This article will sight hard facts and analysis that prove the vast majority of Wall Street's analysts have unrealistically negative viewpoints about the future of Advanced Micro Devices (AMD). That said, it should be noted that there is a small handful of Wall Street analysts, mostly located on the west coast, that are trying to be more realistic concerning the outlook for AMD.
Most analysts are focusing on finding the negative needle in the AMD haystack of positive information
After AMD's Q2 earnings report , which showed that AMD increased PC market share against Intel (INTC), as noted in this Seeking Alpha article by Justin Jaynes, most of Wall St. analysts said that AMD's projections for future console sales were too aggressive.
Instead of focusing on the very low operating expenses associated with AMD's semi-custom console chip business, which will create significant free cash flow over the long term, as noted in this Seeking Alpha article, most Wall St. analysts complained about the low gross margins.
Most of these "glass half empty" analysts, forecasted that AMD's Q3 console chip sales would only be approximately $250 million, and the consensus earnings for Q3 would only be about 2 cents per share.
When AMD reported Q3 earnings, with greater than expected console chip sales of approximately $350 million, and earnings of 4 cents per share from operations, these negative nellies focused upon the 6% sequential decline in AMD's PC business.
So, just as they did after Q2 earnings, most of them again raised their projected numbers, and then promptly downgraded AMD as an investment,. Most of their comments focused on the PC area, , instead of noting that 30% of AMD's revenues were now coming from non PC businesses, versus only 5% a quarter ago.
It appears to me, that most of AMD analysts would rather support the hedge fund shorts, than deal with reality.
Digging into the projections for 2014 sales
AMD guidance is for 5% sequential increase in sales for Q4, over the $1.46 billion Q3 revenues, which equates to $1.53 billion. Annualizing the Q4 sales will result in 2014 sales of 6.14 billion.
Wall Street consensus 2014 revenues are about $5.9 billion.
AMD currently breaks its sales into 2 reporting divisions:
1) Computing Solutions (CS), which includes the PC sales, reported $790 million in net revenue for Q3, and operating income of $22 million.
2) Graphics and Visual Solutions (GVS), which include the semi-custom console chip business, reported $671 million in net revenues, and $79 million of operating income. Since AMD's Q2 GVS sales were $320 million, it appears that Q3 console chip sales were approximately $350 million or more.
What stands out is the far superior $79 million of net operating income for GVS, compared to only $22 million for CS, despite the additional $119 million sales that CS had versus GVS in Q3.
It should be noted that yields/margins generally increase significantly after the initial ramp of a new semiconductor product. I will delve into in this phenomenon in greater detail later on, but it appears to me, that most Wall St. analysts are failing to account for this basic fact in their projections.
Estimating AMD's server area revenues
It should be noted that AMD's Computing Solutions group also includes its SeaMicro business, along with its server chip sales business.
Even though AMD does not break out the server area sales, it is possible to make an annual estimate based upon industry analyst numbers for the server chip industry, combined with Intel's reported numbers.
Most industry analysts estimate that AMD's server area revenues are only 4.5% versus 95% for Intel. Since Intel's annual server area sales are approximately $12 billion that indicates AMD's server area sales are about $600 million, or $150 million per quarter.
Therefore AMD's Q3 PC chip sales were only about $650 million
Therefore the Q4 PC run rate is at an annualized rate of about $2.6 billion. This means that a 10% reduction in AMD's 2014 PC chip sales will result total sales of about $2.25 billion, or a reduction of about $ 250 million.
More importantly, as noted above, the PC area is barely producing any net operating income relative to sales. So, the reduction in PC chip sales for 2014, will have very little effect upon AMD's total net operating income. While the PC chip business has higher gross margins than the semi-custom area, the cost of PC chip marketing and sales devours the additional gross profits.
That is why AMD CEO Rory Read said the following during the Q3 conference call :
But that is a key driver why we are moving in the direction of this transformation, this multi-year strategic transformation. We will invest in those growth markets and we will attack the phase businesses around efficiency and where we can diversify the portfolio and gain revenue.
These are key comments about PC profitability from CFO Devinder Kumar:
If you look at that particular segment from a revenue standpoint year-over-year, revenue is down about $140 million, profitability is up about $36 million. Quarter-on-quarter, revenue is down about $51 million and the profitability went from essentially break even to what we ended up in Q3 at $22 million and that is essentially the power of the expense model, how we are deploying the resources from a transformation standpoint into what we call the growth businesses, including the semi-custom and the PC business which obviously is under pressure.
AMD has been able to successfully reduce operating expenses, such that they can produce profits even when PC chip sales decline, but Wall St analysts appear oblivious to this fact.
Estimating AMD 2014 console chip sales and profits
It only makes sense that total console sales will be higher in 2014 than in 2013, when the initial supply constraints are worked thru, and the new game boxes can be sold in all territories, potentially including sales to China's 1.4 billion people.
While AMD is currently receiving royalties from Xbox 360 sales, they are not earning anything from the Sony PS3 (SNE). Therefore, sales of the Sony's PS4 will produce incremental sales and profits to AMD.
While Sony's PS4 is currently expected to outsell the Xbox One, Xbox total sales (including the heavily discounted Xbox 360) should be up dramatically in 2014, over the supply constrained 2013 launch.
Based upon IDC estimates, total game box sales for Sony, Microsoft (MSFT), and Nintendo (OTCPK:NTDOF) will be approximately 34 million in 2013, and I estimate, 40 million in 2014, the first full year the new game boxes are available without supply constraints. China is the wildcard, which could drive game box sales thru the roof over the next few years.
AMD will earn profits/royalties from all the console sales in 2014, except those of the old Sony PS3.
PS3 sales will fall dramatically in 2014, to only a couple million units, so conservatively; AMD will earn profits on at least 35 million console units in 2014.
AMD should receive an average price of approximately $75 per console chip sold.
Therefore, 35 million times $75= $2.6 billion of 2014 console chip revenues.
AMD's CEO commented during the conference call that the console chip net margin was in the mid-teens in Q3. Therefore, AMD should produce a minimum of a 15% margin on the $2.6 billion of console chip sales in 2014, which equals $390 million of operating income.
A 15% margin, is highly conservative since yield/margin should improve dramatically after the initial ramp.
Overly conservatively totaling AMD's businesses for 2014
Console chip business: $2.6 billion of revenues and $390 million operating income.
PC chip business: $2.25 billion of revenues and zero operating income.
Graphics** (ex console): $1 billion of revenues and zero operating income.
Server business : $600 million of revenues and zero operating income.
Total sales : $6.45 billion.
Total operating income: $450 million.
** Graphics was at a $1.2 billion run rate, which included about $150 million in console royalty income in 2012.
Realistically totaling AMD businesses for 2014
CEO Read's words from the AMD conference call, as noted in this Seeking Alpha article about the semi-custom pipeline, indicates that sales and profits could be substantially higher in this area.
Sr. VP Lisa Su's words from the AMD conference, as noted in the same Seeking Alpha article, about the Verizon data center win being the first she could talk about, indicates that sales and profits could be substantially higher.
Considering that AMD is putting all their emphasis on the growth of Semi-custom and the server area, there is a high probability that there will be substantially greater sales and profits, than in the above " overly conservative model"
Console chip yield/margins
The yield/margin on high volume and highly complex semiconductors always increases dramatically after the initial ramp has been completed.
Because the total number of chips being sold to Sony and Microsoft annually will be approximately 35 million, the ramp could last well into Q2 2014, with yield/margin optimization period continuing until the end of 2014.
Since Q3 was the first quarter of the ramp, it is very conceivable that the ultimate margin from the console chips is 20% or more.
An additional 5% margin on $2.6 billion equals an additional $130 million of profit.
Excluding a small handful of Wall Street analysts covering AMD from the west coast, almost all of the rest are actively trying to be as negative on as possible, without completely losing all credibility in the non-short, buy side community.
2014 will be only the first full year that AMD begins to reap large rewards from their transformation away from the PC area.
I outlined the longer term opportunity at the end of this Seeking Alpha article, in which I conclude:
Bottom line, over the next 5 years, AMD is uniquely positioned to see revenues of its new growth businesses expand, such that they are at least 2 to 3 times bigger than the current PC division. More importantly, the new semi-custom and embedded businesses quickly become consistent free cash flow machines, because most of the costs are upfront and partially covered by their partners/customers.
In conclusion, the key and relevant facts simply do not support the incredible negativity from the vast majority of Wall Street's analysts covering AMD.
The large disparity between actual reality, and the unrealistic viewpoint of these Wall Street analysts, has created a fantastic buying opportunity in the shares of AMD.