Why The Acquisition of AMD by Microsoft Does Not Really Make Sense

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A few months back, KitGuru reported that Microsoft (NASDAQ:MSFT) might be interested in acquiring chipmaker AMD (NYSE:AMD) to save money on its game console processors and help develop smartphone and tablet oriented chip solutions. Last week, a report by Fudzilla reignited the rumor by stating that Microsoft is “seriously talking to AMD” about buying the chipmaker. In a separate post, Fudzilla also reported that according to their well informed industry resources, AMD is about to sell 20% of its stake to private equity firm Silver Lake. The infusion of cash is good news for AMD investors, as on account of the declining revenue base the company’s bottom line has been shrinking. Since it cannot afford to significantly step down its R&D investment, the company’s cash position is a bit precarious to say the least.

AMD’s stock price jumped 10% after the announcement but fell back to the $1.80 level after analysts at Citibank said a buyout was an unlikely possibility. [1]

See our complete analysis for AMD

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The Benefits Just Don’t Seem Worth It

Microsoft uses AMD processors in its Xbox One game console, so one way the company would benefit from AMD’s acquisition is by saving money by designing the chips in-house. However, AMD has admitted that the gross margins it earns on game consoles is much lower than the corporate average. AMD’s company wide gross margin stood at 33% in 2014. In December 2014, KitGuru reported that AMD’s game console chip margins are a bit higher than 15%. Microsoft essentially funds the development of the chip upfront, relieving AMD of the R&D burden associated with the chip development. [2] Thus, we believe that the economic gain from the acquisition will not be high enough to justify acquiring the entire company (AMD’s current market cap is $1.4 billion).

Also, we don’t see why Microsoft would want to take on AMD’s bleeding computing business. In the first half of 2015, AMD’s Computing and Graphics segment revenue declined every quarter in the last year as the company lost market share to Intel and Nvidia. In Q2 2015, the Computing and Graphics business incurred an operating loss of $147 million. The only way Microsoft can benefit from acquiring this business is by using AMD processors for its Surface tablets and its Lumia line of smartphones. But AMD does not have much of a footprint in smartphones, and most of the company’s efforts to expand its presence in the market have not been very fruitful. It has had better success in the tablet market, but we don’t see why Microsoft would want to incur additional R&D expenses to develop its own line of processors for the Surface line of tablets. Microsoft has already lost more than $1 billion on its Surface line of tablets. [3]

Termination of The Cross-Licensing Agreement With Intel

AMD entered into a cross licensing agreement with Intel in November, 2009. The agreement grants both companies non-exclusive, royalty-free licenses to all of each other’s patents. In other words, it guarantees that the companies will not pursue litigation for any potential patent infringements by the other company. As per the agreement, if either AMD or Intel have a change of control (i.e., gets acquired), the cross-license agreement between the two companies is automatically terminated for both parties. [4] Without a cross-license agreement, AMD can be sued by Intel for patent infringement, which could ultimately result in an inability to sell x86-compatible processors.

Not only will Microsoft have to take on the headache to renegotiate the cross-license agreement with Intel, it will risk its collaboration with Intel on many fronts. Microsoft collaborates with Intel in OS development and PC platform standards (bios, firmware, drivers, etc.).  ((Advanced Micro Devices (AMD) Stock Tanks as Microsoft Buyout Rumors Lose Steam, The Street, September 14, 2015))

Our price estimate of $2.43 for AMD is at a 30% premium to the current market price.

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Notes:
  1. AMD Stocks Tanks as Microsoft Buyout Rumors Lose Steam, The Street, September 14, 2015 []
  2. Why Microsoft Corporation Isn’t Buying Advanced Micro Devices, Inc., The Motley Fool, July 1, 2015 []
  3. Microsoft has lost $1.7 billion trying to make the Surface a hit, BGR, August 6, 2014 []
  4. AMD clarifies cross-licence with Intel: change of control terminates agreement for both, KitGuru, May 21, 2015 []