AMD: Overvalued And May Raise Equity Capital

Jul.14.13 | About: Advanced Micro (AMD)

Advanced Micro Devices Inc (NYSE:AMD) is in the process of a turnaround. Management is reducing the operating costs and improving efficiency while executing the product roadmap and attempting to return to profitability. The team running AMD has certainly been effective in releasing new products and winning designs, such as the PS 4's semi-custom AMD processor.

With that said, the company is highly leveraged to the slumping PC market and I think management is not cutting expenses enough to offset the decline of revenue. In fact, given the recent increase in valuations, I think AMD is overvalued and may be forced to raise equity capital in the coming months.

With that in mind, I'm looking at short selling the current roughly $4.30 level with a trailing stop loss starting at $6. Management either cannot cut expenses without cutting into bone, or they are underestimating the slump of PC sales. Given their expense forecast, my optimistic model of revenue suggests the operating loss continues in 2013, which will reduce cash below the comfort range of the firm's management.

Recent Developments

AMD unveiled its 2014 sever strategy and roadmap, which includes three key products. "Seattle" will be the industry's only 64-bit ARM-based server SoC. "Berlin" is an x86-based processor that will available both as a CPU and APU. "Warsaw" is an enterprise server CPU optimized to deliver unparalleled performance and total cost of ownership for two- and four-socket servers.

AMD unveiled the world's first commercially available 5 GHz CPU processor, the AMD FX-9590. The 8-core CPUs deliver new levels of gaming and multimedia performance for desktop enthusiasts. The question remains, how many PCs with the processor will be sold?

AMD announced that the Gene Center of the University of Munich has accelerated its research capabilities using AMD's SeaMicro servers. The SeaMicro servers are like a mini-supercomputer in a box.

Also, AMD unveiled a new family of low power server processors. The AMD Opteron" X-Series is optimized for scale-out server architectures. The new X1150 and X2150 processors beat the top performing Intel Atom processor on key performance benchmarks.

AMD launched three new additions to its 2013 A-Series and E-Series Mobile Accelerated Processing Unit [APU] lineup. The 2013 AMD Elite Mobility APU is the world's first 28nm, quad-core x86 system-on-a-chip (SoC) APU designed for touch small form-factor notebooks, tablets, and hybrids 13-inched and below. The 2013 Mainstream APU is the first and only quad-core x86 SoC solution for entry-level and small-form factor touch notebooks. And the 2013 AMD Elite Performance APU offers the best graphics and compute performance for premium and ultra-thin notebooks.

AMD appears to be releasing excellent products, but I'm not sure they are or will be reflected in the financial performance.

Segment Analysis

AMD has two reportable operating segments; computing solutions includes microprocessors and graphics includes multimedia products. Both segments are leveraged to the PC and server markets.

As such, both operating segments have performed poorly recently. The performance of both segments will probably be poor for an extended period. I expect continued revenue declines. Management is cutting operating expenses, but they may not be cutting costs enough.

The segment analysis suggests the valuations should decline.

Consolidated Forecast And Valuations

From the perspective of the consolidated financial performance, the revenue decline is accelerating. That said, I'm forecasting revenue in the $918 million to $1.06 billion range in the second quarter with the operating loss in the $66 million to $102 million range and the net loss in the $110 million to $166 million range. For comparison purposes, revenue in the second quarter of 2012 was $1.41 billion.

Management is expecting the company will generate an operating profit in the second half of 2013. I'm not buying that. I'm modeling $3.52 billion to $4.07 billion of revenue with an operating loss in the $307 million to $518 million range and a net loss in the $483 million to $694 million range. I think the revenue decline will be too large relative to the cuts in operating expenses.

Price/Earnings 8.1
Price/Book 7.4 6.3
Price/Sales 0.7 0.7
Price/Cash Flow -5.4 -3.1
Click to enlarge

*Price/Cash Flow uses 3-year average.

In terms of valuations, this is a challenging company to value. But on a time series basis, AMD is overvalued. Relative to its five-year averages, AMD is overvalued. I don't consider an S&P 500 comparison relevant. Thus, I consider AMD overvalued.

AMD had about $1 billion of cash at the end of the first quarter. That said, I think the company could raise capital at some point this year. If it announces capital raising efforts, that will be a sign that the operating expense reductions were not enough to cover the revenue declines. A debt offering may come with too many restrictive covenants; thus, an equity offering may happen.

Share Price Forecast

Personally, I think the rise off of the $2 level to over $4 is a bear market rally. With that in mind, I would expect a drop back to the $2 zone and maybe lower. I would place a stop loss at the $6 level and use a trailing stop loss while short selling.

Management is a lot more optimistic than I am, but I don't think that they are right because I modeled a pretty optimistic forecast and I still have the company reporting a huge operating loss. Also, the guidance it gave for operating expenses isn't low enough for the company to return to profitability without a substantial rebound in a contracting PC market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.