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In this article, I will discuss why AMD made a long term strategic decision to focus on semi-custom and embedded markets for future growth and profitability. In the words of CEO Rory Read, from the Seeking Alpha Q1 2013 Conference call:

"we remain on track to deliver more than 20% of our revenue from semi-custom and embedded markets by the fourth quarter, and 40% to 50% of our revenue from these and other high growth markets in the next two to three years. 40% to 50% of our revenue from these and other high growth markets in the next two to three years."

Semi-Custom and Embedded Markets provide multi-year design wins

There is a significant cost to redesign new products, both for the end user and for component suppliers, such as AMD. Systems such as the Microsoft's (NASDAQ:MSFT) Xbox One, and Sony's (NYSE:SNE) PS4, have chosen AMD's semi-custom APUs, because of their superior graphics capabilities. It has taken Microsoft and Sony well over a year to design their new game boxes, which are expected to be sold for the next 5 years or so, while the last models sold for 8 years.

In the cut throat mobile phone, tablet, and PC areas, products are updated annually and sometimes every 6 months. The constant update cycle from numerous competitors, sometimes leaves component suppliers with obsolete inventory, resulting in charge off losses.

Multi-Year Design Wins Better Protect AMD's Valuable Intellectual Property

Many analysts seem to have forgotten that Intel's (NASDAQ:INTC) extremely valuable server/cloud franchise is based upon the patented AMD 64 bit technology. Furthermore, only AMD and Nvidia (NASDAQ:NVDA) control valuable high end graphic technology that will become increasingly important in the future, as described in this Seeking Alpha article

Because AMD and Intel have a cross licensing agreement, Intel was able to use AMD's 64 bit technology, and end up taking 95% of the server market.

But, when AMD's technology is built in a semi-custom product with a multi-year life span, that customer cannot be stolen away until the next proprietary design is put out for bid.

The longer any technology based company, such as AMD, can protect their proprietary IP from copycats, the greater their ability to derive higher net profit margins, over the long term.

Semi-custom and embedded components are much more profitable, when measured over the life of the product, than products that must be constantly redesigned.

Leveraging Reusable IP blocks

AMD is racking up numerous semi-custom/embedded wins, using basic building block cores. This strategy allows AMD to employ fewer designers per semi-custom/embedded wins, which will drive greater profitability in the future. AMD does have specific teams assigned to each customer, which provide continuity for future products. In other words, AMD should have the inside track for the next semi-custom/embedded chips that are required by each customer.

Many Wall Street Analysts Fail to Appreciate the Distinction Between Long Term Net Margins, Versus Short Term Gross Margins.

In AMD's last quarterly conference call, they forecasted that total Gross Margins would fall from 39% in Q2, to 36% in Q3, but the bottom line would move from a loss to a profit. Curiously, a few analysts who were forecasting a loss for the Q3, chose to downgrade AMD, even though the bottom line forecast was better than their expectations.

From a shareholder perspective, what should matter most is the bottom line free cash flow available for either growing the company, and/or reducing debt/buying back shares/paying dividends

In a previous Seeking Alpha article, Advanced Micro Devices: Free Cash Flow above Expectations, it is shown that AMD will be growing the top line revenues by about 22% sequentially, while simultaneously generating enough free cash flow to pay down their liabilities by $200 million, over the next 2 quarters.

Conclusions

The availability of significantly greater bandwidth, which has empowered the growth in loud services, is slowly destroying the "Wintel" monopoly.

While the initial result was bad for AMD, the next era in computing is driving a proliferation of new products, which generally require semi-custom chips.

Thus far, AMD's IP is being employed in all of the major game boxes, which will produce at least 20% of AMD's revenues in Q3 2013.

AMD has indicated that they will be able to announce additional semi-custom/embedded wins over the next few months, and is on track for this category to grow to 40% to 50% of total revenues over the next few years.

Wall Street does not appear to appreciate the long term transformation that AMD is making in its basic business structure. CEO Read and his team, are executing well on their transformation of AMD, to a significantly more profitable business model, for the long term.

Over time the semi-custom/embedded area will produce substantially greater long term visibility and stability in revenues and earnings, for AMD investors, and analysts.

Disclosure: I am long AMD. 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.

Source: AMD: Why The Strategic Focus Is On Semi-Custom And Embedded Markets