Friday, January 23, 2009

AMD on the Ropes

When you go up against Goliath, you had better not make mistakes. The biggest David and Goliath story in the semiconductor chip industry in this decade has been AMD and Intel. Right now AMD is badly battered by the giant Intel, partly because AMD stumbled in introducing quad core microprocessors.

AMD reported fourth quarter 2008 results at its analyst conference yesterday, and they were a disaster. Even when you strip out special or non-cash items, AMD lost a lot of money on its basic operations producing microprocessors and graphics processors.

For details on what happened in the quarter and what management thinks of the first quarter of 2009, see my AMD analyst conference summary for q4 2008.

AMD made its biggest mistake, or double mistake, when it and Intel were transitioning from dual core to quad core chips. Much of today's problems stem from that era. Intel, which had been rapidly losing market share in the high-margin server chip market, decided to kluge together two dual core chips, each a separate piece of silicon. AMD insisted on the more elegant solution of actually putting all four cores for the Opteron on the same silicon chip. Then it ran into design and production problems, delaying its quad core introduction. Intel, with its dominant market share and huge cash flow, had no competition in quad-core chips for about a year. That was enough to regain most of the market share it had lost and to using pricing to keep AMD at bay even after quad core Opterons were finally introduced.

AMD also acquired graphic chip maker ATI, which was a smart move in itself, but they paid way too high of a premium for the acquisition and were saddled with debt that was unsupportable given ATI's marginal profitability.

AMD has always been behind Intel in what is called process technology. AMD's superior chip designs are typically made using larger silicon features than Intel's, which means Intel can put more transistors on any given size of chip.

The fourth quarter of 2008 should have been a magic moment for AMD. The new version of its quad core Opteron processor is at the same process technology, 45 nm, as Intel's current competitors. It is a very competitive chip. AMD also has very competitive desktop Phenom processors and notebook Turion processors. Some people even admit that it is ahead of NVIDIA in graphic chip technology for the first time since ATI was acquired.

But demand for computers fell across the board in the last quarter of 2008 due to the banking crisis. Instead of making a profit, gaining market share, and preparing for the next round of competition, AMD was badly hurt. Intel has a huge inventory of unsold processors, so they will probably be dumping them on the market. And Intel has huge cash reserves, so they can better develop new technology while making little profit during the downturn.

So is AMD finished? By no means. The spin off of their manufacturing operations to The Foundry Company has been well publicized and should be completed in February. At that point the core of AMD will be a design and sales company. AMD's much smaller team of engineers has consistently out-designed Intel for a decade now; maybe they can keep up the heat.

AMD will emerge from its spin off with a substantial amount of cash and somewhat decreased debt. That leaves it vulnerable, of course, to Intel's "aggressive" sales tactics (illegal, according to some nations) and ability to flood the market with cheap processors.

So visibility is practically non-existent here. If the economy turns around before Intel is able to introduce 32 nm based chips, AMD might be able to gain crucial high-margin market share in servers. But once Intel starts selling 32 nm chips, AMD will be at a disadvantage again, for a while, no matter how good their chip designs are.

I still own some AMD stock. It has been the worst performing stock in my portfolio. It is a reminder that even geniuses can lose money for you.

So keep diversified.

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