I began this post thinking about my pathetic Advanced Micro Devices, Inc. (NASDAQ:AMD) stock. I’ve come to learn that everyone in the world right now seems to hate AMD and the stock. Or at least this is true if you believe the stock market reflects public sentiment on the future of a firm. They’re around the 52 week-low of $13 and were at roughly $40 a year ago. However I decided to post a far longer ramble on the two monopolies of the PC industry, their future, how this impacts PC’s, and all of this impact on the stocks that I own.
The Twin Monopolies
As computer makers earned fractions of a few pennies on every dollar (at best) in systems sold, for years two companies have reaped massive profits from each sale. These two companies held the most noticeable monopolies in the PC business: Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC).
Microsoft is the easy one. Once Windows became the default for any computer shipped, MSFT had a stranglehold on every PC sale. After all, what good is a computer if you don’t think you’d be able to use most programs and file formats, etc. PC=Windows to most users.
Intel is slightly more complicated. Despite the billions spent in branding “Intel Inside”, the average PC users still doesn’t really care what’s inside their computer if it does everything that they want. The microprocessor inside just isn’t as visible to them as Windows is. But Intel was able to create a monopoly due to a few factors:
a) Capacity/Production Ability: producing micro-processors requires a tremendous infrastructure and costs. In the face of an entrenched competitor who dominates the market, building out the manufacturing capability appears to be a highly questionable decision. (high barrier to entry)
b) Performance: Intel’s only viable competitor, AMD tripped over its own shoelaces every few years like clockwork. They would have a good product, and then fall and Intel would seemingly have the superior product for an extended time. If you’re already the monopoly, and you’ve got the (generally) accepted best technology, life is pretty good for you.
c) Pricing: Here’s where Intel put the foot to the throat of AMD and pressed down. Hard. In a brilliantly (if not anti-competitive) diabolical strategy, Intel would give a PC maker significant discounts (“rebates”) only on processors over a fixed percentage of the total they needed. So if I made computers, and I shipped 100 a year, Intel would give me a ridiculous discount on every chip I buy from them over 80 that I buy from them. So while I might want to give AMD 20 chips in business so I can keep them competitive with each other for pricing purposes and for consumer choice (some consumers such as gamers, actually prefer AMD), I’d basically be giving away profit. Intel would price these discounts so well, that the chips would basically be free/below cost. It’s a brilliant gambit if you’re Intel, because you stay from a price-war by only giving discounts when it guarantees you a monopoly with a customer, which promises that you won’t have to deal with price competition in the future. And it shuts the door on AMD, because in a business with razor thin margins, PC makers find it hard to turn their backs on extra points of margin.
And so, Microsoft and Intel became the “twin-tolls” of the PC industry (and the “Wintel” label was born). Just like driving on the NJ Turnpike, if you want to get from point A to point B, you have to pay the toll. Want a PC? You got to pay MSFT and INTC. And so business has been good for many years.
What's Happening Now
There’s a terribly overused phrase “Web 2.0”. I don’t pretend to define it. But for our purposes, let’s call it “the web as a platform.” And let’s assume the previous platform was the desktop. If yesterday you wanted to write a document, you opened MSFT on your desktop in Windows and went about your way. Today (and more likely tomorrow) you might go to Google (NASDAQ:GOOG) Docs (formerly writely.com) and create that same document. You’d also save it to your account and could access it from home, work, your parent’s computer wherever. Also, other people could simultaneously edit and collaborate with you while you were working on it. The cost? Free vs a hundred or so bucks for MS Word.
Hmm.... The point isn’t just MS Word, but what if this happened to almost every program that we used? If you accessed all of these applications through a web browser, would it really matter if you did this on Windows, a Mac, Linux or whatever else? Likely no. And if this day does come to pass, we might all no longer pay the “Microsoft toll”. If a string of other competitive operating systems pop-up (a Google one maybe?), at least you have price competition significantly bringing down the cost of the toll.
AMD, the Charlie Brown of processors has certainly appeared to get their act together. This is David vs Goliath come to life. AMD’s market valuation is currently about $7 billion and Intel’s is $108 billion. You didn’t read that wrong. While AMD certainly seems to have gotten their strategy together their stock has been hammered due to a price war with Intel.
But taking a step back, AMD was able to counter Intel’s stranglehold by gaining a technology edge on Intel. AMD chose a superior chip architecture which Intel had to eventually admit defeat and copy—but not before AMD made heavy inroads in the lucrative server market and with computer manufacturers.
Dell (NASDAQ:DELL), until recently the world’s largest PC maker, utilized exclusively Intel chips until this year when they started offering AMD offerings. AMD’s rapid share gains triggered a massive shake-up at Intel and began a brutal price war which resulted in AMD’s stock basically exploding. Intel, a far better funded rival is pursuing the cut-throat (but likely correct strategically) of trying to force AMD into either bankruptcy or irrelevancy. AMD has chosen to not blink in their battle against Intel by matching price-cuts and continuing to heavily build out the production facilities necessary to compete. When you’re in a death-battle with your arch rival who is 15 times bigger than you—people tend to worry the pip-squeak.
Most recently, on 4/9 AMD announced that their revenue (unsurprisingly) was going to miss estimates due to both lower-prices (there is that price-war) and lower volume (a general slow down in hardware sales, no Vista sales bump, etc). Most interestingly, AMD announced that they were going to decrease capital spending by $500 million in the year. There were only two ways that the industry wouldn’t think that AMD was going to die: a large equity investment/financing or a cut in capital-expenditures.
The question is whether AMD couldn’t raise funding or they felt that they could raise it, but it wouldn’t be worth it. If the latter, they believe that they $500 million they will cut will not hurt them in the long term. This is the major risk– that AMD cuts investment to placate the street and remain viable in the short-term, but over the long-term INTC invests and builds out huge strategic advantages that AMD can’t match. The market reacted strongly despite the revenue warning, by bidding the stock up 4-5%.
The price of computers will continue to dramatically fall. If web-based software comes to become a widespread solution for many users, it is very likely that the day for operating system agnosticism will be upon us. This will obviously take a healthy chunk out of computer prices.
If consumers will eventually benefit from some savings in software, they’re already massively benefiting from the savings in hardware. The brutal price war between AMD/Intel has already dropped the prices in desk/laptops dramatically. Cheaper prices helps sell more PC’s (and that seems to be the only thing that does!), and so I find it hard to believe that computer makers would ever allow themselves to get back in the position of being beholden to Intel again—why would you give them their pricing power back? Never!
So I see AMD going in one of these three (now four) directions:
1) AMD will raise enough funding to send Intel (and all investors) a clear signal that they are here to stay and compete without question in the short-term. Nothing answers this question in the long-term other than having strong market share. OUTCOME: Intel will realize that AMD is not going away, and they are depressing their own profits in a scorched earth battle, and vicious price wars will abate. The market share will stabilize (maybe 70/30) with better (but nothing like pre-AMD Intel) margins for both.
2) AMD and Intel remain mired in a vicious price battle for years. AMD will almost certainly be able to raise funding (at least to stay afloat) if for no other reason that too many powerful people have too much at stake. It is in the interest of not only Dell, HP (NYSE:HPQ), Gateway (GTW), Lenovo (OTCPK:LNVGY) to make sure that Intel isn’t allow to have them over a barrel again, but also the Google’s of the world who are building out massive server farms on an unprecedented scale. So AMD and Intel continue to viciously battle over price and eventually Intel’s entire management team will be forced to step-down by angry shareholders. They will have destroyed too much wealth, because Intel’s current valuation is at least partially based on them being as profitable as they once were.
3) The most interesting scenario: Why wouldn’t Dell or HP just buy AMD? They would have a ridiculous cost advantage over all of their competitors because not only would they be vertically integrated, but Intel would go back to their ridiculous pricing leaving competitors at an even great cost disadvantage. How about Apple buying AMD? They switched over to x86 recently and currently use Intel. They could swallow AMD whole, and have another powerful differentiator from PC’s and save a little dough. Microsoft? Yeah, MSFT. What if the king of Redmond also envisions the day when people might become O/S-agnostic and decide that they, like Apple, will own their machine end to end (hardware and software). Why not build an elegant solution running on AMD chips something no one else can match? Does Google really want to eventually put a computer in every home so they can access Google services? Maybe AMD could help with that…
4) AMD cuts capital spending for the year and invests only in what they perceive as critical to keep up with INTC. Strategically, they could also be doing this to gain more favorable financing terms by showing that they have options to more financing. In this case, they could announce next quarter an investment infusion and continue with their capital expenditures. If this does not come to be, AMD likely hopes to succeed in cutting investment in very long-term areas that won’t cripple the company in the next 2-5 years and then hope to be able to ramp up investment when financial conditions improve. Otherwise, AMD might be blinking. Basically, INTC was able to play the killing stroke that AMD won’t feel until a few years from now when they just find themselves at such a position of cost or technological inferiority that actively competing with INTC is an impossibility. Obviously if you believe this to be the case, you should be selling!
Previously, I thought the scenarios are ranked in probability order. Although if I was Dell or HP, $10 billion isn’t a lot of cash to gain such a potentially key strategic advantage. However, given today’s announcement it’s clear that AMD has (apparently) chosen #4, to cut spending. This puts to rest immediate liquidity and viability questions, but raises new ones around their long-term right to win vs INTC from a cost and technology perspective. It will be interesting to hear on their earnings call next week a) where the cost cuts will be coming in b) whether AMD is closing the door on raising more capital this year for further capital investments.
I didn’t discuss a few other factors which I’ll sweep in here:
1) AMD is currently suing Intel for anti-competitive practices. If the way I was describing their tactics sounded a little like that, it’s probably because it actually is. Fortune has written some excellent articles profiling Intel behavior and the lawsuit over the past couple of years. Intel was in the news just the other day because they have “lost” some critical emails. All of the news combined with the whispers you hear from manufacturers tell the story of a ruthless INTC doing everything in its power to kill AMD. If this comes to light, a substantial settlement would not be surprising. The irony of INTC providing the settlement that would cement AMD’s position as a long-term player due to having the funds to invest in R&D and facilities would be very rich. Although strategically it’s quite clear that INTC would delay any kind of settlement until the very last minute. If AMD doesn’t last as a viable competitor, who cares if their creditors or a shell of their former arch-enemy is enriched? Not INTC. The death of their only competition, AMD is worth fare more than any settlement (I’ll be it’s worth more than 2x AMD’s current market cap– about $20 bill)
2) AMD is scrappy and quite brilliant. Despite having an R&D budget less than a quarter of INTC’s, AMD has quite frequently out-innovated them. This is very impressive and speaks to the power of the talent at AMD. If one were to browse message boards and blogs, AMD also seems to have won the PR battle of which company is better to work for. A quick glance reveals that former INTC employees and partners are quite scathing in their words. I believe it safe to say that AMD has won the hearts of those in the computer industry. INTC is (nearly) in the same boat as MSFT in this way.
3) Dell has been pushing AMD hard lately. Dell went from zero AMD, to very quietly featuring AMD in most of their print advertisements that I’ve seen over the past few months. This could be due to ridiculous prices that AMD is offering or it could be due to Dell wanting to break INTC’s stranglehold on the market. Either way, getting AMD out there listed as a component in most PC manufacturers does more than any advertising ever could, because it positions them as a clear viable alternative. Dell is as main-stream as it gets, when they start pushing AMD processors, consumers start to ignore the fact they had gotten used to buying Intel processors all those years. Intel built a great brand in terms of awareness. Who can forget that tone at the end of all those commercials. Here’s their problem: it doesn’t (and never did as far as I can tell) stand for anything. All of their marketing spending through the years has gotten them nothing but the equity of “being inside of people’s computers”. That’s not a defensible marketing positioning. In fact, as a brand manager let me tell you: that positioning really, really sucks.
So I’m betting on AMD. For now. If they’re cutting into the future for the sake of the short-term, I’m looking to get out. And I’d also say that the PC manufacturers should have their heads examined if this is the case – because they’re handing back over monopolistic pricing control back to Intel. If they do that, when the chickens come home to roost, you all better not be holding Dell, HP or any of those other stocks! But Intel would look pretty good again – after all, monopolies always do.
Disclosure: I own AMD, GOOG, YHOO, and have recently begun selling MSFT stock.