Why Are Investors Beating Up on AMD?

Yes, it probably paid too much for ATI, but the chipmaker has goodies on the way and offers a big advantage in servers that Intel can't touch

by Arik Hesseldahl

It's a lousy time to be a company with a lot of debt, high fixed costs, and an acquisition that in hindsight looks ill-advised. In short, it looks like a lousy time to be chipmaker Advanced Micro Devices (AMD).

That's the apparent opinion of investors who briefly drove AMD stock down to under its 52-week low Aug.6, when it traded as low as $12.38, beating its previous nadir of $12.60 from Apr. 5. In recent years, AMD had been flying high, making rival Intel (INTC) sweat by capturing some of its market share in the high-margin server-chip business.

Much of the August pummeling has come as a result of a "sell" rating from Caris & Co. analyst Daniel Berenbaum, whose target price is $10.

Looking back at all AMD has accomplished in the last three years—landing its chips in servers and a personal computer from Dell (DELL), and more recently notebooks from Toshiba (TOSBF) (see BusinessWeek.com, 07/30/07, "In Switch, Toshiba Buys AMD Chips"), both of which had used microprocessors from Intel exclusively—it's surprising to see how tough its position in the market still appears, Berenbaum says. "There are a lot of positives to cite. AMD has proven that its microprocessor business has come a long way. It serves a lot more of the PC market than it used to and has design wins with every major name, and that is something you couldn't say two or three years ago."

Racking Up Debt

The problem, he says, is AMD's ability to generate cash and finance its long-term debt. On Oct. 25, 2006, it bought graphics chipmaker ATI, a $5.4 billion deal that AMD financed with $1.8 billion in cash and a $2.5 billion loan from Morgan Stanley (MS). That raised AMD's long-term debt to nearly $4 billion at the close of its most recent quarter, compared with $1.3 billion at the close of 2005. Meanwhile, losses have been stacking up. For the quarter ended June 30, AMD reported a $457 million loss on sales of $1.4 billion. That came after a $504 million loss on sales of $1.2 billion for the March quarter.

It might have been a good deal if ATI had delivered as Chief Executive Officer Hector Ruiz had promised. But it hasn't. Its latest round of graphics chips have run behind schedule. Meanwhile, Nvidia (NVDA) , ATI's main rival in the graphics chipset business, has been gaining market share, while ATI's has been falling. Research firm Jon Peddie & Associates pegged AMD's share of the graphics chipset market at under 20%, down from over 26% a year ago, while Nvidia and Intel saw their market positions grow. "I think AMD overpaid for ATI," Berenbaum says. "I think management overreached in taking a company that ultimately hasn't delivered what was expected in terms of accretive performance." AMD declined to comment. Its latest graphics-chip release, the FireGL line of graphics accelerators for workstations, was released Aug. 6.

Meanwhile, prices for microprocessors in PCs and servers have remained under constant pressure, thanks in part to Intel's technological lead and AMD's misjudging of demand in certain segments of its business. Its main hope, Berenbaum argues, is to sell about $1.4 billion worth of assets, including outdated manufacturing gear, and the remainder of its holdings in Spansion (SPSN), its former flash-memory subsidiary, in order to keep the boat afloat.