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Advanced Micro Devices (NYSE:AMD) is one of the world's largest semiconductor companies, based in Sunnyvale California. It develops computer processors and related technologies for the consumer and business markets. AMD's revenue generation is driven by the provision of computing solutions including microprocessors, chipsets, embedded processors and dense servers. Graphic solutions, including GPUs, also form part of the corporation's revenue. Computing solutions make up 65.7% of the revenue generated in trailing twelve months ended 28 Sep 2013 (AMD, 2013); while graphics and visual solutions make up 34.3% of the total revenue (TTM).

Market performance

Shares of AMD are quoted on the NYSE and are valued at $3.31 as at November 04, 2013. The stock of the company declined from touching a peak of $8.20 in March 2012 to below $2 by the end of 2012. AMD generates a majority of its revenue from computing solutions. However, the decline in demand for personal computers in the past few years and Intel's (NASDAQ:INTC) continuing dominance has affected AMD's shares adversely. The PC demand deteriorated because of global recession and an increasing consumer preference for tablets and smart phones. Despite these adverse conditions the company is putting up a fight and shares are up 84% since Nov 2012.

GPU and Servers

The PC industry has been experiencing a period of slow growth, which is why AMD has redevised its strategy and plans on shifting its business focus from PCs to other technology sectors like gaming consoles, micro servers, cloud computing and graphics. However, AMD is not completely abandoning the PC market. It recently launched HSA (Heterogeneous System Architecture) and announced server strategy and road map for the year 2014. AMD has also secured new business partnerships with growth prospects like SeaMicro and Verizon (NYSE:VZ). Yet there are problems that AMD needs to address. It is the leader in the gaming console market but the margins are low. As far as micro servers are concerned, Intel and Qualcomm (NASDAQ:QCOM) pose a significant threat; Intel already dominates the PC industry. On the graphics front, AMD is innovating but NVIDIA (NASDAQ:NVDA) seems to be ahead.

Following are some catalysts that can affect AMD's prospects in the future.

Gaming consoles

AMD architecture is featured in Microsoft's (NASDAQ:MSFT) Xbox One and Sony's (NYSE:SNE) Playstation 4. The manufacturing of these consoles has spiked AMD's revenues for the recent quarter. AMD is also pushing for unified PC-console gaming, meaning that PCs and consoles will use the same hardware. This will favor game developers as the designing of games will become easier. If it is relatively simple to get XboxOne games up and running on PCs with AMD graphics, publishers might not see the need to spend the additional cash to optimize for NVIDIA cards (Brunner G., 2013). This PC-console strategy could favor AMD in the market. The anticipated short term growth of gaming consoles is 10% and they hold a 50% share of the overall gaming market (Gartner, 2013). A new report from DFC Intelligence and Live Gamer predicts a growth in the console market revenue of 29 percent, from 2013 to 2017. So, on the console front AMD seems ahead of its competitors and can benefit from the growth prospects in the gaming industry.

Microprocessors and servers

"Our strategy is to differentiate ourselves by using our unique IP to build server processors that are particularly well matched to a target workload and thereby drive down the total cost of owning servers. This strategy unfolds across both the enterprise and data centers and includes leveraging our graphics processing capabilities and embracing both x86 and ARM instruction sets", said Andrew Feldman, general manager of the Server Business Unit, AMD. AMD is releasing three processors in the near future.

Seattle: In 2014, AMD will set the bar in power-efficient server computing with the industry's premier ARM server CPU. The 64-bit CPU, code named "Seattle," is based on ARM Cortex™-A57 cores and is expected to provide category-leading throughput as well as setting the bar in performance-per-watt (AMD unveils servers strategy, 2013). ARM based chips consume less power and are cost effective. Seattle is a candidate for dominating the servers market in 2014.

Berlin: It is the first server APU. It utilizes the Heterogeneous System Architecture and includes four steamroller cores. Berlin will replace the current Opteron 3300 series processors at the end of this year. The ability to share memory between the CPU cores and the IGP could make Berlin well suited for GPU computing applications.

Warsaw: Warsaw is a server processor designed for private and public cloud uses and high performance computing. In a nutshell, Warsaw is AMD's traditional effort against Intel in the server market and known as a large core chip. Warsaw is optimized for two and four socket servers and touts an easy migration from AMD's Opteron 6300 series.

In short, as AMD's x86architecture competes with Intel, it is up to the ARM Seattle to generate sales and increase market share. "We believe ARM will win out in the long run," said Feldman. So ARM is AMD's best bet. We have to wait and see how it pans out.

Cloud computing

AMD acquired SeaMicro to gain access to leading technologies and competencies in cloud data centers, which is the fastest growing center of the servers market. According to iSuppli, micro server growth is on track to grow from 0.2% of the overall market in 2011 to 10% of the market by 2016, constituting 1.2M shipments. Therefore, the acquisition of Sea Micro puts AMD in a favorable position as far as micro servers and cloud computing are concerned. And there is growth prospect as the iSuppli research showed.

AMD also sealed a deal with Verizon Inc. which is anticipated to provide around 50million USD in revenue over the next year, as Verizon would be using AMD-Seamicro's SM15000 for cloud computing and cloud storage. This will lead to an increase in AMD server sales and revenue in the future. All in all, AMD is set to head in the right direction as far as cloud computing is concerned.

Graphics and visuals

AMD is launching new API (Application Programming Interface) called MANTLE. It replaces conventional APIs like DirectX and OpenGL. AMD is working in collaboration with EA Games (NASDAQ:EA) in developing Battlefield 4 that would come with MANTLE support. MANTLE can work on any platform like Linux, Windows or Mac for that matter whereas DirectX can only work on Windows. If MANTLE has the same level of graphics performance then it is unlikely for DirectX developers to optimize games for NVIDIA which use DirectX. NVIDIA could lose serious share here. It appears that MANTLE would make cross platform development much easier and that appears to be the performance advantage for ATI Radeon graphics. The graphics development is promising but again we have to wait and see how the market responds to MANTLE.

Overall, the change in strategy, i.e. to shift from the conventional PC business, may be the right move for AMD. The gaming console industry is in growth. Graphics development shows promise; however, cloud computing and the ARM processors are the real growth prospects, provided that AMD succeeds in executing its plan. The PC industry is saturated and dominated by Intel. There is not much prospect for growth but AMD is not totally abandoning this market. All that being said if the plan is executed correctly AMD will experience a growth in sales in the short term, providing a base for sustainable long term growth.

Valuation

Shares of AMD are valued by taking the estimated multiplier i.e. 25x and multiplying it with the earnings to derive price targets. The table is as follows:

Price targets using a 25x multiplier

EPSP/eTarget Price
High$0.4825x$12
Mean$0.1325x$3.25
Low$-0.12NANA

*Values for 2014 Dec EPS estimates taken from yahoo finance

The mean price target is around the same as the price stands today. Our price target estimate also shows that there is a possibility of share price rising to 12USD next year. But the price targets are calculated for reference only so the price could end up between the mean and high. Note that the model assumes that share price is positively correlated to the increase in EPS.

Conclusion

AMD has been in turmoil for the past few years. The earnings were not growing and it sent a bad signal to the market and rightly so. AMD was not up to the mark in the recent past, whether it was the bulldozer architecture launch or the Llano failure (Verge, 2013). Despite all this, AMD has changed its strategic course earlier this year and is diversifying away from the PC industry into consoles, micro servers and cloud computing. Consoles are a potential growth prospect and are estimated to grow by 29% for the next four years. The ARM processors are cost effective and energy efficient and should attract sales in the future. Furthermore, cloud computing is a growing sector and AMD has been farsighted enough to seal a deal with Seamicro. The deal with Verizon is also advantageous as AMD would be providing cloud servers and storage through Seamicro to Verizon, resulting in increased sales. On the graphics front, the new MANTLE API is an attraction. Its future is not yet clear but it should generate sales in the short term because the gamers and developers are anxious to gauge its performance. Apart from the Intel-dominated PC industry, AMD is prepared for the short term future while setting a base for long term success. AMD will show an improved financial performance in the near future but its long term performance is dependent on the response by consumers and competitors to this new strategy. So it can be concluded from the analysis that if AMD executes the plan correctly and sticks to its redefined strategy then the stock is a "buy".

Risk factors

There are certain risks faced by the company:

  1. Intel can come up with a counter strategy to erode AMD's earnings in servers and cloud computing. PC is already dominated by Intel.
  2. Analyst opinions can play a role in affecting the share price.
  3. Declining demand in PC industry can further erode earnings.
  4. Entry of new players in the gaming console industry can further squeeze margins.
Source: Is AMD's Newfound Strength In Graphics And Servers Enough To Offset PC Misfortunes?