AMD Versus Intel - Not A Fair Fight
Advanced Micro Devices (AMD) is a producer of central processor units (CPUs), chipsets, and graphics processor units (GPUs), primarily for desktop, notebook, and server computers. The company has long played the foil to Intel (INTC), producing compatible x86 CPUs that provide similar performance but at generally cheaper prices. Today, the two companies still hold avirtual duopoly on the x86 CPU market, with Intel at 80% market share and AMD at 20%.
AMD also entered the graphics processor market in 2006 with its purchase of ATI. Graphics processors have become more and more important in computing as operating systems continue to add fancy visual tricks and computers are used more and more for photo and video editing and viewing. The story is similar here for AMD as it is with CPUs. Overall, the company plays second fiddle to Intel, with about 25% market share vs. 60%, while Nvidia (NVDA) holds about 16% share. It is important to note, though, that in high-end performance GPUs, AMD and Nvidia are about neck-and-neck in both market share and performance (Intel doesn't participate in this segment).
The biggest business model difference between Intel and AMD is in regards to manufacturing. While Intel owns its own chip fabrication plants (fabs), AMD in 2009 spun off its manufacturing into GlobalFoundries, or GF. As a result, AMD is now a "fab-less" design house. This dramatically reduces the firm's ongoing costs and capital expenditure requirements, and has allowed AMD to shore up its balance sheet and stabilize margins. Total debt had been reduced from $5 billion down to $2 billion since the spin, and operating margins have improved from negative territory to around 7-8% over the last 3 years.
While AMD has greatly improved its prospects over the last several years, there are still plenty of challenges going forward. The primary one is simply keeping up with its arch rival. Intel is a formidable competitor, with huge economies of scale that lead to massive advantages in R&D spend (8 times AMD) and profitability (30% operating margin). These lead to very tangible product differentiation.
Just this year we've seen several examples of this. Consider that Intel's Ivy Bridge processors use a proprietary, "3D" 22 nanometer (nm) technology that is at least a generation ahead of the 28nm process AMD is using for its current chips. AMD has seen little success with its Fusion or Llano products against Ivy Bridge. A similar situation exists in server processors, where AMD's "Bulldozer" chips started off well late last year, then declined in Q2 year after Intel launched its Romley line in March.
Consider also that AMD had to spend over $400 million this year to terminate a 28nm exclusivity deal with GF because they were having manufacturing problems and the challenges become very clear. While AMD's fab-less strategy has helped the firm stay afloat, it also creates new issues in the battle with Intel.
Finally, let's talk about the ongoing flat-lining of PC sales. Put simply, PC sales have been weak for almost 2 years now. In Q2, Hewlett-Packard (HPQ) reported a 12% decline in desktop/notebook shipments, and rival Dell (DELL) was close behind at -11.5%. Overall, U.S. shipments were down 5% and flat globally. Most of the big PC makers are citing weak global economies, but I'm not so sure I buy it. A bigger culprit is probably the consumer move to tablets and especially smartphones. Unfortunately for AMD, they have no roadmap to enter either of those spaces.
With revenues expected to be down in double digit percentages this year, and probably only a modest correction next year, the prospects for AMD are not so bright. Yes, the stock is cheap, with a 14.4% EBIT/EV ratio, and at about $3.50, the stock sells over 40% below my fair value estimation of $5/share. But here's the thing. Intel's EBIT/EV is similarly cheap at 13.6%. Intel pays a 3.7% dividend (AMD pays none). Intel is forecasting revenue growth this year, has far better margins, far better market share, far more advanced technology, and a far better roadmap that includescurrently shipping products in the smartphone/tablet space. So why not just buy Intel?!
Disclosure: Steve owns INTC