Why is Intel’s datacenter business struggling?

Intel's datacenter business has performed badly during the second quarter. This is despite the fact of how the major cloud computing companies are growing.

Intel's datacenter and artificial-intelligence (AI) segment produced $4.65 billion of revenue in the second quarter, down 16% year over year. Analyst Vivek Arya of Bank of America pointed out during the earnings call that this performance was close to 25% below expectations, which was likely a big reason the stock had dropped around 9% by Friday afternoon. That is in sharp contrast to 2020, when Intel’s datacenter segment produced operating income of $10.6 billion on $26.1 billion of revenue. That's an operating margin of about 40%.

There were multiple factors behind the failure of Intel's highly profitable data center business.

Firstly, Intel's datacenter customers are adjusting their inventory levels to better reflect current market conditions. Companies that sell servers don't want to hold so much component inventory in the face of uncertain demand, while customers that use Intel's datacenter chips for their own datacenters are believed to be adjusting their upgrade and expansion plans as the economy weakens.

Second, Intel is facing difficulties in getting its hands on components it needs, including Ethernet and power supply components. Supply chain constraints are still hampering the semiconductor industry, although a drop in demand could go a long way toward fixing that problem.

Lastly, Intel admitted to some execution problems with its Sapphire Rapids datacenter CPUs. An apparent design change was done on the product line as the company aims to keep "the quality bar high," according to CEO Pat Gelsinger. Production of the main Sapphire Rapids CPUs won't be ramping up until the end of this year and into next year, pushing back some revenue.

For the full year, Intel has lowered its expectations for its server-related total addressable market to reflect slower growth. As it rebuilds its product portfolio, the company also expects to grow more slowly than the overall datacenter market. Intel is the market leader, but it's facing pressure from competitive products from rival Advanced Micro Devices.

Intel is optimistic that Sapphire Rapids will be a successful product line, but Gelsinger admitted during the earnings call that the company's execution around it hasn't been its "finest hour" in execution, adding, "We're rebuilding our execution machine."

Sapphire Rapids, as well as ancillary products like its Arctic Sound-M data center GPU, are expected to help the company tap into that growth once it gets its ducks in a row.