Sell This Sinking Tech Stock, Wait Until Q4 To Reinvest

Oct.24.12 | About: Advanced Micro (AMD)

Advanced Micro Devices (NYSE:AMD) announced that it plans to cut its workforce by 15%, or the equivalent of 1,800 jobs, in an effort to reduce its operational costs. This decision is expected to be completed within the year as the troubled chipmaker tries to survive in a challenging tough environment. According to Reuters estimates, the move will result in operational savings of $190 million for the next fiscal year. However, it would result in restructuring expenses in the fourth quarter of around $80 million. There were no details as to how disruptive the move will be and which divisions the company will be closing.

There have been various reports about the demise of the PC industry. These chipmakers have struggled to remain competitive and operate efficiently. In fact, AMD CEO Rory Reed expects that the PC market will remain sluggish for the next few quarters. Given this tough situation, the company plans to diversify significantly beyond the PC industry for the coming years. Although there are no detailed plans yet, this move should improve profitability going forward. It is expected to spell out its future strategy before the month ends.

The latest quarterly results show that the company needs some overhauling. It reported a third-quarter loss of $0.20 per share, a decline of 10% over the previous quarter and 25% decline year on year. In contrast, Intel (NASDAQ:INTC) reported a slightly disappointing third-quarter result. It reported earnings per share of $0.58, a decrease of 19% compared to the same period last year. On a quarter-on-quarter basis, this reflects an increase of 5.1%. This seems relatively good in a continuing tough environment. Another industry peer, NVIDIA (NASDAQ:NVDA), posted better-than-expected third-quarter earnings. It announced that third-quarter earnings per share amounted to $0.29, an increase from the previous quarter's $0.25 per share and last year's per-share earnings of $0.15. I believe that the success of AMD's peers can be attributed to their swift reaction to the current developments. For example, a majority of NVIDIA's growth can be attributed to its exposure to the mobile market. On the other hand, Intel's strategy hinges on the success of ultrabooks, phones, and Intel-powered tablets.

While its competitors have moved into the smartphone and mobile arena, AMD has experienced decline on its major business segments. For instance, its computing solutions are still down by 11.4%, sequentially, and 27.9% from the prior year's quarter. The third-quarter results appear to be a continuation of the softening in trends experienced during the second quarter. This is due to slower consumer spending and inventory rebalancing ahead of the Windows 8 launch. Its graphic business also posted disappointing results. Sales from this division declined by 6.8% compared to the previous quarter, and are down by 15.1% from the previous year. The graphics division has experienced pressures due to the slowdown in the PC market, despite growth in desktops and consoles.

Given this situation, I expect that most cost savings from the workforce reduction will be reinvested into newer business ventures such as tablet-style computers in emerging markets, site consolidations, and cloud computing. AMD's inability to penetrate immediately into the mobile market has bigger costs in the future. I believe that it is way behind its competitors in terms of market positioning in the mobile segment. Furthermore, it would need to refine its cost structure first before moving into these new segments. The main problem is that AMD has no buying time with regard to capturing customers in the mobile segment. With cutthroat competition, it would need enough of a war chest to launch a campaign against formidable opponents such as Intel and NVIDIA.

All Is Not Lost, but It Would Be Rough for AMD Shareholders

Industry pundits would find it contradictory to cut costs and find new markets. In fact, there is no need for AMD to invest in large capital into these new business ventures. During the conference call, Read said that these markets are adjacent. This means that it could reuse more of its design components as part of its modular chips in the future. The CEO also said that it has been preparing for the transition into these markets and it could happen faster than the company expected.

This could be true, but investors have already discounted the uncertainties. In fact, the company has posted slower than expected growth despite the peak cycle of the semiconductor industry. For the last 10 years, revenues have grown by 5.37%, but margins have reversed from negative 45.4% in 2002 to 5.6% in 2011. It experienced peak levels for the fiscal years 2009 and 2010. ARM Holdings (NASDAQ:ARMH) posted revenue growth of 12.89% for the last 10 years. Its operating margins have increased from 27.4% in 2002 to 30.3% in 2011. Meanwhile, Marvell Technology (NASDAQ:MRVL) experienced revenue growth of 27% for the last 10 years. Its operating margins have also increased from negative 14% in 2002 to 17.8% in 2011. These companies are somewhat insulated from the PC industry downturn as their revenue sources are diversified. This is something that AMD should strive for.

AMD has provided limited earnings guidance, suggesting a cautious tone from the management. It has guided that the fourth quarter will have a sequential revenue decline of 9%, or equivalent to $1.16 billion. Operating expenses are expected to be flat compared to the previous quarter. For the current fiscal year, analysts expect the company to post a loss of $0.14 per share. This implies a decline of 134% compared to the same period last year. For the next five years, analysts expect the company to grow its earnings by 11.67% a year. This seems optimistic given current situation of the company.

Moving forward, there will be significant challenges for AMD. It would be very difficult to compete with established players in the tablet and smartphone space. Also, Intel's Ultrabook has gained traction and is attracting a client base. Intel has been focused on capturing the high-end market with some successes. Considering Intel's strong financial base, I would not be surprised if it takes market share from AMD in the coming quarters. I encourage investors to avoid AMD shares for now until management has a clear strategy to return to profitability.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.