Several days ago Barron's had a story reading: AMD: Take-or-Pay GlobalFoundries Deal May Spell Inventory Build, Says Bernstein.
In that article analyst Stacy Rasgon of Bernstein Research reiterated her underperform rating on Advanced Micro Devices (AMD) with a $2.50 price target, arguing that investors fail to appreciate a huge payment AMD will have to make to one of its manufacturing partners, GlobalFoundries, this quarter, as it continues to feel the effects of sagging PC microprocessor demand.
Her logic goes like this: AMD is on the hook to buy $1.15 billion worth of wafers from GlobalFoundries this year, in a "take or pay" arrangement. And since AMD's PC revenue will be declining about 20% this year, she sees the company being on the hook for a big payment, and thinks this will lead to write-downs.
As Stacy Rasgon notes:
The Q4 commitment due is, in fact, nothing short of astonishing. Given their purchases in the first three quarters of the year, to meet their total $1.15B commitment AMD is contractually obligated to take over $400M in wafers from GlobalFoundries in Q4, almost double the run-rate in the first three quarters of the year. AMD's purchases from GlobalFoundries in the first three quarters of the year totaled $269M, $255M, and $222M respectively, or $746M overall. Therefore, to meet their $1.15B total commitment, this implies purchase requirement of $404M in Q4, up 82% sequentially (Exhibit 4). Therefore, their purchase commitments are almost doubling in Q4 from their current run-rate, into a quarter where their CPU revenues are likely declining further. And of course there is the additional $250M wafer commitment due in Q1.
Given the trajectory of likely revenues vs. purchases, we see little possibility for AMD to meet their commitment without building a significant amount of CPU inventory that they will have to try to sell into next year, bringing risk of write-downs and charges.
For the most part I take for granted what most analysts say, because I also take for granted that they have done the research and the work to verify what they claim. Most of the time that is.
However, when it comes to analysts over company announcements or public company comments, I side with companies, because making a public claim that you cannot back usually means that lawyers will end up making money in class action suits.
Having said this, when I looked at the comments to see reader reaction to the Barron's article, one comment noted:
E-mail I received from AMD
Thank you for your email. You are correct; our wafer purchase commitment to Global Foundries is ~$400M in Q4 2013. As we indicated on our October earnings call, we are on track to meet that commitment and indicated that our inventory levels in the 4th quarter would be flat from Q3 levels. We believe this inventory level is appropriate to support our business, as we've seen strength from our high-end A8/A10 APUs, our recently launched R7/R9 GPUs and the continued semi-custom production. We will also begin shipping Kaveri, our next-generation desktop APU in the 4th quarter.
Of course I did not take the article comment for its word, so I sent an email to AMD's investment relations department myself, asking them to verify that this was indeed the company's answer to the article.
About two days later, I received an email from Liz Luckow, from AMD's investment relations department, saying:
Hi George, yes, confirmed.
So while the logic of Bernstein's analysts was sort of correct, the situation is not exactly as the analyst noted.
And since AMD is on public record saying that they will not have an inventory problem and that their level of inventories will remain about the same -- and that also probably means there will be no inventory write-downs -- I believe them.