It has not escaped me that in the recent month, AMD's (AMD) share price has rallied strongly. AMD shareholders, who commentate on my articles, persistently tell me that I'm wrong about AMD, and that rally in its share price is evidence that AMD is undervalued. I, on the other hand, could not disagree more. I simply see the rally in AMD's share price, as an increase in risk that shareholders are buying into. Simply put, AMD is too capital intensive, and its present market valuation is too high.
I have spent a considerable amount of time trying hard to figure out how much free cash flow AMD expects in full-year 2018. We know that AMD started the year with Q1 2018 having a use of free cash flow of $132 million. However, AMD is seasonal, with H1 being typically weaker and H2 generally being stronger - in terms of free cash flow generation; with Q4 being its strongest quarter. However, given that AMD does not give any forward guidance for free cash flow, it remains difficult to make an educated guess for the full year 2018 free cash flow.
Previously, I estimated from AMD's Q4 2017 earnings call that AMD would indeed be free cash flow positive and reassured of this by CFO Kumar's comments on the Q&A part of the call. However, given that Q1 2018 started off with negative $132 million, it will be interesting to see what free cash flow 'positive' actually means for AMD.
I put my top estimate at $50 million in free cash flow because I assume that if AMD was able to generate a significant amount of free cash flow, above this figure, then it would not need to have had proposal 3 at the Annual Stockholders' Meeting.
To remind readers, proposal number 3 of AMD's annual meeting had been to,
increase the number of authorized shares of common stock from 1.5 billion shares to 2.25 billion shares
Earlier this month, this proposal got strong shareholder approval, so it will be curious to see if the number of shares outstanding starts to once again to trickle up. Because this increase in share count is for a 50% shareholder dilution, which is a significant amount.
Having said that, when a Goldman Sachs analyst questioned AMD's management on this proposal, CEO Su brushed it off and said that it was 'good housekeeping' and that shareholders need not be overly concerned and that AMD has no plans raise funds via an equity raise.
Given that AMD finished Q1 2018, with roughly $1.04 billion of cash and equivalents and that AMD's total principal debt, including its secured revolving line of credit, was $1.7 billion, this puts AMD with a net debt position of very roughly $650 million.
Now, given that AMD is very capital intensive and that AMD is unlikely to break even from a free cash flow perspective until the back end of 2018, I am interested to see how AMD will meet its current liability of $229 million in the coming twelve months ($223 million plus interest cost related to amortization of the debt discount of $6 million).
AMD has in the past highlighted how its optimal cash levels needed to run its operations were roughly $600 million of cash. Once the debt of $229 million is repaid, AMD will be getting close that threshold. Therefore, it's the reason why AMD felt it appropriate to include the following provision in its recent 10-Q.
Should we require additional funding, such as to meet payment obligations of our long-term debt when due, we may need to raise the required funds through borrowings or public or private sales of debt or equity securities [...]
I suspect part of the reason for AMD's recent rally in its share price will have been because of AMD's strong Q2 2018 guidance for revenue to be up 50% YoY - which is quite remarkable indeed. However, given that AMD has in some small ways been a beneficiary of selling GPUs to miners, and that according to Nvidia's (NVDA) earnings call, that its crypto revenue is expected to fall quite significantly in Q2, this is possibly the reason why AMD felt appropriate to guide for full revenue to be up only around mid-20%, in spite of expecting Q2 2018 to be up 50% YoY - which implies quite a slowdown for the rest of the year.
I am a practitioner investor and not just a financial blogger. Before I make any investment in a stock I remind myself of Charlie Munger's quote,
When they're talking, they're lying, and when they're quiet, they're stealing
Investing is difficult at the best of times; but paying up $12 billion market cap for AMD, when there is a real possibility that AMD will still not be strongly free cash flow generative in 2018, making it likely to need to sustain its growth through an equity raise seems like a big price to pay.
Disclaimer: Please do your own due diligence to reach your own conclusions.
Note: The only favor I ask is that you click the "Follow" button so I can grow my Seeking Alpha friendships and our Deep Value network. Please excuse any grammatical errors.
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Disclosure: I/we 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.