Why Are Investors Beating Up On AMD?

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It's a lousy time to be a company with a lot of debt, high fixed costs, and an acquisition that in hindsight looks ill-advised. In short, it looks like a lousy time to be chipmaker Advanced Micro Devices (AMD).



That's the apparent opinion of investors who briefly drove AMD stock down to under its 52-week low Aug.6, when it traded as low as $12.38, beating its previous nadir of $12.60 from Apr. 5. In recent years, AMD had been flying high, making rival Intel (INTC) sweat by capturing some of its market share in the high-margin server-chip business.



Much of the August pummeling has come as a result of a "sell" rating from Caris & Co. analyst Daniel Berenbaum, whose target price is $10.



Looking back at all AMD has accomplished in the last three years -- landing its chips in servers and a personal computer from Dell (DELL), and more recently notebooks from Toshiba (TOSBF) [see BusinessWeek.com, 07/30/07, "In Switch, Toshiba Buys AMD Chips"], both of which had used microprocessors from Intel exclusively -- it's surprising to see how tough its position in the market still appears, Berenbaum says. "There are a lot of positives to cite. AMD has proven that its microprocessor business has come a long way. It serves a lot more of the PC market than it used to and has design wins with every major name, and that is something you couldn't say two or three years ago."



Racking Up Debt

The problem, he says, is AMD's ability to generate cash and finance its long-term debt. On Oct. 25, 2006, it bought graphics chipmaker ATI, a $5.4 billion deal that AMD financed with $1.8 billion in cash and a $2.5 billion loan from Morgan Stanley (MS). That raised AMD's long-term debt to nearly $4 billion at the close of its most recent quarter, compared with $1.3 billion at the close of 2005. Meanwhile, losses have been stacking up. For the quarter ended June 30, AMD reported a $457 million loss on sales of $1.4 billion. That came after a $504 million loss on sales of $1.2 billion for the March quarter.



It might have been a good deal if ATI had delivered as Chief Executive Officer Hector Ruiz had promised. But it hasn't. Its latest round of graphics chips have run behind schedule. Meanwhile, Nvidia (NVDA) , ATI's main rival in the graphics chipset business, has been gaining market share, while ATI's has been falling. Research firm Jon Peddie & Associates pegged AMD's share of the graphics chipset market at under 20%, down from over 26% a year ago, while Nvidia and Intel saw their market positions grow. "I think AMD overpaid for ATI," Berenbaum says. "I think management overreached in taking a company that ultimately hasn't delivered what was expected in terms of accretive performance." AMD declined to comment. Its latest graphics-chip release, the FireGL line of graphics accelerators for workstations, was released Aug. 6.



Meanwhile, prices for microprocessors in PCs and servers have remained under constant pressure, thanks in part to Intel's technological lead and AMD's misjudging of demand in certain segments of its business. Its main hope, Berenbaum argues, is to sell about $1.4 billion worth of assets, including outdated manufacturing gear, and the remainder of its holdings in Spansion (SPSN), its former flash-memory subsidiary, in order to keep the boat afloat.



Now the Good News

Is there a light at the end of this tunnel? Doug Freedman of American Technology Research thinks there is: He rates the stock a "buy." "I don't think what we're seeing with AMD has much do with its fundamentals as it does with nervousness about the credit markets," he says. "But that's not to say AMD doesn't have its fundamental challenges."



The indicators of turning the ship around are encouraging in a few spots. PC sales in the second quarter, typically a seasonally weak one, bounced back stronger than most people realized, Freedman says. "If PC sales come in anything close to seasonal patterns, we'll have a strong year," Freedman says. And AMD has recaptured some of the market share it lost in the first quarter. Encouraging numbers from other PC makers, such as Hewlett-Packard (HPQ), which reports earnings Aug. 16, could be revealing.



AMD also has a new graphics-chip family and a server-chip family, code-named Barcelona, coming soon. They are aimed precisely where they need to aim -- at higher-priced products. Barcelona is a server chip with four cores -- a core being the central brain on a chip -- that will be sold for a higher price than a typical chip that goes into a PC or notebook, and as such will generate higher margins per unit than the chips sold for lower-end systems. A successful Barcelona launch would go a long way toward generating some much-needed cash.



Full Pipeline

But AMD's main challenge with Barcelona will be fighting the perception that it's not as fast a chip as previously hoped. Barcelona is expected to ship with clock speeds in the range of 2 to 2.5 gigahertz, when analysts and customers had been hoping to see speeds closer to 3 GHz. AMD says it expects to release speedier versions of the chip by the fourth quarter. After Barcelona, AMD has another chip, code-named Shanghai, in the pipeline for 2008. This one will be built on more advanced 45-nanometer manufacturing technology, allowing smaller transistors on a chip and thus more computing power than current 65-nanometer manufacturing technologies. After that is a 45-nanometer chip called Sandtiger, set for 2009, which will have eight cores.



Intel isn't sitting still, though. Among other things, it plans to introduce chips built on 45-nanometer manufacturing technology before the end of this year. Code-named Penryn, the chip will use a new technology that Intel says will reduce its power needs while boosting its speed. "AMD's biggest problem is that it doesn't have much on its road map that's really exciting until 2009," says Jim McGregor, an analyst at InStat/MDR in Scottsdale, Ariz.



How much lost market share has AMD managed to retake? Mercury Research in Cave Creek, Ariz., pegged AMD's total share of the market for PC, notebook, and server chips at 22.9% in the second quarter to Intel's 76.3%, which for AMD is an improvement over its 18.7% share in the first quarter, and even slightly ahead of its share in the second quarter of 2006.



Dean McCarron, head of Mercury Research, says much of AMD's sales strength, however, came from the lower end of the market, where profit margins tend to be leaner. "AMD demonstrated that the first quarter was an artifact of arithmetic and not as dramatic as it appeared to be," he says. "Its share started to come back, but the average selling prices for both [AMD and Intel] were down pretty significantly."



Easier Upgrades

AMD does have one advantage that Intel doesn't have -- at least not to the degree AMD does. AMD has long made its server chips pin-compatible with prior models, so servers using AMD chips are easy to upgrade -- just swap in a new one to replace the old. It's often not as easy to upgrade servers using Intel chips, McCarron says. Intel's chips are less often pin-compatible between generations, so servers are more difficult to upgrade. "I think the Barcelona release that's coming before the summer is over will kick off a wave of server upgrades," he says. That would boost the volume of chips with higher margins and give AMD some much-needed cash.