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Summary

  • Following AMD's earnings report, the stock popped by 5% after hours.
  • The report made clear that AMD's console sales were not a fluke and can help sustain AMD in 2014.
  • PC sales remain a weak spot as Intel continues to successfully exploit its process advantage.
  • I expect that process advantage to be negated once Global Foundries and other ARM foundries put their own 14 nm FinFET processes into production.

AMD (NYSE:AMD) rewarded investors' patience with an after-hours pop of about 5% following its calendar 2014 Q1 earnings release. AMD posted strong revenue growth of 28% y/y to $1.4 billion, beating analysts' consensus of $1.34 billion. AMD also posted an operating profit of $49 million but a GAAP net loss of $20 million due mostly to severance packages and debt refinancing. Non-GAAP net income was $12 million, also exceeding analysts' expectations of breakeven.

Patience Rewarded

AMD investors have come to expect negative market reactions to its earnings reports, so we were pleasantly surprised by the afterhours uptick. This reflects a growing awareness that AMD's recent return to profitability (net GAAP income of $0.12 in 2013 Q4) was not merely a short lived fluke. Although I've always acknowledged that AMD was a risky investment, I felt it had long-term potential as a turnaround story.

The concept of an AMD turnaround has been a particularly hard sell among conservative investors who embrace Intel (NASDAQ:INTC) as an invincible force in computing. Intel would simply crush AMD in the PC space with its superior process technology, while gaming consoles would afford AMD only a brief respite from the Intel onslaught. Since consoles were vastly inferior to PC gaming rigs, holiday sales would quickly subside.

The Intel supporters have been partly correct. AMD's PC business continues to decline. Revenue was down 12% y/y to $663 million in the Computing Solutions Group with a small operating loss of $3 million. But AMD made its final $200 million payment to Global Foundries as part of its 2012 wafer purchase obligation, so at least AMD is out from under that particular cloud. Computing Solutions should be profitable going forward.

AMD's real strength was in its graphics segment, which posted a 117% y/y revenue gain to $734 million with operating income of $91 million. There was a sequential drop of 15% from the Holiday season, but that was to be expected. The custom SOCs AMD sells to Microsoft (NASDAQ:MSFT) and Sony (NYSE:SNE) for their Xbox One and PlayStation 4 consoles are booked in this segment and are responsible for the revenue jump.

Console sales are still strong, and supply demand balance was only achieved in Q1. I expect console sales of about 5 million units/quarter as the installed base of 160 million Xbox 360 and PS3 console owners upgrade in the coming years.

Intel supporters and PC gaming enthusiasts who derided the performance of the new generation consoles failed to recognize that the value proposition of the consoles overall was very compelling. The consoles represented "good enough" performance for a bargain basement price of $400-500.

AMD's graphics chip business is also doing well. According to AMD, professional graphics saw sequential growth in Q1 on the strength of AMD's dual graphics processors in the new Apple Mac Pro. AMD's high end graphics cards continued to be in short supply in the quarter due mainly to demand for crypto-currency mining.

Even after crypto-currency demand wanes, AMD's high end graphics cards will still offer very competitive performance compared to Nvidia (NASDAQ:NVDA) as demonstrated by Anandtech's review of AMD's top end R9 290X, so I don't expect demand to fall off very much if at all. The composition of AMD's graphics customers will shift back to more traditional PC gaming enthusiasts who have been effectively excluded by digital currency miners.

No Longer Disadvantaged?

Since last year, I've been pointing out that many ARM foundries such as TSMC, Samsung and Global Foundries have been working on their own 14-16 nm FinFET processes. At the same time, Intel supporters were looking to Intel's planned 14 nm FinFET process, due to go into production this year, as the final devastating blow that would crush Intel's competitors. When I pointed out that nothing is as transitory as technological advantage, I received no small amount of comment ridicule. Intel's process lead was insuperable, many believed.

The announcement yesterday of a collaboration between Samsung (OTC: OTC:SSNLF) and Global Foundries on 14 nm FinFET technology may have had some catalytic effect on market perceptions and contributed to the afterhours pop. In fact, Samsung and Global Foundries have been long standing partners in the IBM (NYSE:IBM) sponsored Common Platform alliance, so cooperation between the companies should not have come as any surprise.

The ARM foundries have understood for well over a year the threat posed by Intel's 14 nm FinFET process, and have moved to negate that threat by developing their own version. Intel supporters who believe that can never happen are simply kidding themselves. I'll repeat it again: nothing is as transitory as technological advantage.

AMD's turnaround story may not have been completely convincing in the context of AMD console sales, but becomes much more compelling in a world in which Intel doesn't enjoy a process advantage. Such a world is probably difficult for many investors to get their minds around, and that's fine with me. The market will be that much more surprised when it happens.

Near-Term Outlook

It remains to be seen when exactly Global Foundries will have 14 nm in production. I expect sometime late this year or early 2015. That leaves AMD with a holding action in PCs while using console sales to keep its head above water financially. AMD's outlook for next quarter of basically flat revenues probably assumes one of the two custom SOC wins that AMD is expecting. As I've said before, that win is likely to be Nintendo.

This win, combined with continuing sales of SOCs to Sony and Microsoft, will keep AMD solvent for 2014 while it awaits the arrival of 14 nm.

Source: AMD's Turnaround Is Real