"AMD Shares Crushed on Weak Q3 Outlook; Analysts Fret about Inventory, Intel." The headline, one of many articles that ran in 2012, spoke to the dismal future of the personal computer market. Advanced Micro Devices (NYSE:AMD) was founded in 1969, and was one of the largest suppliers of CPUs for PCs. In 2006, AMD shares were as high as $41 and AMD was in the process of completing talks to acquire ATI Technologies (one of the largest semiconductor companies in America) for $5.4 billion. By 2012, AMD shares had fallen so low that they were trading below the $2 mark. At that point, the common belief was that they would soon be acquired or forced into bankruptcy. AMD had gone from being an industry leader, to a shell of its former self, with little market share. Ultimately, AMD was faced with a choice, they had to completely reinvent themselves, or they were going to fail.
AMD got hit by a perfect storm. The combination of the financial crisis of 2008 and AMD's acquisition of ATI resulted in a unbearable debt load. At the same time, AMD was losing market share in their primary market, PC CPUs, to Intel (NASDAQ:INTC) fast. By 2012, AMD owned less than 20% of the CPU market, with the majority of the market belonging to Intel. Further, not only was AMD losing market share, but the entire market itself for PCs started contracting for the first time in history, declining at a rate of around 10% a year. By the end of the decade AMD was bleeding cash. This trend continued after AMD sold off most of their divisions, including their manufacturing and fabrication capabilities. AMD was in dire straits, they were broke and being pushed out of a market that was quickly evaporating.
However, at the end of 2011, AMD started to make some important changes. Their size was small relative to other companies in the industry, $2 billion compared to Intel's $120 billion, and they had massive debts. In an effort to survive, AMD decided to evolve into a more entrepreneurial company. To that end, AMD sought to grow revenues quickly by focusing on growth markets.
This growth started with the hire of Rory Read as CEO. He was a successful veteran from Lenovo, who quickly replaced the management team around him. He brought in new talent from across the industry, including managers from competitors like Nvidia (NASDAQ:NVDA) (Jean Cristophe Baratault, who led Nvidia's successful GPU program, a market AMD now competes in). This new talent formulated a three step transformation plan in 2012 to fundamentally rebuild AMD.
The three step plan was: "Restructure, Accelerate, and Transform." Working under tight time restraints, they sought to achieve the plan by 2015, giving them two years to complete their goals.
The first phase involved restructuring AMD and its balance sheet. This required AMD to become more lean and more efficient. AMD was being weighed down by an ugly balance sheet and an inefficient corporate structure, which made it impossible to operate effectively. They were bleeding cash, and as an organization, they had trouble deploying new product lines. For example, products were of subpar quality, and were late to the market. This created an environment where competitors, with superior products, were making a strong impact.
In various transcripts, the leadership talked about the need to roll out innovative products and get them to market in a shorter timeframe. This was achieved by decreasing costs and the breakeven point. The leadership at AMD made a commitment to drastically cut costs by 2015, setting a hard goal to cut operating expenses by 25%, maintain a cash level of at least $1.1 billion, and restructure their debt load. As of this year, they have stayed on track to hit these goals. 14% of the workforce was cut, and overhead expenses were reduced by 20%. Additionally, cash levels have been kept above the base level goal. AMD has aggressively attacked their outstanding debt load, decreasing total liabilities by almost half, and successfully negotiating a restructuring of their remaining outstanding debt in 2013. This deal is projected to save millions in cash flow. All this has had a noticeable effect with AMD reporting a profit in Q3 of 2013 for the first time in years (which also helped them close the deal to refinance their remaining debt).
However, cutting costs and restructuring their debt was not enough, AMD also needed to "restructure" their culture. Management committed to creating a culture focused on constant innovation and turning out multiple new products across multiple markets, every year. While costs were cut elsewhere, R&D funding was in the low 20% of revenue, way above industry leader Intel's 7%. While AMD vigorously trimmed their workforce, they also aggressively hired successful personnel from across the industry who had a history of successfully developing new products. Further, AMD made it a point to quickly create more intellectual property (IP), and it became company policy to "cross-use" blocks of IP across any market they could enter. AMD did not want to solely be a leader at creating new IP, they wanted to maximize the value they received for the work they had completed. This allowed them to, in effect, turn out more IP, quickly, as they made a point to apply the same basic work to multiple ends.
Their stabilized financial position and streamlined structure has allowed them to deliver on the rest of their plan. AMD has focused on creating a nimble corporate structure, using financial efficiency and innovation.
Phase Two -"Acceleration"
In 2012, when this plan was announced, AMD was centered entirely in the PC CPU market, with 95% of their revenue derived from this single source. Moving forward, AMD would not be able to thrive if they continued to focus on this market. Not only was the market drying up, but AMD did not have a strong enough presence in the market. The next phase was about changing this. Phase two of their plan was "acceleration." This involved introducing new lines of products in "growth" markets beginning at the end of 2013, continuing in 2014. AMD also increased the turnaround rate of introducing follow on products in the product lines. This phase also reemphasized the desire to become a leader in IP, allowing AMD to differentiate themselves from the competition.
AMD had always been a leader in innovation, something that took renewed focus as they maintained R&D spending at high levels. Management now looked to take advantage of this innovation ability and apply it to new markets. AMD started by identifying five new markets, which were all small with growth potential. These markets, called the future "pillars" of AMD, are: ultra-low power devices, embedded, professional graphics, semi-custom, and dense servers. Simultaneously, AMD wanted to continue increasing their market power in the PC market without directly competing with Intel or Nvidia. They approached these new markets in a holistic fashion, going back to the Phase One efficiency goals applying innovation.
In 2012, AMD acquired SeaMicro, a small technology company that was doing work in micro and dense servers. Servers were a field cornered by Intel, with 95% of the market. Intel had been following a traditional strategy where they would release standard product lines based on the same chip architecture from a decade before. Further, they had ignored the micro and embedded server markets entirely because they did not see either markets as strong revenue generators. AMD combined its IP with the server expertise of SeaMicro to aggressively target these markets. They also pursued a "Semi-Custom" strategy. AMD recognized that some of the largest potential consumers of server products were companies that were big enough to afford unique equipment built to their specifications. Companies such as Facebook (NASDAQ:FB) and Google (GOOG, GOOGL), who worked with massive amounts of data, thereby, requiring the use of server farms. This was a great growth opportunity, as these companies also had the resources to pay for these services.
Intel bet that server market technology and demand wouldn't change, AMD focused on companies being willing to pay more for custom designs and on dense and micro servers becoming more popular. By the end of 2013, the micro server market alone had increased by 230% and is projected to soon increase to 10% of the total market. Thus far, AMD strategy is winning. By leveraging its ultra-low power IP with SeaMicro's existing IP to produce a new kind of chip architecture design called "Seattle."
The IP in making this new design is wholly owned by AMD, and this time AMD didn't make the mistake they had made previously in the server market. Many of Intel's server chips were based on AMD patented technology that Intel licensed, something AMD has not done with their "Seattle" technology. Instead of competing head on with Intel, AMD attacked niches that are projected to grow quickly. They changed the nature of the server game completely, by creating a next generation product unlike anything else on the market.
AMD leveraged its success in the micro and dense server fields to create new opportunities in the semi-custom field. Using the some of the IP they developed for "Seattle," AMD announced a major deal with Verizon (NYSE:VZ) at the end of 2013 to create semi-customized servers for their business. It was their first major win in testing out the "semi-custom" strategy. Since announcing the Verizon deal, AMD's CEO has said that there are two more "major" deals that will soon be announced in spring 2014. And although he has refrained from saying who the companies are, he has specifically mentioned targeting Facebook, LinkedIn (NYSE:LNKD) and Google in the past. The Verizon deal vindicated their strategy to build "semi-custom" server infrastructure tailored to meet customer's specific needs, while the release of "Seattle" should give them a comfortable first-mover advantage in emerging server markets.
Although AMD has seen success from expanding into the servers market, their biggest win so far has been in entering the professional graphics market. AMD decided to focus on professional graphics cards as one of its pillar industries. To do so, they leveraged a similar low cost strategy that has been successful in their other target markets. For example, AMD has been able to undercut graphics giant Nvidia, by focusing on a "unified" strategy to target gaming with low cost solutions across all of the different possible platforms (notebooks, consoles, and computers). The timing was perfect for this aggressive strategy as new gaming consoles have been released, for the first time in years, this past quarter. Sony's (NYSE:SNE) Playstation 4, and Microsoft's (NASDAQ:MSFT) Xbox One sold seven million units in their first two months out, and that was before their release in much of East Asia. They are projected to sell tens of millions more units over the next year alone. Soon enough, Nintendo's (OTCPK:NTDOY) new Wii will join the console selling spree this year. It has been hotly debated which console will win the "console wars," but whichever sells the most, AMD still wins because all three consoles are run on AMD graphics cards. AMD's aggressive unified gaming strategy won them the contracts to provide the cards for "only" around a $100 a console.
This makes AMD the ultimate winner of the console wars and has provided new opportunities for expansion. With all three consoles running on AMD architecture, every console game designed must be optimized to run on AMD-specific technology. This has multiple effects. First, it makes AMD attractive to other products that are involved with gaming as well due to the economies of scale in developing game software and optimizing it to certain hardware structures.
For instance, Dell, which produces "Alienware," a line of computers specifically designed for gaming, has recently announced that future Dell computers will be running on AMD GPUs. The rationale is that games that are originally made for console hardware will be optimized for AMD hardware and thus "hardcore" gamers will want compatible computers running on AMD hardware as well. In short, AMD cornering the console world has effectively created a moat around the gaming world, since it would be cost-prohibitive for any of the consoles to now switch to a different product.
AMD plans to build on the console win in the future by going beyond gaming. Technology companies have envisioned turning the gaming console into a ubiquitous living room/tv console-a single device to perform all of your functions, turning the living room into an interactive environment. By becoming integral to gaming consoles, AMD has positioned itself to be integral to everything from connecting to the internet, watching TV, playing games, to controlling "smart" applications throughout the house. The future potential is broad, but the foundation starts with gaming consoles. The hope is that by moving into gaming and cornering that niche now, it will position AMD to be the foundation architecture that this potentially large market will be based upon. AMD's dream is that one day every household will have a central control console running on AMD technology.
In creating these new graphic cards, which are significantly cheaper than their main competitor Nvidia, AMD has also managed to garner attention from Apple (NASDAQ:AAPL) and from "crypto-currencies." Going back to their "acceleration" goal of releasing multiple new products and cross-using IP blocks, AMD has leveraged the IP block used in developing GPUs for gaming consoles to make similar cards that are a great match for Apple's new MacBook Pro. Due to its very small size, the new Pro has specific requirements, and AMD was able to procure that contract, creating a relationship with one of the world's biggest and most innovative companies. Given the low price points of the GPUs, AMD has become the highest recommended card for "crypto-miners," people who "mine" bitcoins and litecoins. This was an industry that did not exist a few years ago but requires large amounts of computing power at both a low upfront and low power cost. This is an industry that is a perfect match for AMD. While the industry is still small, it is quickly growing. As of now, none of AMD's competitors have released a product comparable for crypto-mining, mainly because the market is small. AMD has been able to fill this niche at little cost by leveraging existing products and IP.
Finally, AMD has continued focusing on the PC market, specifically, notebooks and mobile devices which are markets dominated by Nvidia, Intel, and Qualcomm (NASDAQ:QCOM). To do so, they focused on building cheaper, lower power CPUs, that they knew would not be as popular in North America or Europe. In effect, they ceded most of the first world market to Intel and Nvidia's higher quality (but more expensive) products. But AMD has managed to secure a continuing stake overseas in what they call the "entry level market." In places like India or China where AMD now has 40% of the PC market, AMD has decided to stop directly competing with Intel and Nvidia on a qualitative basis. They have managed to take similar IP in designing ultra-low power chips for PCs, and applied that same IP to products in the mobile device field, and have recently launched two products to target "entry level" ultra-low power mobile devices, with a further two on the way, "accelerating" the rate products hit the market. This is a field that Nvidia and Intel have avoided because their focus is on higher end mobile devices, which gave AMD the opportunity to build market share. They are continuing with their "accelerate" phase here by not only differentiating themselves from the competition with their IP and targeting a different market segment, but by also planning on a near constant flow of products. In less than a year after their first two ultra-low power notebook and mobile device chips were introduced, AMD was preparing to roll out the third generation of those chips. This is a much more aggressive strategy than established companies like Apple or Intel, who typically introduce a product per year. This aggressive strategy has paid off as AMD has increased market share and revenues.
Phase three, "Transform," called for AMD to fully redefine themselves from a traditional CPU manufacturer to a growth market company. This phase seeks to have AMD attain at least 50% of its revenue from what they defined as "growth" markets by 2015. These growth markets, the five described in the previous phase, are slated to become, in CEO Read's words, the "pillars" of a new AMD.
AMD decided that they would enter the Transformation phase after the 2013 4Q earnings. However, they are well on track to meet their goals. Two years ago, AMD was a narrowly focused company. 95% of their revenue was derived from the PC market, and it looked as if AMD was a dying company. Now, less than two years later, over 30% of AMD's revenue is coming from other markets, some of which AMD previously had no presence in.
The end goal, repeatedly asserted by management, is to see AMD defined as a "growth" market company. After being crushed for their sole dependence on the CPU market, they want to be a company that is not reliant upon one market, but rather is constantly adapting and targeting new markets as they continue to grow.
AMD has managed to become profitable and free cash flow positive for the first time in years, despite shedding sales in the traditional PC market, which has shrunk worldwide. They have successfully reduced its debt load and refinanced what debt remains, shoring up the balance sheet. AMD has found a way to unlock the potential in its existing IP, create new IP, and diversify into related but previously untapped fields. AMD made a conscious decision to stop competing head-on with bigger companies, such as Intel and Nvidia, and to differentiate their products by targeting subsets of markets such as entry level PCs, instead of higher end PCs. In essence, AMD stopped doing what everyone else around them was doing and made a point to be different. Further, they looked at what potential customers wanted; this decision has paid large dividends by creating a "semi-custom" market. By making an effort to diversify their portfolio and actively looking to apply their IP, AMD is evolving and gaining traction in multiple industries. They are reducing their risk as well because they are no longer solely situated in a collapsing market. AMD made a commitment towards streamlining the various processes at the company and maximizing efficiency, while building a new team of people. In doing so, they created a culture focused on maximizing the value and return on work. This new found efficiency and aggression has allowed them to release new products at a quicker pace. Already, they have managed to release multiple new product lines and are showing a drastically shortened timetable between product launches.
AMD still has a long way to go. AMD's balance sheet still needs work and, while profits and growth are projected to continue, the margin for error is still small. AMD was able to position themselves to take advantage of openings left by its competitors, but it can't expect those companies to not react as AMD's profits increase. AMD's new focuses and aggressive diversification have brought them several wins in the past two years. It is the change in culture and focus, however, that will lay the foundation for AMD's continued success in the future.
Rory Read, the CEO that has led AMD through this transformation, has been very active this past year giving interviews. Recently, in interviews with Bloomberg and CNBC, he commented that people misunderstand AMD. Rory said people think of AMD as a PC company. However, that AMD doesn't exist anymore. The new AMD is a growth market company, with a continually diversifying portfolio. Read was asked how he felt about Intel, to which he responded that they only competed in one market, PCs, and that was not AMD's identity anymore. AMD was forced to drastically transform itself in two years and unlike its established competitors, is now functioning more like an exciting, nimble, emerging entrepreneurial growth company, that has learned from its mistakes.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.