Transforming a multi-billion dollar, capital intensive manufacturer into a slimmer company with very little capex, takes time to successfully complete. AMD completed a full divestiture of any remaining stake in its old manufacturing assets over a year ago, but the transformation to a profitable and growing company did not start until this year.
In almost all cases, Duopoly competition produces consistent profitability for the #2 company, except in heavily capital intensive businesses. When an industry requires very high capital expenses to remain competitive, the larger more efficient manufacturer can increase market share and profits, while the #2 company loses money. With the exception of a few product cycles, when AMD was first to market with an innovative design, Intel consistently used their manufacturing prowess to starve their significantly smaller competitor of profitability.
AMD has 2 main business units; the PC/server area, and the Graphics area. In the PC/server area, AMD's only competitor is Intel (INTC). In the high-end Graphics area, AMD's only true competitor is Nvidia (NVDA). While Intel is increasing its efforts in the Graphics area, they have been mainly relegated to lower level products, leaving only AMD and Nvidia to compete in the high-end space.
Where AMD is just now showing signs of dominance, is the fusion of the Central Processing Unit, referred to as the CPU, and Graphic Processing Unit, called the GPU. The game console design wins thus far utilize what AMD calls an APU, which stands for Accelerated Processing Unit.
Although both Intel and Nvidia have created a single chip holding both the CPU and the GPU, AMD appears to have the clear lead in integrating the functionality of these separate processing units. For the power of AMD's APUs to be more fully harnessed, and become more broadly accepted beyond custom game boxes, requires that software be written to support these next generation fusion processors. AMD's efforts to create industry standards for next generation APUs, has been well supported by industry giants Qualcomm (QCOM), Samsung (GM:SSNLF), Texas Instruments (TXN), LG, Arm (ARMH), who are members of The Heterogeneous System Architecture (HSA) Foundation.
What has Changed?
Now that AMD is able to access the manufacturing prowess of TSMC, (TSM) Intel will no longer want to wage a price war against AMD in the PC space, or in the server market. Additionally, there are unofficial reports that AMD will be using or working with Samsung, the other massive Asian semiconductor manufacturer.
When the PC space was growing, it made more sense for Intel to increase market share through tough price competition, which starved AMD of the cash flow needed to fund investments into next generation manufacturing facilities. But, that strategy no longer makes sense, when Intel is being forced to sacrifice profitability in order to gain market share in the growing mobile area.
From the Chromium projects' website updated May 2012:
Traditionally, web browsers relied entirely on the CPU to render web page content. With capable GPUs becoming an integral part of even the smallest of devices and with rich media such as video and 3D graphics playing an increasingly important role to the web experience, attention has turned
on finding ways to make more effective utilization of the underlying hardware to achieve better performance and power savings. There's clear indication that getting the GPU directly involved with compositing the contents of a web page can result in very significant speedups. The largest gains are to be had from eliminating unnecessary (and very slow) copies of large data, especially copies from video memory to system memory. The most obvious candidates for such optimizations are the <video> element when using a hardware decoder and the WebGL canvas, both of which can generate their results in areas of memory that that CPU doesn't have fast access to. Delegating compositing of the page layers to the GPU provides other benefits as well. In most cases, the GPU can achieve far better efficiency than the CPU (both in terms of speed and power draw) in drawing and compositing operations that involve large numbers of pixels as the hardware is designed specifically for these types of workloads. Utilizing the GPU for these operations also provides parallelism between the CPU and GPU, which can operate at the same time to create an efficient graphics pipeline.
Since Android has taken over the mobile world, nobody can deny the vision and competence of the top software designers at Google.
While Intel has some lower-end GPU capabilities, AMD and Nvidia are the recognized leaders, with more than a full cycle advantage.
Graphic capabilities will become increasingly important as the internet becomes dominated by video, rather than simple text file transfers.
AMD has much more experience and success in 64 bit server chips than Nvidia. Because AMD has a wide lead in high-end graphic oriented server chips over both Intel and Nvidia, it appears that AMD is in a better position to benefit from the explosion in video over the internet, which could explain why so many top managers have joined AMD over the last year or so.
Top Talent Joins AMD to harness GPU Efficiency gains
As partially discussed in this Seeking Alpha article, many top managers have joined AMD over the last year from Apple (AAPL), Qualcomm, Nvidia, etc. In most industries today, especially in Silicon Valley, the bulk of a top manager's compensation is based upon incentive stock options. The best and brightest in Silicon Valley, and throughout most of the world, desire to be employed at a company/university where their genius can "make a dent in the universe," in the words of the late Steve Jobs.
When top silicon valley talent switches employers, they are generally motivated by the upside from the incentive stock options they receive. Nobody on earth understands what is transpiring in the technology world better than the top talent in Silicon Valley. Therefore, when a number of silicon valley "insiders" put their careers on the line, in exchange for a large incentive stock grant, it is equivalent to large insider buy transactions. Clearly, large and very profitable companies such as Apple, Qualcomm, Cisco (CSCO), etc., can afford to pay larger cash salaries than AMD, but what they cannot do is provide large upside in their already bloated market valuations.
Demand for Graphic enhanced Customized Devices Driving AMD Growth
Both of the dominant game box platforms are using AMD in their customized devices, that do not conform to Windows, Apple OS, or Android, yet the software developers are happy, because the X86 platform processors provided by AMD allow for easy porting.
Because the PC/Microsoft is losing its monopoly as the dominant OS computing device, does not mean that demand for AMD's high-end graphics capabilities is waning. As discussed earlier, just the opposite is true. AMD's third quarter sales will increase by over 20% quarter-over-quarter, and year-over-year. Most impressively, AMD's third quarter operating expenses are dropping by 5%, while the topline revenue is increasing by over 20%.
So... What is there Not to Like?
Wall St. is short AMD in a big way, and is too stubborn and uninformed to simply cover their monstrous 120 million share short position. So they have come up with a whole slew of Swiss cheese excuses for not facing reality.
Excuse #1: They talk about the PC going away, which is utter nonsense.
Even though the 3,977 person survey of US adults was sponsored by Intel, the research firm IDC did produce results that most people I know agree with.
From All Things D article:
- 97 percent of respondents still consider their PCs to be their primary computing device.
- Of those, 41 percent say they intend to buy a new machine in the coming year; that number rises to 54 percent for parents and millennials.
- They consider access to their PC essential for daily existence. When asked what they would give up before losing access to their PC for a week, 73 percent said exercise, 71 said candy and sweets, 65 percent said caffeine, 58 percent said TV and 33 percent said their car.
- Total time spent on computing devices of any kind amounts to 43 hours a week, but more than half of that time - about 21 hours - is spent in front of a PC.
"But where the PC shines is in productivity. As much as consumers like their tablets, when it comes to getting anything important done, the PC is the tool they use to do it: 83 percent of respondents to the IDC survey said they are more productive on a PC than on a smartphone or tablet."
When a PC breaks, people who are productive will replace it. Therefore, the PC is not going away anytime soon.
Excuse #2: The game console business is dying, which again, is utter nonsense.
More people are playing electronic games than ever before. The game box user experience is 100 times more robust than what can be found on a handheld device, which explains why hard core game box and PC gamers do not stop playing, and play handheld games instead.
The analogy would be that a golfer gives up playing golf, so he can play miniature golf instead.... It simply does not happen.
Excuse #3: The forecasted gross margins are down 3% in the third quarter over the Q2.
Think about this twisted logic by a number of the Wall St. analysts after Q2 earnings conference call. These shills for the shorts had AMD losing money for the third quarter before the company gave clear guidance of profits for the third quarter. So, the analysts increased the bottom line from a loss to a gain, and then downgraded the shares.
All that really matters is bottom line profits, and not gross margins. I was long Supervalu (SVU) late last year, when Wall St. was short the stock up to their gills, and stubbornly refused to cover at $2/share. The shares recently traded above $8, and the shorts were covering almost the whole way up. Supermarket retailers have razor thin gross margins, but many produce enormous free cash flow. Which is why Cerberus, the super successful private equity firm tendered for up to 30% of SVU, while also buying out the Albertson's group of stores and some other chains from SVU.
All signs point to the recent game boxes to be blow out best sellers. In the most connected society on the planet, South Korea, their Government estimates that approximately 45% of its citizens are addicted to electronic games. South Korea is to connected devices, as California is to surfers and software design. Most trends related to electronic devices will show up in S. Korea before the rest of the world.
Bottom line, there is huge pent-up demand for game boxes in China, where they are presently banned, and from casual gamers who decide to upgrade to more intensive gaming.
Excuse #4: Cloud-based gaming will destroy the need for game consoles, and PCs.
First of all, Cloud-based gaming requires servers that will be based upon high-end graphics chips from either AMD or Nvidia.
Secondly, for most high-end action games to function correctly, the response times must be instantaneous. Even the fastest connection will take way too much time relative to a device on the premises. Anybody who has played high-end action-based electronic games will notice an unacceptable delay from a cloud-based game.
Excuse #5: Intel has a manufacturing lead over AMD's suppliers.
Intel said the same thing about the mobile area 10 years ago, and today they have practically no mobile share at all. Qualcomm, Apple, and Samsung have destroyed Intel in mobile processors, despite the so-called Intel manufacturing advantage. If the Intel advantage is so important, why do AMD and Nvidia dominate in high-end graphic chips? Graphic demands will be increasing dramatically over the next decade, and AMD will do the same thing to Intel, that Qualcomm did in the mobile phone space, in my opinion.
The GPU will become increasingly important to the efficiency of most devices, because of the need to model the real world. Modeling the real world is most efficiently effected by using parallel processing based GPUs. Almost all of the supercomputers use parallel processing.
It does not matter if the client device becomes increasingly "thin" as in Google glasses. Whatever camera data is sent to the cloud for processing, will require GPU-based parallel processing servers, rather than more CPU horsepower.
Excuse #6: AMD is overvalued, which is based upon the ridiculously low estimates by the Wall St. analyst/shills for the shorts.
AMD is in the first inning of a profit resurgence, yet most of the Wall St. analysts have already decided that there will be very little profits relative to sales, and very little growth.
AMD is just this quarter ramping up production of the custom chips for Sony and Microsoft, but the negative Nellie analysts have already decided that next year's shipments will be lower than any year, since the last game box models were launched, 8 years ago.
When I look at the consensus estimates from Wall St., and their bogus valuation, I think about the classic line: "Garbage in, garbage out."
AMD is now the Preferred APU provider for TV consoles
AMD has the inside track as the preferred supplier of APUs to all the other giants (Apple, Google, Samsung, etc.) that will be fighting to control the newest interactive audience, the TV room. The main reason for the other digital giants to choose AMD over the competition, is because all the gaming content developers are now optimizing their games for AMD's APUs.
Electronic games run better on the hardware that they were optimized for originally, than on other platforms that they are ported over to later.
The AMD Model will Produce Bottom Line Profits
AMD does not need large gross margins from their custom business customers, because most of the costs have already been covered by those same companies. AMD entered the third quarter at about a breakeven operating run rate, so most of the gross margin from the new console APUs flows directly to the bottom line.
Over the last 8 years, MSFT and SONY have sold an average of 10 million consoles each per year. Even though the first year of new consoles in 8 years should be well above average, let's use 20 million for a 2014 model.
Average APU priced at $75 times 20 million = $1.5 billion X 25% gross margin = $375 million
Let us assume that the new server chips do not gain traction, and the rest of a myriad of new products only produce the same results as the current breakeven run rate.
Therefore, $375 million less interest of $170 million = $255 million divided by the approximately 600 million of outstanding shares = 41 cents EPS in 2014.
A duopoly company that produces year-over-year increases in sales and profits of at least 20% should sell at least at a market multiple.
15 times 41 cents = $6.15 per share target price.
In my opinion, AMD will be incredibly successful with their new low cost, high efficiency per watt, 64-bit ARM based server chips, due to roll out in mid 2014.
Therefore, I believe that the 41 cents EPS from the above model, is extremely conservative, and therefore the target price is also well below my longer-term target. I will update the model after the next conference call.
Conclusion: AMD is using extremely conservative numbers for their third quarter forecast. More importantly, they will build on those numbers in subsequent quarters.
The Bottom Line is that AMD offers tremendous risk/reward at these prices.