AMD: The Permanent Pretender?


By Sam Jaffe For a while, Advanced Micro Devices (AMD) seemed like one of the few bright spots on the technology landscape. It was the only real competitor to Intel (INTC) in the microprocessor market throughout the 1990s and has long promised to steal the throne. Alas, it has yet to deliver on that promise.

In the midst of the current tech market upheaval, it looked like AMD might finally do it. Intel was having trouble rolling out its Pentium 4 chips. Meanwhile, AMD's new Dresden megaplant had finally worked out the kinks and was nearing full production, and market-share momentum was building on AMD's side. Thanks to all this good news, AMD's stock price rose 115% for the year through July 3.

After the Independence Day holiday, things somehow went awry. The company announced late on July 5 that it would miss its revenue and earnings estimates for the second quarter. The stock promptly lost 27% in trading on July 6. It closed at $21 on July 10, 30% lower than a week earlier.

WHAT'S WORSE? The biggest question on investors' minds, which won't be answered until the company releases its second-quarter results after the market close on July 12: Is the revenue shortfall due to a brutal PC price war or a temporary hiccup in the volatile flash memory business? "That's the $64,000 question," says ABN Amro analyst Paul Leming, who rates the stock a speculative buy.

"If it's due to lower-than-expected price cuts in PC microprocessors, that bodes very poorly for the next few quarters. If it's primarily a flash memory problem, then the market will be more forgiving." The company has declined to give specifics on the revenue shortfall beyond saying that both markets were disappointing.

Leming thinks a flash memory problem is the more likely scenario. But he says in the long run, that problem might be just as damaging for AMD. "People forget that 40% of its revenue comes from flash memory, and that market is suffering from a severe fundamental problem of overproduction, so that's almost as much of a worry as any problems they might be having in the PC business," he says.

STOPPED DEAD. Flash memory, which is the primary data-storage method in many consumer electronics devices, has always been a volatile business. But thanks to the explosion in cell-phone usage, which accounted for 48% of all flash sales in 2000, growth expectations going into 2001 were enormous. Of course, now we all know that the mobile-phone revolution has stopped dead in its tracks, and hundreds of millions of Ericsson (ERICY), Nokia (NOK), and Motorola (MOT) phones are collecting dust on warehouse shelves. It shouldn't be too much of a surprise that flash memory sales have declined rapidly in 2001.

AMD executives were as aware as anyone of the slowdown in the handset market earlier this year, yet the company continued to guide analysts into believing that it would have sales of $1.1 billion for the quarter ended June 30. That lends credence to the theory that lower PC processor prices are the real villain behind the recent earnings warning. The company is now expected to have sales of $985 million. The earnings shortfall, however, is even more shocking. Rather than earn $0.27 a share for the quarter, the company changed its guidance to a range of $0.03 to $0.05.

This isn't a company that has been bashful about hyping its successes. It's true that those triumphs have been pretty amazing given the moribund PC market. Just a few years ago, AMD struggled to keep 10% of the PC microprocessor market. In June, it announced that it had garnered 22% and by yearend would have the capacity to manufacture 30% of the chips the market needed. "For the first time there is a viable competitor to Intel, and that competitor [AMD] is producing higher quality products," vice-president for external relations Ben Anixter said at the time.

NARROWED GAP. It's now clear that the market-share growth came at a significant cost. "Competitive pressures in the PC processor market depressed the company's average selling prices," said AMD's July 5 press release. Translation: A vicious price war is going on. For a brief period earlier in 2001, AMD had a superior product in its Athlon chip, which led to a marketing bonanza. Since then, Intel, which owns about 75% of the processor market, has narrowed the technology gap with the release of its Pentium 4 family of chips.

The Pentium 4 launch hasn't been as successful as previous upgrades. Intel is being very tight-lipped about Pentium 4 sales, but it's clear from recent earnings warnings that they're not living up to expectations. Indeed, Intel couldn't have chosen a worse time to launch a new product, as demand has gone into negative territory in 2001 for the first time since the PC's birth in 1981.

AMD's July 5 warning underscores Intel's response so far to AMD's recent market-share success: cut prices, and cut them deeply. "If it comes down to a price war, it's an unfair fight," says ABN Amro's Leming. "Intel has the size and the resources to outlast them. AMD will lose."

CHEAP, AGAIN. This leads most investors to the problematic conclusion that AMD may well be fighting a losing battle on both of its main fronts. Demand for flash memory is depressed, and PC demand is falling into a bottomless pit. On the positive side, it means AMD's stock is very cheap. The company, which expects to make $1.38 per share in 2001 compared to $2.36 in 2000, has a price-to-earnings ratio of 7.6, which is less than a third of the p-e ratio of the Standard & Poor's 500-stock index.

AMD has been cheap many times before in its history, and it has been unable to transform itself into a growth stock. Unless economic and market conditions change dramatically, chances are AMD won't be able to do it any time soon, either. Jaffe writes about the markets for BusinessWeek Online in our daily Street Wise column

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