Advanced Micro Devices (AMD) has seen its stock price climb up by ~70% in the last one month, as the fears over its bankruptcy recede due to its new design wins. The company's stock has been hammered over the last 5 years as Intel (INTC) tightened its grip over the server and PC processor markets. AMD was hurt further by the secular decline in the PC market, with tablets and smartphones winning over potential PC customers. AMD was also beaten soundly by Nvidia (NVDA) in the discrete GPU market. With its core PC market declining, AMD has been forced to restructure. The company is now focusing on newer markets such as dense micro servers and embedded processors to survive. Its efforts in making custom processors have proven to be quite successful. AMD managed to win over Sony (SNE) (for its next generation PS4 gaming console) from arch rival Nvidia. With Nintendo already in the bag, AMD is also very close to winning over Microsoft's (MSFT) new Xbox 720 processor as well. This will give AMD a complete monopoly in the gaming console processor industry and will ensure that it survives over the next 5 years. The stock is risky given that AMD does not have a great balance sheet and its position in the PC market remains precarious. However, if AMD is able to build on the console wins in other markets, then the stock has the potential to go much further.
AMD's changes focus to New Growth Markets
AMD has realized that it needs to urgently shift its focus from the declining PC market where it remains a second rate player. The company is coming out with APUs for the tablet and hybrid laptops market later in the year. The company is also going to focus on the dense micro server market using its SeaMicro acquisition. The recent gaming console wins will ensure that AMD gets a steady supply of revenues, which can support its fixed marketing and research costs.
1. Tailor-made Silicon Focus - AMD has got the greatest success in this area as it has managed to win over two crucial accounts. AMD believes that customers are shifting towards custom built processors to differentiate themselves from the competition. Most of those customers do not have the expertise or experience to design and make processors. AMD is uniquely positioned with its CPU and GPU expertise to fulfill the needs of these customers. AMD has managed to win over the PS4 processor account by creating a unique 8 core Jaguar solution for Sony. Apple (AAPL) designs its own processors and gets them made by Samsung (GM:SSNLF). In the future, AMD would look to build on the current design wins to win over bigger customers.
We think the semi-custom is an era that's just beginning because I believe that you are going to see this move where many players are going to look for differentiated solutions, they don't want just an off-the-shelf commercial processor, they don't have the capability to create the silicon themselves, they are going to want to work with a company like AMD who will tailor and innovate together with them to create a unique solution that allows them to differentiate in the market because when that customer wins we will win and that I believe we are just at the beginning of that opportunity.
2. Embedded Processors - AMD is targeting to generate 20% of its 2013 revenues from the embedded processor segment. The company has got a good integrated graphics processing product, through which it will target fast growing medical and industry segments. AMD is already a big supplier of GPUs to the PC gaming segment. Advanced GPUs are now being increasingly used in professional applications, as demand for imaging grows.
Areas like dense computing in terms of embedded processors in areas like industrial, medical, gaming, areas where we see both a graphical interface and a CPU across the interface. That combination plays exactly through an APU fusion strategy. I think it's very important as we look forward in 2013, we must continue to diversify that portfolio. 20% is a clear objective of our revenue by year end in these new high growth segments and we are on track… I believe that we are equally well-positioned to attack the embedded segment and the semi-custom segments where we are going to see players like Sony, like Medical Devices in the industrial sector where they need to have the graphical experience combined with the compute solution, where we will apply our hardware technology as well as our software technology around something called heterogeneous computing, which allows the effect of compute power of both the CPU and GPU to be unlocked in these new workloads that are emerging.
3. Tablets and Detachable Laptop Hybrid Markets - All major PC players have shifted focus towards the mobile devices industry in order to counteract the decline in the PC/laptop shipments. Intel will be coming out with advanced Silvermont chips by December 2013, while Nvidia is ready to start shipments of its next generation Tegra 4 and Tegra 4i in the next two quarters. AMD cannot afford not to play in this market. AMD has laid out a roadmap in which it will start selling "Temash" and "Kabini" processors for the mobile devices market, while "Kaveri" will be targeted towards the higher power PC market. It will be difficult for AMD to become a leading player where incumbents like Nvidia and Qualcomm (QCOM) have a solid technological and market lead. But the mobile devices market is a huge one with more than 1 billion units expected to be shipped in 2013. This means that even if AMD manages to win a small market share, it will manage to get a decent amount of revenue from this segment.
- Stock has run up a lot in recent days - The stock has rallied strongly with the broader S&P market, which has made some investors jump ship. The valuation still remains cheap and the stock price remains well below its all time highs. The company is in the second phase of its turnaround and the major gains will be reaped during the 3rd phase. New product launches in the 2nd half should act as a catalyst even as the console revenues provide a solid base for expansion.
- Manufacturing Risk - AMD sold its fabs to a JV with a Middle East investment group in order to raise cash. However, the company retains a close relationship with Global Foundries and is contracted to buy a minimum level of silicon from the foundry. If AMD fails to buy the required minimum number of chips, then it has to pay a large fine. AMD faces another risk if its partner foundries like TSMC (TSM) and Global Foundries fail to keep up with industry leader Intel in process technology. Intel is going to build mobile chips on its leading edge 22 nm node by the end of the year, while TSMC and others are still stuck at 28 nm. Intel will start producing chips on the 14 nm in 2014, which means that it will increase the lead over others.
- Cash Flows below par - AMD is the only big semiconductor company which is losing cash and that has weakened its balance sheet. Nvidia, Qualcomm and Intel have solid cash positions and are also generating large free cash flows each quarter. AMD does not have the cushion like others to take big risks and fail. The company is on a target to reduce 25% of its overall operating costs by Q3 2013, which should help reduce the pressure on the balance sheet.
AMD does not remain very cheap after a strong stock run in the last few months. The stock valuation has doubled with a P/S of 0.6x and the market capitalization has increased to $2.9 billion. AMD's valuation remains well below the broader industry P/S average at 2.7x. AMD was not a screaming buy when I last wrote about it, however the stock will go up if it manages to win over the Xbox account and shows new tablet/laptop design wins.
AMD's stock has been one of the best performing semiconductor stocks in 2013, giving a return of ~78% as compared to the ~18% return given by S&P 500 and Intel. However, the long-term performance remains bad. Over the past 5 years, AMD stock has lost ~44%, compared to ~4% loss given by Intel. The stock has more than doubled from its recent low of ~$1.8 made in late 2012. However, it still remains almost ~30% below its 52-week high of $6.46, reached during early 2012. This shows that AMD still has a lot of room to go up.
AMD has gone up dramatically since I had written that AMD is an alluring opportunity for investors given its history and valuation. The company management has done a good job in shifting AMD's focus to less crowded markets, using AMD's expertise in combining processing with graphics performance. While AMD will continue to deliver new generation processors for the tablet and PC markets, the company is looking to put more energy into newer and faster growing segments like embedded processors and dense micro servers. The company faces risks from bigger companies like Intel, Qualcomm and Nvidia in the mainstream mobile and PC CPUs and GPUs markets. However, the market remains big enough for a small player like AMD to create a big niche. While the stock has surged in the recent days, there is more room to go up. I would advise investors to hold on to their positions as AMD continues to execute in its turnaround.