Advanced Micro Devices: Vindicated After Intel's Warning, But Near Term Pain Ahead

Sep. 8.12 | About: Advanced Micro (AMD)


Advanced Micro Devices (NASDAQ:AMD) develops CPUs, GPUs, and CPU/GPU hybrids for tablets, PCs, and servers. The company's stock has seen significant punishment since it missed on Q2 revenues and guided for a 1% decrease in revenues +/- 3% sequentially for Q3. To add to the pain, Intel (NASDAQ:INTC) had just guided for a 6% sequential increase for its Q3, so not only did the shaky PC ecosystem hurt AMD, but the fear of very significant share gain on Intel's part further fueled the short thesis for AMD (I was actually pretty appalled at the discrepancy between Intel and AMD's guidance). Here is an annotated stock price chart with the corresponding events:

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However, in what investors apparently took to be a cue to continue to drive AMD into the ground, Intel issued a Q3 revenue warning. The firm projected revenues of $12.9B - $13.5B, with a 2% sequential drop at the midpoint of the guidance. Notably, this is roughly in line, percentage wise with AMD's fairly conservative guidance for Q3. Importantly, if AMD actually comes in-line with the previously stated guidance (which was conservative to begin with), the short thesis will be significantly diminished, as AMD's troubles will no longer appear to be heavily weighted towards company specific issues.

Further, while it is still completely reasonable to expect that AMD will also warn (or not warn and then miss), I would like to examine the optimistic side of AMD's upcoming report and, more broadly, its future in the industry.

Lower Expectations

While Intel had forecasted an aggressive sequential and year-over-year increase, AMD had actually forecasted a sequential and year-over-year decrease. While not particularly good, the results from Intel, Dell (NASDAQ:DELL), and HP (NYSE:HPQ) confirm that there is an industry-wide weakness in the PC space and that AMD is simply being hit with the same headwinds that everyone else is being hit with. CEO Rory Read, a veteran of Lenovo, has repeatedly warned of this slowdown and the headwinds.

Further, I expect that AMD's guidance was probably fairly conservative as issuing warnings for two consecutive quarters would look pretty foolish.

Opportunity For Share Gains Across The Board

Even as the PC market has stalled, AMD only holds about 19% of the x86 CPU market. In an era where, for most users, CPUs are "good enough", the focus will be on new features at a cheaper, value price. AMD's integrated graphics designs are currently far superior to anything that Intel has to offer at a much lower price point, enabling a fundamentally new feature (gaming capabilities) for cheaper. This could very well help AMD take share, especially in the low end to midrnge notebook space, from Intel.

Even more interestingly, AMD's share of x86 server CPU shipments is only about 5.5%. AMD's products here, while not world-beating in performance/watt, still offer a compelling performance/$ metric for a number of workloads. If AMD can simply claw back even just 5% of the market share here, this would double AMD's current server sales.

In addition, if the ARM (NASDAQ:ARMH) low power threat in servers is to be believed, then AMD's acquisition of SeaMicro coupled with the firm's low power "Brazos" cores (which are much faster than Intel's current "Atom" processors) puts the firm in an excellent position to compete. AMD has 64 bit, high performance, low power cores today as well as an interconnect fabric via SeaMicro that can make the "micro-server" a reality today. ARM and its legion of licensees are "talking the talk" but not yet "walking the walk".

Finally, in the graphics segment, AMD is uniquely positioned. AMD makes both discrete graphics cards for desktop, professional, and HPC use just like Nvidia (NASDAQ:NVDA) does. But AMD also has world-beating integrated graphics in the PC space. So while the very low end graphics card will likely go the way of the dodo (much to Nvidia's chagrin), AMD is in a position to re-capture that market with its CPU/GPU hybrid solutions while at the same time supplying high end, high margin graphics cards. AMD's discrete graphics card market share increased to 40.3% in Q2 from 37.8% in Q1, proving that the firm is still very competitive in this two-horse race.

Tablets: A Pretty Nice Opportunity

With the upcoming release of Windows 8, both Intel and AMD will find homes for their designs. Intel will enter the ring with its 32nm "Clover Trail" system-on-chip design on release day. AMD plans to crash the tablet party in 2013 with its "Tamesh" dual-core APU based on the firms' upcoming "Jaguar" cores coupled with "Graphics Core Next" graphics cores. These will be built on a 28nm process and should prove to be quite competitive with the available offerings on a performance per watt basis. Further, AMD recently paid heavily for the privilege of being able to source its 28nm chips at other foundries besides Global Foundries, so supply constraints should not hold AMD back here as they did with the original release of Llano.

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Game Console Wins

AMD is also very well positioned for the next generation of game consoles with its graphics and CPU expertise. While only Nintendo's upcoming Wii-U console is confirmed to be powered by AMD's graphics, the industry rumor-mill has strongly suggested that AMD has all three next generation consoles (Microsoft's (NASDAQ:MSFT) Xbox and Sony's (NYSE:SNE) Playstation as well) "in the bag" for graphics.

The more interesting, and much less "confirmed" part, is on the CPU side. Nintendo's console will be using an IBM (NYSE:IBM) designed part, and for a while it seemed certain that IBM would also be supplying the chips for both the next Xbox and Playstation, but according to Semiaccurate, AMD has actually won the CPU designs for both consoles as well. This was further hinted at in CEO Rory Read's Citi Technology Conference presentation:

"We've done well in game consoles. The next generation game consoles aren't announced, but we believe we're well positioned to compete for those next generation game consoles leveraging that APU model that is based on both the CPU and graphics IP that we have."

If true, this could serve as a very nice, consistent revenue stream for AMD over the next several years, although this is likely not going to be a near-term driver.

AMD's Financial Health: Fully Intact

I have seen numerous comments regarding AMD's financial health. The short sellers are screaming for bankruptcy, but that just is not really a realistic near-term scenario. Cash, cash equivalents, and marketable securities were $1.76B at the end of Q2, up from $1.71B at the end of Q1. Debt was unchanged at $2.02B. While debt slightly exceeds cash, this is not a company about to go bankrupt. In the most recent quarter, despite the revenue miss, AMD was still profitable and cash flow positive.

Further, AMD has been cutting operating expenses significantly with the most recent quarter coming in at 8% less than the prior guidance. This was, according to the company, due to lower bonus accruals and discretionary spending cost controls late in the quarter.

Conclusion: A High Risk PC Player That Can Take Share

Make no mistake: AMD is a high risk play. Intel's warning showed just how weak the PC space is and will likely continue to be in the near-term. But AMD's advantage is that it can profitably take share, especially in the low end, since it does not rely on the gargantuan gross margin profile that Intel enjoys. Further, AMD's presentation at Hot Chips showed that the firm still fighting to get new and, I daresay, exciting designs out the door. "Steamroller" seems to fix a lot of the silliness that happened with the firm's "Bulldozer" architecture, "Jaguar" seems to be a great follow-up to AMD's highly successful low power "Brazos" product, and the firm's graphics chips are still highly competitive.

That being said, this is a long term, risky play. If you want safety, do NOT buy AMD. The short sellers have done an excellent job driving the stock price down each and every chance that they can. It will take a significant positive catalyst to cause a squeeze, and given Intel's abysmal warning, such a catalyst may not be here to pull the stock out of the fire in the near term.

Disclosure: I am long INTC, AMD, NVDA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.