Three Scenarios Which Can Significantly Lower Our Valuation For AMD

Owing to a decline in PC shipments, market share loss to Intel (NASDAQ:INTC), and a late entry in new emerging markets, AMD’s (NYSE:AMD) revenue base shrank in 2012 and 2013. Despite a week Q4 2014, AMD’s 2014 revenue grew by 4% annually, and the company delivered its first full year of non-GAAP profitability in three years, as it successfully ramped up a diverse set of new products in non-PC growth markets. However, weaker-than-expected PC sales, the market share loss and a seasonal decline in the semi-custom business led to a disappointing Q1 2015.

Despite short-term weakness, AMD remains optimistic about its long-term growth opportunities. Though the company agrees that the next several quarters will be challenging, due to the adverse market environment, it remains focused on its strategy to improve its financial performance and build  on its strengths through continued investment in its technology and IP, which will drive product innovation and differentiation. AMD expects the second half of 2015 to be stronger than the first half, across the board for all its businesses.

Our price estimate of $3.31 for AMD is at a 40% premium to the current market price. In this article, we list down certain scenarios where our valuation for the company can decline significantly.

See our complete analysis for AMD

Semi-Custom & Embedded Revenue Increases To Only $3 Billion (~40% Downside)

AMD has seen strong growth in its Semi-Custom & Embedded Business in the last three years, with revenue from the division increasing from $698 million in 2012 to $2.4 billion in 2014. In March 2013, AMD devised a unified gaming strategy to drive the gaming market across consoles, cloud platforms, tablets and PCs. The strategy has clearly paid off well so far, as the company now powers all major next generation consoles including Sony’s PlayStation 4, Nintendo’s Wii U and Microsoft’s Xbox One.

After a strong Q3 2014, where the company supplied a significant number of products to Microsoft and Sony to support the holiday demand spike for gaming systems, AMD has seen a seasonal decline in its semi-custom business in the last two quarters.

The game console business has a cycle of three to four years. Microsoft and Sony launched new products in late 2013 and thus AMD expects another few years of strong game-console revenue growth from them. Additionally, last year, AMD announced securing two new wins in the segment, which are expected to deliver combined total lifetime revenue of approximately $1 billion over approximately three years. Design work for these opportunities has started and AMD anticipates first silicon revenue from these deals in 2016.

Based on the above factors, we expect AMD’s Semi-Custom & Embedded revenue to reach $3.5 billion by the end of our review period. However, there is a possibility that the company is overestimating the gains from the two new designs wins mentioned above, and it may not be successful in securing similar large design wins for its semi-custom business post 2016. If AMD’s Semi-Custom & Embedded revenue increases to only $3.0 billion over our review period, our valuation for the company will decline by as much as 40%.

AMD’s Sever Market Share Increase To Only 2% (~15% Downside)

AMD’s server market share declined from 15% in 2007 to 1.7% in 2014, as per our estimate. The success of Intel’s Xeon processors combined with AMD’s execution issues are the key factors responsible for AMD’s continuous slide in the server market. Nevertheless, with new improved servers, its industry-leading graphics processing capabilities and its strategy to embrace both the x86 and ARM architectures, AMD remains committed to strengthen its foothold in the server processor market.

In October 2012, AMD announced its collaboration with ARM Holdings to design server processors using the ARM technology in addition to its x86 processors for multiple markets, which makes AMD the only processor provider to bridge the x86 and 64-bit ARM ecosystems. AMD believes that ARM CPUs have the potential to account for 20% of the server market by 2016 or 2017. ^[1]

AMD’s first ARM processors were set to ship this year, but appear to be behind schedule. Additionally, the company has decided to exit the dense server systems business to increase investments in its server processor development. AMD has retained the fabric technology as part of its overall IP portfolio. It believes that there are strong opportunities for next-generation high-performance x86 and ARM processors for the enterprise datacenter and infrastructure markets, and will continue to invest strongly in these areas.

We expect AMD to regain some of the its lost server market share, estimating the same to touch 5% by the end of our review period. If the company fails to do so and its market share in servers increases to just 2%, it will lead to a 15% decline in our valuation.

AMD’s GPU Market Share Remains Constant (>10% Downside)

AMD and Nvidia (NASDAQ:NVDA) account for almost 100% of the  Graphics Processing Units (GPU) market. The market shares of the two companies have fluctuated a lot between quarters, but Nvidia still manages to retain its lead over Intel in the discrete GPU market with a 76% market share.

In the professional graphics segment, though Nvidia still commands the lion’s share of the market (with a 75% market share, AMD managed to gain few points of the market share in 2014. Last year, Apple (NASDAQ:AAPL) adopted AMD’s FirePro graphics card (replacing Nvidia GPUs) for its MacBook. Given AMD’s limited presence, it will look to enhance its offerings and compete on price with Nvidia. AMD cut the price of some of its professional GPUs by 50% in December last year to better compete in the market.

We currently estimate a slight increase in AMD’s GPU market share over our review period. At its 2015 Financial Analyst Day, AMD announced updates on its Computing and Graphics  product roadmaps for accelerated processing unit (APU), central processing unit (CPU), and GPU products planned for introduction in 2016 and beyond. The company plans to enhance its graphics technology by offering the first high-performance graphics processing unit (GPU) in the industry featuring die stacked High Bandwidth Memory (HBM) using a 2.5D silicon interposer design using stacked die.

However, Nvidia, too, is fighting hard to extend its leadership in the GPU market. In the future, if the company introduces new products and technologies which are superior to AMD, then the latter might find it difficult to gain market share. If AMD’s GPU market share (discrete desktop GPUs, discrete notebook GPUs and professional GPUs) remains around the current level for the rest of our review period, there will a little over 10% decline in our valuation for the company.

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1. AMD reboots server technology strategy with first ARM chips, Tech World, June 18, 2012 [↩]