AMD: Growth Opportunities & Challenges In The Game Console Market

by Trefis Team
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Quick Take

  • In order to reduce its dependence on PCs, AMD has launched a semi-custom chip business which targets a wide range of markets including gaming.
  • Game consoles account for 42% of the $65 billion global video game market. AMD believes that gaming is one of the key pillars of its embedded custom APUs.
  • Instead of licensing its technology, AMD now sells its chips to game console manufacturers.
  • It now powers all major next generation consoles including Sony’s PlayStation 4, Nintendo’s Wii U and Microsoft’s Xbox One. It expects upcoming semicustom SoC products for Sony and Microsoft to be the primary growth drivers for the second half of 2013.
  • Rising competition in the market: Nvidia’s own handheld gaming device (Shield) competes with console makers like Sony and Microsoft. Additionally Amazon is rumored to be working on a new game console which will hit the market by this year end.
  • Though game consoles offer lower gross margins, a majority of the gross margin dollars from the division falls to the operating margin.

In an effort to reduce its dependence on PCs, AMD (NASDAQ: AMD) launched a semi-custom chip business unit this year where the chip combines its central processing and graphic capabilities and can be integrated with its customers’ intellectual property. The new unit focuses on high-volume, high-value applications that span a wide range of markets, including gaming. AMD believes that the semi-custom model has the potential of being a long-term revenue generator for the company.

AMD devised a unified gaming strategy in March this year that addresses its plan to drive the gaming market across consoles, cloud platforms, tablets and PCs. It believes that it is effectively positioned to drive the next revolution in gaming, which will help it differentiate itself from competitors. AMD now powers all major next generation consoles including Sony’s PlayStation 4, Nintendo’s Wii U and Microsoft’s (NASDAQ:MSFT) Xbox One.

The company anticipates 22% sequential growth in revenues this quarter and expects the upcoming semicustom SoC products for Sony and Microsoft to be the primary drivers. We believe that a diverse revenue stream is a good long-term business strategy, especially in light of declining PC shipments. However, there are a number of factors that can limit AMD’s growth in this segment.

See our complete analysis for AMD

Previously AMD’s graphic technologies were integrated into Microsoft Xbox 360, Nintendo Wii and Nintendo Wii U. AMD has never sold GPUs for game consoles, but received royalties for each console that utilized its graphics technology. However, the next generation Microsoft and Sony game consoles will utilize AMD’s system-on-chip Jaguar core and Radeon HD graphics chips. In short, AMD will now sell chips to these players instead of licenses.

AMD believes that gaming is one of the key pillars of its embedded custom APUs and expects embedded processors to constitute a much higher percentage of its overall revenue in the future.

What Are The Growth Opportunities In The Game Console Market?

Despite stiff competition from other forms of gaming, game consoles account for 42% of the $65 billion global video game market. [1] Though the winding down of the current console generation has lowered sales, the broadening of consoles beyond core video games has increased household penetration in the U.S. to 57%, compared to 40% in the previous generation. Jon Peddie Research valued the PC gaming hardware market at $23.6 billion in 2012 and forecasts the market to cross $30 billion by 2015. [2]

Recently, China officially announced that it will lift its 13-year-old ban on foreign video games consoles provided companies develop their products in the free trade zone designated by the government. China is the world’s most populous nation and the move can significantly increase sales of Nintendo, Sony and Microsoft game consoles in the future. [3] By having a presence in all the three game consoles, AMD can significantly increase its processor shipments in the future.

msgames

Rising Competition In The Market Limits Growth Potential For Exisiting Consoles

Nvidia’s (NASDAQ:NVDA) graphics powered Sony’s Play Station 3, but the company backed out from negotiation for Play Station 4. While the reason is not clear, we speculate that declining margins was an important factor behind the company’s decision. However, wanting to leverage the growth in the gaming market, Nvidia launched its own handheld gaming device – Shield – earlier this year and started shipping the same last month.

Shield is an Android-based portable gaming console that also offers PC game streaming features. What differentiates Shield from other devices is that it is the only device to play Android games with an integrated gamepad. Powered by the Tegra 4 processor, Shield is Nvidia’s maiden attempt as a gaming hardware provider, pitching it against console makers like Sony and Microsoft. Nvidia believes that open platforms such as PCs and Android are outgrowing the traditional console market.

Amazon is another big threat for AMD’s leading game console customers. Amazon is rumored to be working on a new game console which will hit the market by this year end. It will be leveraging Android games and applications available on its platform and have its own dedicated controller powered by Qualcomm (NASDAQ:QCOM). Rumored to be priced around $99, the Amazon game console will give stiff competition to Microsoft and Sony. (Amazon Android-Powered Game Consoles: A Huge Impact on Microsoft, Sony, Nvidia, Qualcomm and Advanced Micro Devices, Fiscal Insider, August 12, 2013))

Game Consoles Offer Lower Gross Margins

While the game console segment offered good margins for hardware manufacturers historically, it has become a low margin business now. AMD’s gross margin declined from 41% in Q1 2013 to 40% in Q2 2013. With a higher mix of game console revenues, the company expects margins to further decline to 36% in the current quarter.

However, AMD claims that game consoles have comparatively lower operating expenses and thus majority of the gross margin dollars from the division falls to the operating margin. For the next few quarters, AMD expects low double-digit operating margin for this business which it believes will more than offset the impact of lower gross margin.

Impact On Valuation

The embedded processors segment accounts for approximately 16% of AMD’s valuation, as per our estimate. We currently expect revenues from the division to rise from $228 million in 2012 to over $1.4 billion by 2020. If revenues reach $2 billion instead, there will be 10% upside to our price estimate. On the flip side, if revenues only reach $1 billion, there will be a less than 10% downside in our estimate.

Our current price estimate of $3.76 for AMD is in line with the current market price.

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Notes:
  1. Microsoft: Global video-game market hits $65 billion, and consoles still lead the way, Geek Wire, May 17, 2013 []
  2. PC Gaming Hardware Market to Hit $23.6 Billion in 2012, Jon Peddie Research, May 3, 2012 []
  3. China To Lift Console Ban, Forbes, July 7, 2013 []
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