products or services are introduced, that capture new customers, but the core market approach remains intact. Starbucks and Nike have expanded their product lines but both remain focused on a premium customer experience. Starbucks serves over 100 million customers across its 30,000 stores around the world. That is a lot of customers, but its TAM would increase manyfold with the introduction of lower-priced menu items found at competitors like Tim Hortons and Dunkin’. However, Starbucks has chosen to focus on ways to serve its core customer better, rather than chase new ones.
Investors need to treat TAM projections skeptically. Management teams will enthusiastically describe how a product will capture hundreds of millions of customers 5 to 10 years out. Be mindful of the myriad micro and macro risks that will likely materialize between now and then. Just look at the many products and services today that did not exist just 15 years ago when companies were planning for a future that didn’t envision the iPhone, social media, cloud computing, Uber, rock-bottom energy prices, or Zoom meetings.
As investors seeking value, while trying to avoid downside risk best we can, we patiently await opportunities where TAM flimflam has been fully exposed.
DISCLAIMER
The information contained herein is for informational and reference purposes only and shall not be construed to constitute any form of investment advice. Nothing contained herein shall constitute an offer, solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. Investment accounts and funds managed by Generation IACP Inc. may or may not continue to hold any of the securities mentioned. Generation IACP Inc., its affiliates and/or their respective officers, directors, employees or shareholders may from time to time acquire, hold or sell securities mentioned.
The information contained herein may change at any time and we have no obligation to update the information contained herein and may make investment decisions that are inconsistent with the views expressed in this presentation. It should not be assumed that any of the securities transactions or holdings mentioned were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities mentioned. Past performance is no guarantee of future results and future returns are not guaranteed.
The information contained herein does not take into consideration the investment objectives, financial situation or specific needs of any particular person. Generation IACP Inc. has not taken any steps to ensure that any securities or investment strategies mentioned are suitable for any particular investor. The information contained herein must not be used, or relied upon, for the purposes of any investment decisions, in substitution for the exercise of independent judgment. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. We make no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained herein. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained herein.
All products and services provided by Generation IACP Inc. are subject to the respective agreements and applicable terms governing their use. The investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. Nothing herein shall constitute an offer or solicitation to anyone in any jurisdiction where such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation.
