David beating Goliath sounds romantic but in the technology industry Goliaths are tough to beat. Once a company consolidates and gets to a market share of 70% or 80% and builds a lot of infrastructure around itself, the Company becomes tough beast to beat. Such has been the story of the x86 CPU market where Intel (NASDAQ:INTC) consolidated its moat over time. Many aspirant Davids have died over the last 30+ years trying to fight the industry giant but, miraculously, one David has survived. That David is AMD (NASDAQ:AMD).
So, what is the secret to this David's survival?
It so happens that, in spite of Goliath's strength, once in a great while David can come up with a new tool that Goliath has not seen - like a sling shot - and beat Goliath. AMD did precisely that to Intel in the late 1990s with its Athlon product.
But, unlike the folklore of David who killed Goliath with the slingshot, AMD did not kill Intel but just annoyed the heck out of the company. Once Intel got past the annoyance, it came back stronger and squashed AMD. The chart below, courtesy Google Finance, highlights the point and the changing fortunes of AMD.
AMD's miserable existence since 2005, when the Company last had a competitive product against Intel, can be seen in the market share image below (source: Passmark).
As of 2016, AMD was barely alive and was a bottom feeder scraping through the lowest ASP and lowest margin niches of the x86 market. As grim as it is, even the above picture paints an overly rosy picture of AMD's shape. The 20% market share that AMD had, came with such low margins that there was little value accretion at the Company. At the same time, lacking any competition at the high end, Intel was commanding exceptionally high margins. The disparity was evident in the companies' relative valuation. Around the beginning of 2016, AMD had a market capitalization near $2B and Intel had a market capitalization around $150B! Nuances aside, Intel had 4x the market share of AMD and 75x the market capitalization.
Then, towards the beginning for 2016, something started happening. Our modern David was still looking black and blue from all the beatings from Goliath but David started talking about this new tool that can win out against the Goliath. Some speculators started sizing up the new tool that David was building and started handicapping David. Things again started to look good for David.
That is precisely what happened to AMD when it started talking about the imminent arrival of its "Zen" family of products. (What makes this Zen so good? We will not get into the technical details but suffice it to say that Zen is a family of products that are competitive with the best that Intel has to offer. )
For the first time almost two decades, AMD had a credible x86 architecture that can challenge Intel at the high end of the x86 market. Expecting AMD to take some market share back from Intel, and given high end is where the margins are, risk tolerant investors ran up the stock throughout 2016 in anticipation of the Zen family of products.
The stock ran up almost 5x in a period of 12 months and the Company's market capitalization reached about $10B.
We have been watching this story from the sidelines - very cautiously - given AMD's checkered history. While the Zen story is a good one, there are several very big risk factors. Some of the key risk factors are:
The Company may be delayed in getting to a functional and competitive Zen products The Company may be delayed in developing the motherboard and graphics infrastructure necessary to enable the Zen products The Company may not be able to get a good manufacturing yield causing the margins to shrink , volumes to drop, and, most importantly, delaying the release timing of the Zen The Company's new GPU chip, Vega, which goes along with Zen, could be delayed and also have an impact on Zen launch
The problem for AMD is that it does not have a great balance sheet or a large time window to make Zen a reality. Once Intel got a scent of what AMD is up to, it is bound to develop strategies to respond. The first three risks listed above, in particular, were so big that, if manifested severely, they could decimate AMD. Given the "Do or Die" risk profile, we decided to stay on the sidelines until AMD posted its first quarter of revenues with products based on the new Zen architecture.
In the meantime, the stock continued to run up. After running up 5x in 2016, the stock ran up about another 50% and hit a 52-week high of $15.55 in February.
On March 1st, AMD finally announced the release of its high-end desktop processor Ryzen 7. The announcement included endorsements from the top 3 PC brands - Lenovo, HP and Dell. Two weeks later, the Company indicated that it will begin selling its mid-range CPU Ryzen 5 starting April 11th. All of this indicates that the Company's execution risk with Zen core was now largely a thing of the past.
Subsequently, AMD delivered a better than guided Q1 results and indicated that the Company's margins improved due to Ryzen sales. This implied that Ryzen not only worked but can be made profitably.
In spite of this seemingly great news bits, the stock price collapsed and as of the writing of the article, the stock trades at around the $10 level.
So, what is wrong? Did the stock price rise from the $2 level at the beginning of 2016 to the $10 level essentially capture the upside at AMD?
Is a $10B valuation for AMD as good as it gets?
The answers to these questions are complex, nuanced, and best dealt in multiple focused bites. What is ahead is going to be one of the most exciting narratives in the semiconductor industry.
In a series of articles, we will explore some of the highest alpha opportunities in the semiconductor industry for 2017 and 2018. The stocks covered in this series, in addition to Intel, will include NVidia (NASDAQ:NVDA), TSMC (NYSE:TSM) and, possibly, Apple (NASDAQ:AAPL).
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Disclosure: I am/we are long AMD.
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.