Decoding AMD's Q2 Execution Shortfall

| About: Advanced Micro (AMD)

Advanced Micro Devices (NYSE:AMD) shareholders have seen a significant destruction of wealth over the last four months, with the stock plummeting from just over $8/share to the low $4's. The downtrend began after the Q1 2012 earnings report, in which the company beat estimates on the top and bottom lines. The stock was then demolished, going from the $6 range to the low $4's, after the company hit investors with a one-two punch of a revenue warning coupled with weak guidance at the quarterly report. So, what happened?

Listening to the Q2 report, it seems that the main issue was weak desktop channel sales that "started in China and then spread globally." Unfortunately, it seems that AMD's Llano sales in the channel is suffering the Osborne effect. Let me explain:

When average users go to buy an OEM system from the likes of Dell (NASDAQ:DELL) or Hewlett-Packard (NYSE:HPQ), they're generally not interested in the specifics; that is, they likely won't read in depth performance benchmarks. They'll see the buzzwords and key words such as '3.0GHz', 'Quad Core', and '8GB of memory', and simply buy the system that seems to best fit their price range. AMD's products are actually pretty strong in this way: even their '4 core' Bulldozer chips that more often than not underperform a '2 core' Intel (NASDAQ:INTC) Sandy Bridge chips in CPU-intensive tasks, look attractive to the average buyer.

In the notebook space, the specifics of the hardware are even less important, with users favoring the right mix of portability, battery life, and cost. AMD's products also do well here, especially as low-cost alternatives to higher-priced Intel alternatives with the same 'checkbox features'.

But things got too hot for AMD in the channel. The systems that are sold in this segment are usually systems from 'white-box' OEMs and chips sold directly to the end user. The white-box OEMs and the folks buying their CPUs directly from retailers and e-tailers are more "in the know" about the performance characteristics of the systems they're buying. Further, the folks selling are usually more knowledgeable about what products offer the best "bang for the buck" (this is one of the competitive advantages that small computer businesses have over companies like Dell).

This leads to the issue then: why should these folks buy a Llano based desktop when they know that Trinity is on its way, and know that it is a fairly significant step up from the Llano chips? AMD's channel partners will know not to load up too much on Llano, especially given what's in the pipeline; they wouldn't want to have to suffer inventory write downs when the new stuff hits.

But to add salt to the wound, AMD isn't just competing with itself; it's up against Intel. While AMD's Llano and Trinity chips still offer a very clear competitive advantage on the integrated GPU side of things over Intel's offerings, AMD finds itself in the following conundrum: channel partners that are trying to sell 'gaming capable' systems will most likely want to use discrete graphics cards from either AMD or Nvidia (NASDAQ:NVDA) paired with Intel's CPUs due to Intel's generally superior gaming performance even with their low end "Pentium" chips. And for systems that don't require gaming-class graphics performance, Intel's integrated graphics solutions will be adequate paired with Intel's superior CPU performance.

Finally, there's the additional issue that desktops are just not all that fashionable these days. Power users and budget-minded folks alike still buy desktops for the performance per dollar (and at the high end, the raw performance), but the general public is clearly flocking to portability. So I suspect that weakness in desktop sales in general hurt AMD here, especially since the company has only 19.1% of the x86 processor market, but has 43% of the desktop x86 market. Microsoft's (NASDAQ:MSFT) upcoming Windows 8 operating system is particularly desktop-unfriendly as it focuses on the touch-friendly Metro UI, so I don't suspect the software giant's upcoming operating system will help matters here.

AMD needs to focus on gaining a greater portion of the notebook and netbook market share. Their products are competitive there, and the success of the firm's low power Brazos, mainstream Llano, and Trinity chips in the notebook space is a testament to this. AMD does not need to retake the x86 CPU performance crown in order to get back on track. What it does need to do is continue to make parts that are attractive on a performance per dollar and performance per watt basis in the notebook space. Having a highly competitive product in the x86 tablet space that will be born with the introduction of Windows 8 will also help the top and bottom lines going forward.

Disclosure: I am long INTC, NVDA, AMD.