AMD (AMD) manufactures and markets microprocessors used in servers, desktop PCs and notebook PCs. A slowdown in global PC shipments, internal factors such as a change in leadership, a manufacturing glitch last year and a slow response to rapidly changing consumer needs has led to more than 60% decline in AMD’s stock price since March 2012. Declining cash reserves, mounting debt and negative cash flows from operations have dampened investor confidence in the company.
Our price estimate of $3.15 for AMD is at a premium of over 20% to the current market price. While we are wary of the factors that make it tough for AMD to see a quick turnaround, we believe AMD’s renewed focus on targeting high growth markets with new platforms and partnerships combined with its restructuring plan to revive its existing business can help it get back to profitability in the near future.
Here we provide a quick snapshot of how AMD makes money, the important segments that contribute to its business, and certain factors that could help turn around its business in the future.
What are AMD’s key markets and customers? What are the most important segments that contribute to its growth?
1. PCs: AMD manufactures and markets microprocessors and chipsets used in notebooks and desktops. Microprocessors are a PC’s central processing unit (CPU) which drives its power and performance. A chipset is the PC’s ‘nervous system’, sending data between the microprocessor and input, display, and storage devices such as keyboard, mouse, monitor, etc. AMD sells its processors to original equipment manufacturers (OEMs) and original design manufacturers (ODMs) such as Hewlett-Packard, Dell, Toshiba, and Sony.
Out of the $5.4 billion revenue earned by AMD in 2012, 64% was derived for the PC market. The $3.5 billion revenue from PCs can be further split into $1.3 billion, $1.6 billion and $0.6 billion from the sale of desktop processors, notebook processors and chipsets, respectively. On account of the drastic decline in AMD’s computing segment revenues and a $100 million inventory write-off, its operating margin from the division declined to -1.5% in 2012, compared to 15.5% in 2011. We believe that as demand for AMD products revives and it starts achieving higher productivity gains, its margins will rebound close to the historical level.
AMD currently accounts for approximately 17% and 14% of the desktop processor and notebook processor markets respectively. We estimate AMD’s market share in both divisions to increase marginally over our review period. AMD processors are more popular in the value segment and cheaper notebooks. With increasing demand from emerging markets, we expect demand for lower-priced AMD processors to increase in the future.
2. Servers: Servers manage large amounts of data, direct data traffic, perform complex transactions, and control central functions in local and wide area networks and on the Internet. With the rapid increase in online data processing, the server market is a fast growing division. AMD sells its processors directly to server manufacturers such as IBM (IBM), Dell (DELL), HP (HPQ), Fujitsu (OTC:FJTSF), etc.
AMD derives approximately 5% of its revenue from the sale of server processors. Its operating margins from the division are the same as that of the computing segment. AMD’s share in the server processor market has declined from 13% in 2008 to 4.5% in 2012 primarily due to execution issues and Intel’s increasing share in the server market with the launch of its Xeon processors.
However, since the launch of its Bulldozer architecture, AMD has seen a steady increase in demand for its high-end server processors. Additionally, AMD is in the process of designing ARM technology based processors in addition to its x86 processors for multiple markets, starting with cloud and data center servers. The new generation server products will start production in 2014. The collaboration with ARM will make AMD the only processor provider to bridge the x86 and 64-bit ARM ecosystems. We believe AMD can see a turnaround in its market share 2013 onwards.
3. Embedded Products: AMD designs embedded connectivity devices to address customer needs in PC-adjacent markets such as network-attached storage, telecommunications and networking equipment, Internet access devices, and other similar applications. Embedded products currently account for over 4% of AMD’s total revenue and earns similar operating margins as the PC business division.
AMD is focusing on increasing its share in additional embedded markets including communication, industrial and gaming among others. It intends to leverage the success of its APUs and graphics to tap the growing potential in such markets. AMD targets increasing the revenue contribution from its embedded business to almost 20%. While being extremely discrete about the progress so far, the company did declare in its last earnings call that it has scored significant design wins to meet the target.
4. Graphic Processing Units (GPU): AMD also manufactures high performance GPUs that generate realistic and interactive graphics on PCs. Usually a dedicated GPU and central processing unit (CPU) work in tandem to increase overall speed and performance of a system. AMD sells its products to PC manufacturers who offer customized desktop PCs to users as well as individual consumers (gamers) and digital media enthusiasts.
AMD derives 26% of its revenue from its GPU division and earns 13% operating margin on the same. The $1.4 billion GPU revenue can be further split into $600 million, $220 million and $580 million approximately from discrete desktops, professional graphics and discrete notebooks processors, respectively.
Nvidia is the only major competitor in all three markets. AMD currently accounts for 30%, 16% and 38% of the discrete desktop, professional graphics and discrete notebook processor markets respectively. Because of intense competition between the two companies, we estimate AMD’s market share in discrete notebooks and desktop GPUs to remain around the current level. However, since AMD has a very low penetration in the professional GPU market, we anticipate its market share to increase over our review period.
5. New Tablet Platform Could Open Additional Revenue Stream
Having failed to score significant design wins, AMD’s earlier efforts to enter the tablet market were unsuccessful. Its first two tablet chips, including last year’s Hondo and Z-01 tablet chip, failed to make an impact. Earlier this year, AMD introduced its Temash platform that targets the fast growing performance tablets and hybrid markets. AMD claims that the new processor offers 100% higher graphics processing performance compared to its predecessor, Hondo.
We believe that AMD’s growing focus on the mobile computing market will have a minimal impact on turning around the stock price as it has a long way to go before it can effectively compete with Intel and established ARM players in the tablet market. Nevertheless, its mobile computing strategies could provide an additional revenue stream for AMD. We estimate Temash’s target market to reach 29 million by 2016. (Read: AMD’s Entry Into Tablets Will Not Help Its Stock)
Disclosure: No positions