AMD's Spin-off: Abu Dhabi to the Rescue

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Pricey Upkeep

AMD has racked up losses of $1.6 billion on sales of $2.8 billion this year, and much of those losses are associated with the expense of owning and operating expensive chip fabs that cost about $3 billion to $5 billion apiece to build, and about $1 billion to upgrade every two years or so. There are also costs related to holding and distributing stockpiles of unsold chips (BusinessWeek.com, 05/30/07) when demand doesn't match expectations.

AMD's research-and-development expenses—$1.85 billion, or 30% of sales, in fiscal 2007—will drop significantly, says Doug Freedman, an analyst at American Technology Research in San Francisco. "We estimate that AMD spends $150 million to $200 million per year on process-technology R&D," he wrote in an Oct. 7 research note. Freedman rates the stock a "buy" with a price target of $10.

Although AMD stands to gain from lower operating expenses, it will be transferring much of its intellectual property—and some that it doesn't own—to a third party. That may not sit well with Intel (INTC), with which AMD has had a series of cross-licensing agreements going back to the 1970s. The latest such agreement expires in 2010. Intel spokesman Chuck Mulloy says the company "has some concerns" about the deal but declined to be specific. "The agreement gives them a number of rights with respect to our technology and gives us some rights with respect to their technology," he says. "We're in the process of evaluating this, and we have a lot of questions. As is our normal practice, we will vigorously defend our intellectual property." The companies are already litigating an antitrust suit filed by AMD against Intel in 2005.

Drop in Global Demand

While AMD has arrangements with Singapore's Chartered Semiconductor to pick up extra chipmaking work when demand outstrips its capacity, slack demand costs big money in underused equipment. Foundry will be free to seek business from other chip companies that don't own their own fabs. "The good news for AMD is that they won't have to worry about absorbing the expense of all that capacity with just their own production requirements," says Nathan Brookwood, head of research firm Insight64.

AMD's headcount will drop by about 3,000 as its manufacturing employees are shifted to the new company. But these same employees will still be devoted to making AMD's chips. New employees will be added in time as Foundry attracts new customers, Sonderman says.

The breakup would seem much better news if worldwide demand for PCs and other products that require chips looked stronger. "We recently met with several major PC makers in Taiwan who suggested that…fourth-quarter orders have been cut in recent weeks due to global macro demand deterioration," Craig Berger, an analyst at FBR Research, wrote in a recent note.

Hesseldahl is a reporter for BusinessWeek.com.