Qualcomm's Bid to Chase Intel in Servers Fell Victim to Broadcom

Ian King (Bloomberg) -- In early November, Qualcomm Inc. Chairman Paul Jacobs stood on a stage in the heart of Silicon Valley and vowed to break Intel Corp.’s stranglehold on the world’s most lucrative chip business.

The mobile internet and cloud computing were booming and the data centers running this digital economy had an insatiable thirst for computer servers -- and especially the powerful, expensive server chips that Intel churns out by the million. Qualcomm had spent five years and hundreds of millions of dollars designing competing processors, trying to expand beyond its mobile business. Jacobs was leading a coming-out party featuring tech giants like Microsoft Corp. and Hewlett Packard Enterprise Co., which had committed to try the new gear.

“That’s an industry that’s been very slow moving, very complacent,” Jacobs said on stage. “We’re going to change that.”

Less than a year later, this once-promising business is in tatters, according to people familiar with the situation. Most of the key engineers are gone. Big customers are looking elsewhere or going back to Intel for the data center chips they need. Efforts to sell the operation -- including a proposed management buyout backed by SoftBank Group Corp. -- have failed, the people said. Jacobs, chief backer of the plan and the son of Qualcomm’s founder, is out, too.

The demise is a story of debt-fueled dealmaking and executive cost-cutting pledges in the face of restless investors seeking quick returns -- exactly the wrong environment for the painstaking and expensive task of building a new semiconductor business from scratch. It leaves Qualcomm more reliant on a smartphone market that’s plateaued. And Intel’s server chip boss is happy.

“They were the ones that had enough clout to make a mark,” said Alan Priestley, an analyst at Gartner Inc. “Qualcomm had the best chance.”

The idea of a Qualcomm server chip business started in late 2012 as the company looked for new markets beyond smartphones. Server processors can sell for more than $10,000 each in a market utterly dominated by Intel. The idea was to get the energy efficient properties of mobile chips into a more powerful design that would appeal to data center owners such as Microsoft and Google that were looking to save on operating costs and needed a balance against Intel in price negotiations.

Qualcomm repurposed its design center in Raleigh, North Carolina, adding engineers from Intel, IBM and Advanced Micro Devices Inc. It was home to some of the most accomplished processor engineers in the industry. They’d already designed some of the company’s best mobile chips, products that made the San Diego-based company the biggest provider of silicon for smartphones.

The 1,000-person team was tasked with creating chips capable of performing some of the toughest jobs in computing, from making complex calculations that predict the weather to mapping the human genome. The most common use, though, is crunching the information flowing through giant data centers owned by the likes Microsoft, Facebook, Amazon and Google. When you search for something on the web, check your social-media app or buy something online, these are the chips making it happen. Intel rakes in almost $20 billion a year in revenue selling the components.

To break into this business, you can’t just make a good chip. What’s really needed is a road map of future processors that will improve over time dependably. Then comes software and engineering support to convince data center operators that all their programs and services will work with the components. One server chip can’t just be popped out and replaced with a different one in an afternoon. The process takes years and customers are loath to change what’s already working -- even if they’re sick of paying Intel so much.

Just designing a server chip costs hundreds of millions of dollars these days. The last time Intel was seriously challenged was in 2006, when AMD got a fifth of the market. Work began on this AMD server processor in 2000, when Mark Zuckerberg was still a teenager and the word "cloud" referred only to white fluffy things in the sky. AMD’s market share ended up back at almost zero as its new products came late or didn’t live up to their billing. By 2015, some analysts worried AMD might go bankrupt.

Qualcomm was one of the few companies capable of challenging Intel again. Its $5.5 billion annual research and development budget is third only to Intel and Samsung in the chip industry. By the launch event in November last year, Qualcomm was beginning to attract public support from companies such as Microsoft and Facebook, leading some analysts to predict an end to Intel’s lock on all the profit.

All was looking good as Qualcomm and Jacobs prepared for the coming-out party in San Jose, California. But two days before the event, rival Broadcom Inc. announced it wanted to buy Qualcomm in the industry’s biggest-ever deal.

The hostile takeover battle that ensued pitted two divergent views of the industry’s future. Broadcom’s Hock Tan saw inevitable commodification and preached consolidation and cost-cutting to prepare. He also planned to borrow as much as $106 billion to pay for the deal, leaving less cash for R&D. Jacobs argued that, rather than pouring cash into debt payments, chip companies needed to keep investing in emerging technology to find new markets.

The U.S. government blocked the deal in the end. But before that happened, many investors sided with Tan, forcing Qualcomm to slash spending plans by a billion dollars. The budding server business was the main victim of those cuts.

By early this year, it was clear Qualcomm’s support for the server effort was evaporating, setting off a frantic round of deal negotiations to try to save it. Anand Chandrasekher, who oversaw the business, persuaded a group of investors including SoftBank and Singapore’s Temasek Holdings Pte. to support a management buyout. They made an offer, but Qualcomm Chief Financial Officer George Davis demanded the transaction close by a specific time, scuttling the deal, according to people familiar with the process.

After Jacobs was ousted from Qualcomm in March, he offered to buy the server chip business, too. He even proposed letting the company keep a minority stake. Qualcomm could avoid spending money on the project, but could still profit later if it worked out. But Qualcomm’s board insisted that Jacobs give up any attempt to return to Qualcomm and abandon his plan to try take the whole company private, the people said. He refused. Once again, the unit was left hanging.

Former Intel executive Renee James considered buying the unit to integrate into her data center chip startup, Ampere Computing, according to the people. However, Chandrasekher had earlier brokered a deal with the Chinese province of Guizhou to fund part of Qualcomm’s server chip work. In return, the local government demanded the transfer of chip designs and exclusive rights to sell the processors in China. Ampere’s James balked at the conditions, which would have locked her out of a giant market, the people said.

In May, Chandrasekher left after leading Qualcomm Datacenter Technologies for almost half a decade. Others followed. By June, the company had cut about 280 jobs in Raleigh and 43 in California. Almost half the unit’s engineers have gone now, and some of them are working for James at Ampere. That’s left the Qualcomm unit short of the expertise needed to continue, even if it had full funding, according to former employees.

Qualcomm President Cristiano Amon said the company has "right-sized" the server business for the market opportunities. The division will now concentrate on selling chips to a couple of the largest cloud providers, and Chinese customers such as Alibaba Group Holding Ltd. and Tencent Holdings Ltd. through the joint venture with Guizhou province.

Behind the scenes, work has been shelved on a successor to the chip that rolled out with much fanfare at the November event. Qualcomm will consider adapting the existing design for use in smartphone base stations, but as a direct competitor to Intel, the effort is over.

“Qualcomm became more like Broadcom even though the acquisition didn’t happen,” said Shane Rau, a semiconductor analyst at IDC. “You had a company with deep pockets and an understanding of what the customer base wanted. The market was hungry for such a vendor.”

Qualcomm Chief Executive Officer Steve Mollenkopf is now saying future growth will come from the company’s traditional strength in the mobile phone industry, which will start a transition to so-called fifth generation, or 5G, technology next year. His board is backing him and plans to announce a bigger pay package for the CEO, according to people familiar with the situation. The company also said it’s on course to generate $5 billion in sales from other markets in its 2018 fiscal year.

That leaves Intel, which is more than ever the only major supplier of chips that power the internet. In its latest quarter, the company turned $5.5 billion of sales from its server business into $2.7 billion of operating profit.