AMD Valuation

Last year AMD bought ATI for $5.4 billion. Today AMD is valued by the market at $5.9 billion. What gives? What sort of valuation should be put on AMD stock?

AMD, of course, makes microprocessors, or CPU's, the cores of computers. It traditionally competed only in the PC space until it introduced its Opteron processor for servers in 2003, and usually had less than 10% of the market, with Intel having about 90%. From 2003 until 2005 AMD had a good run, gaining market share and hitting a stock price over $40 in January 2006. Then Intel struck back. By slashing its prices and promising a new generation of chips for later in 2006, Intel first cut into AMD's profit margins and then began to regain market share. The new chips introduced in 2006 had their faults but were overall on par with AMDs. Then came the ATI acquisition, which saddled AMD with a lot of debt. To add to this toxic brew, AMD's quad-core chips, code named Barcelona, were delayed in 2007. For more AMD background and history check out my AMD page.

Because of the necessity of competing on price and the poor sales of ATI chips after the acquisition (competitor NVIDIA introduced new graphics chips that put ATI behind), AMD has had a very bad year. The good news is that the stock is now astonishingly cheap, if you are willing to pick up on the risk. Last week a wealthy shiek bought some $600 million's worth, so you would not be alone in your gamble. [I own AMD stock and also owned ATI stock before the merger. I also once owned NVIDIA stock but foolishly sold it.]

Lets use the numbers from AMD's latest quarter, Q3 2007, as a proxy for its current condition [See also my AMD October 18, 2007 Analyst Conference Summary]. Revenues were $1.63 billion, up 18% from Q2 2007 and up 22% from year-earlier.

Which would seem to say that AMD is accelerating out of its 2006 slump, at least on the revenue side.

Q3 2007 net loss was $226 million, which tells you the core story of AMD's low stock price. While it was better than the net loss of $457 million in Q2, it was a reversal of a net income of $121 million in Q3 2006. Q3 2006 in itself was not a good quarter for profits.

The main reason I think AMD is underpriced is because in Q3 2007 it reached positive cash flow. That is, much of the net loss was for non-cash expenses, including ATI acquisition costs. AMD spent the money on ATI last year, but under generally accepted accounting principles (GAAP) some of that expense is written off over time.

Also, AMD shipped a record number of processors in Q3. Despite predictions by Intel fans that AMD would sink back into the obscurity from whence it came, and claims that AMD notebook chips sales would be down, AMD's processors for notebook computers had 68% better unit shipments than the year-earlier quarter.

After some real problems marketing graphics chips after the ATI acquisition, that segment seems to be getting on track with a 29% sequential increase in graphics revenue.

Intel has always led AMD in process technology (the ability to put more logic gates in the same area of a chip). Just a few years ago AMD was typically two years behind Intel. This month Intel introduced chips using 45nm technology, though they don't seem to be actually available in any quantity yet. AMD said it 45nm chips will ramp in Q2 2008. My guess is that means a May release, so AMD has closed that gap down to 7 months. But AMD has a lead in putting 4 processor cores on a single semiconductor chip, and in design architecture.

If AMD were a recent startup investors would probably consider it a tiger, given all these trends. Intel is a heavy competitor, of course, so heavy that many nations are looking into Intel's reputation for illegal anti-competitive practices and AMD had to file a lawsuit to force Intel to allow computer makers to by AMD chips without retribution.

While Intel is AMD's main danger, a secondary risk would be the possibility of a slowing of the expansion of the computer market. Given the booms in India, China, Russia and elsewhere, I'd prefer to bet on a strong global market even if the U.S. market weakens.

One place AMD shines is giving its customers (the computer makers) what they want, in contrast to Intel's take-it-or-leave-it approach.

Another downside concern is the slow pace of introduction of quad-core Opterons. If AMD does not get its act together on this soon, it could lose all the gains it made since 2002 in the relatively high profit margin AMD market.

On balance, I see AMD growing in 2008, with positive cash flow and progress probably positive GAAP net income by the second half. AMD's stock price probably won't move above $15 per share until this current run of market turmoil ends and AMD shows 2 consecutive quarters of profitability.

But with a current revenue annual run rate of $6.5 billion, and apparently accelerating, I think a rational market would put the market cap at no lower than $7 billion. Which works out to $12.65 per share.

And if indeed AMD continues to gain revenues as quickly as it has lately (possible with its new Phenom processor, quad-core Opteron, and Spider graphics system), it could go a lot higher a lot sooner than most analysts and investors think.

AMD believed it would have a long-term competitive advantage if it became the only company with high-end graphics and general microprocessor capability. It might still be proven right.

Strangely, while I've been writing this its AMD's stock price has risen to $11.05, from $10.55 or so when I started writing.

More data:

www.amd.com
competitors:
www.intel.com
www.nvidia.com