One of the things that continually keeps [[AMD]] analysts/investors on edge is the Wafer Supply Agreement ("WSA") that the company was forced into as a result of the spin off of its semiconductor manufacturing plants into what is known today as Global Foundries. In particular, each year the company needs to purchase a certain number of wafers from Global Foundries. Now, if the company sees enough demand for its products, then it can satisfy the requirements of the WSA and everything is just peachy.
However, if AMD doesn't see enough demand for its products, it has to do one of two things:
- Take The Wafers - AMD can simply choose to buy the wafers and end up with more inventory than it needs. For a company like AMD where its liquidity is quite fragile, spending hundreds of millions on wafers that lead to a bunch of excess inventory that, frankly, will probably see major write-downs isn't all that desirable.
- Pay - In this case, AMD can simply pay a sort of "cancellation fee." This still costs the company money, but the company can structure deals with Global Foundries to make the payments much more gentle on the company's cash flow statement (i.e. in installments over a fairly long period of time). This still hurts, but it's often nowhere near as bad as having a boatload of unsold, going-stale inventory that cost the company a boatload upfront.
In 2012, after PC sales had fallen off a cliff and after Intel (NASDAQ:INTC) began taking meaningful share in areas of the PC market where AMD has traditionally been strong (i.e. cheap), the company had to make the very tough decision to "pay" Global Foundries a $320M termination fee. The fee was set to be paid in three parts by the following dates:
- $80M by Dec. 28, 2012
- $40M by Apr. 1, 2013
- $200M by Q1 2014.
Well, $120M down with $200M to go next quarter for that particular termination fee. However, what has had investors concerned is the company's ability to do the following:
- Hit the remaining commitments for 2013.
- Hit its commitments in 2014 despite what is likely to be a tough PC environment (secular + likely substantial share loss).
While I will freely admit that I expected 2013 to be fine on this front, I did have my reservations about 2014. However, given a critical piece of new information that CFO Devinder Kumar gave at the Credit Suisse Technology Conference, it seems likely that AMD is well-positioned to hit its commitments during 2014.
Game Consoles And GPUs Coming To Global Foundries?
While it has been believed that AMD would be building most - if not all - of the chips that it plans to sell into the game console space at Taiwan Semiconductor (NYSE:TSM), it looks as though AMD will actually be moving at least a part of the game console orders to Global Foundries, which frankly will go a long way to satisfying WSA commitments.
Now, while the console chips alone probably wouldn't be enough to take care of the WSA, there is a very important implication here: AMD is finally beginning to move higher volume, higher priority chips to Global Foundries. Until recently, AMD's GPUs have all been built at TSMC as have its low power/low cost APU lineup ("Kabini" and "Temash"). If AMD can move the vast majority of its product lines to Global Foundries, then there is very little reason for investors to worry about take-or-pay charges since AMD's total chip business (~$6B/year in sales) should be more than enough to take care of that commitment and then some.
While AMD certainly has its challenges, as long as the company can move the vast majority of its wafer business to Global Foundries, take-or-pay charges should be a thing of the past. The big risk, though, is that TSMC is generally a much more reliable partner and has - at least in recent history - had an easier time transitioning to next generation process nodes and ramping them in volume compared to Global Foundries.
However, if AMD plans to stay on n-1 or n-2 generation nodes for the vast majority of its products, it'll be fine at Global Foundries. And, given how aggressively Global Foundries has reportedly been pricing wafers, it could probably get a better deal there, too.
Disclosure: I am long INTC, 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.