By David Sterman
If you sat in the corner office at Intel (Nasdaq: INTC) a few years ago, you'd have ample reason to gloat. The company's key rival in microprocessors, AMD (NYSE: AMD), was headed for oblivion, choking under $5 billion in debt and a weakening product lineup. All Intel had to do was step on the gas, create a bigger technology lead with its own chips and simply wait for AMD to declare bankruptcy.
Well, AMD never got hold of that script. A few years later, the company suddenly has the potential for a really impressive turnaround. And although Intel is -- and always will be -- the undisputed industry leader, an investment in AMD may actually be the wiser move.
In a bid to survive, AMD shed most of its manufacturing capabilities by selling its plants to a newly-formed company called Global Foundries (in which AMD retains a 14% stake). As a result, total debt shrank from $4.7 billion in 2009 to $2.4 billion at the end of 2010. Still, these moves to shed assets hardly constituted a game plan. The company realized it lost too much ground since the middle of the last decade, when its Opteron chips were so good they steadily took market share (in computer servers) from rival chips offered by Intel. Gross margins rose to 50% by 2006, but would go on to fall below 40% by 2008 as Intel fought back with price wars and new chips. Intel now controls 96% of the market for server chips.
Yet in the past 12 months, AMD has vowed to rebuild lost market share by rolling out new chips to power notebooks, desktops and servers. Few gave the company a fighting chance. But it looks like AMD took that task seriously. Its newly-released chips are finding a home with many new customers, and quarterly results are good and getting better.
Building a head of steam
Investors first spotted a turn when AMD released first-quarter results back in April. The company's new "Brazos" chip was a clear hit with notebook manufacturers that needed very low cost chips in a very thin form factor. (A typical chip goes for $25 to $30.) The company has racked up more than 100 design wins, and Brazos is now on track to be the fastest-selling new chip in the company's history. Management now thinks AMD can boost notebook market share from a current 13% up to around 25%. Yet the first quarter was still a bit messy, as AMD boosted expenses to prepare for its next new chip -- Llano.
At the time, most investors took a wait-and-see attitude, uncertain whether major computer companies would entrust AMD with their business so soon after it seemingly flirted with bankruptcy. Well, like the Brazos chip, the Llano chip (which sells for $60 to $100) appears to be a hit. Customers appreciated its ability to consume little power while delivering robust graphics capabilities. (Some Llano-powered notebooks can run on batteries for nearly 10 hours before needing a re-charge.) AMD exceeded second-quarter forecasts last week by about 10%, thanks in large part to strong demand for the new chips.
As a third and final leg to the rebound, AMD is readying its "Bulldozer" line of chips aimed at the server market. In recent meetings with analysts, management has noted a strong level of interest in the new server chips from major purchasers. And though sales won't formally begin until the end of the current quarter, management thinks market share for chips in the server market could rebound from a current 4% into double-digits. Here again, improved power efficiency and graphics capabilities for the Bulldozer chip will presumably appeal to some of the market, whereas Intel will still most likely appeal to those looking for the fastest speeds.
The real proof in the new product rollout can be found on the gross margin line. As noted earlier, the company's gross margins fell below 40% in 2008, a level which makes it nearly impossible to generate profits. Now, thanks to those new chips, gross margins are rebounding. Second-quarter margins hit 45.6%, a rise of 100 basis points compared with the previous quarter, and could rise another 100 basis points in the current quarter (assuming the Bulldozer chips get out the door by the end of September). By next year, some analysts think AMD's gross margins could again approach 50%, a level not seen in five years. This assumption underpins Sterne Agee's earnings per share (EPS) forecast of $0.96 in 2012. Shares trade for less than eight times that view.
And that debt-laden balance sheet? This should soon be a relic of the past. Citigroup thinks AMD's free cash flow growth will be so strong in coming quarters that the company will have more cash than debt by early next year.
Perhaps the most remarkable aspect of AMD's recent upturn is the fact that the company's corner office sits empty. A search for a new CEO has been underway for six months, and many believe shares won't really rally until a new CEO is named and a roadmap for 2012 and 2013 is laid out. This makes now a good time to step in and buy the stock, as an ample number of investors remain on the sidelines.
With earnings power approaching $1 a share in coming years, an earnings multiple of 12 may prove to be the likely target, pushing the stock up to $12 in the next 12 months, or 50% higher from current levels.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.