The importance of the performance crown

Mercury Research published their numbers showing some very interesting facts. Anyone with doubts about the importance of keeping the performance crown needs to look at this graph.
AMD’s drastic decline in overall ASP coincides with the release of Intel’s Core 2 microarchitecture. One thing to note is the increase in ASP gap between the two vendors from ~$35 in 2006 to ~$55 in 2007 simply because one had a better product. It is suffice to say that $20 per CPU is the price to pay for losing the performance crown. That is a third of the average value of an AMD CPU and is quite a lot of money.

Breaking it down further by market segment it becomes apparent what Intel meant by ‘walking away’ from some of the businesses. AMD’s mobile ASP is even lower than Intel’s desktop prices. Another thing to note is the continuous price erosion on Intel’s mobile segment. The gap between mobile and desktop is diminishing due to the tremendous demand for lower priced laptops towards the end of 2007. One can get a sense of how AMD is well entrenched in this space forcing Intel to lower prices if it wants to get back market share. The surge in Q207 server ASP for AMD comes from the Iranian supercomputer purchase which is rumoured to be paid in oil.
One thing that needs to be taken into context when looking at these figures is the fact that AMD lost a lot of money in 2007 while Intel took in healthy profits. Mentioned in an earlier blog, both companies have adjusted their business model to try and meet historic margin levels. And to some degree we have seen results. But as Intel and AMD continue to battle it out, the one without the superior product has no option but to compete on price. The problem is there isn’t a lot of wiggle room starting from $60 per CPU.

A Review of the IDC numbers

I can see that someone has done a ‘Sharikou’ on Intel’s recent financial performance. A ‘Sharikou’ is an analysis method popularised by a similarly named blogger, where a desired result is only realised by varying the point of reference. Ignoring the usual method of 'like-for-like' or sequential comparisons, the blogger instructs his readers to compare Intel’s 2007 numbers with 2005 to get a “better understanding”. He doesn’t justify why his method gives a better understanding, but at least you can see that Intel’s revenue and margins are trending down – ‘Sharikou’ method successfully utilised.

IDC numbers (using only conventional methods of comparison) were released showing interesting trends. The total 2007 processor volume went up 12.5% while revenue only improved by 1.7%. IDC says that there was a degree of price erosion that occurred earlier in the year. True enough, but when someone suggests that Intel isn’t lean because it can’t reproduce the same margins as two years ago, I feel sorry for the poor analysis, and quite frankly, it isn’t surprising whenever the “Sharikou” is applied. In a duopoly where the market or revenue share is a zero sum equation (almost), comparing how much AMD and Intel performed using the same frame of reference, makes the most sense.

Intel and AMD did see an overall decrease in ASP mainly because of the larger presence of AMD in the notebook and server space (margins naturally decline as market share in a doupoly approaches 50%%). But it is interesting to see who was hit the hardest:
Global 2007
Volume increase: 12.5%
Revenue: $30.55B
Revenue increase: 1.7%

Intel 2007
Revenue (Digital Enterprise / Mobility CPUs): $25.89B
Revenue increase: 8.7%

AMD 2007
Revenue (Computing): $4.70B
Revenue increase: -12.4% (down from $5.64B)

It is quite evident that AMD has taken the brunt of the ASP erosion considering that market share only shifted by a couple of percentage points while both companies reported record volume shipped. In terms of laptop and server prices it is clear that the business environment has changed and the good news is both companies are taking steps to adapt. AMD has delayed Fab38 and for obvious reasons. At the moment they have the capacity to supply 80 million CPUs for the 70–75 million demand (2008) for AMD based systems. They now seemed to be content to play in the box they were forced to be in. Intel on the other hand plans to improve by divesting non-performing businesses, creating new high margin products and the usual, by outpacing the competition with better products using a better process.

It is premature and erroneous to dismiss the benefits of Intel’s 45m before the ramp is complete. Intel's guidance of flat margins throughout 2008 is likely due to their tendency to be on the cautious side and isn't sufficient to make quick assumptions on the company's cost structure or pricing strategy. Meanwhile AMD can only expect more difficulty as K8 gets even more outdated and K10 is ramped with very poor yields. In 2007 AMD managed to ship 400K QC units. It isn’t such a big number considering this is just 0.6% of their total volume. Barcelona or K10 is considered by many as a disaster in terms of performance. Financially, we have yet to witness how much damage it can do to AMD… assuming of course AMD ramps K10 on 65nm.

The comeback kid? AMD's Q4/2007

SUNNYVALE, Calif. — Jan. 17, 2008 — AMD (NYSE: AMD) today reported fourth quarter 2007 revenue of $1.770 billion, an 8 percent increase compared to the third quarter of 2007 and flat compared to the fourth quarter of 2006 2 . In the fourth quarter of 2007, AMD reported a net loss of $1.772 billion, or $3.06 per share, and an operating loss of $1.678 billion. Fourth quarter net loss included charges of $1.675 billion, or $2.89 per share, of which $1.669 billion were operating charges. The non-cash portion of the fourth quarter charges was $1.606 billion.

This is quite a comeback considering so much negative news surrounding the company. The substantial increase in revenue while keeping OpEx flat helped drive the company to almost break even. In fact the computing group reported an operating profit of $21M. Overall AMD beats the overly negative market consensus of $-0.36 per share reporting in a loss of only $0.17 per share. Margins were up 3% to 44% which would lead anyone to wonder what could have happened if Barcelona was executed as planned. While the $1.606B goodwill charge significantly affects the valuation of the company, one can argue that the stock seem to have already taken this into account.

From the company’s business standpoint it appears that AMD is doing all the right things. Key to the improvement is the change in priority. Like Hector said, their number one goal is profitability while the second is serving the customers. Essentially that means AMD is optimising product mix to generate the most revenue as opposed to running both their Fabs at peak volume just to grab market share. It seems like Hector has indeed humbly learned his lesson and breaking the monopoly is off the agenda.

From a product execution standpoint AMD says that B3 is ready. The conference call painted a better picture of how the Barcelona fix is progressing. Engineering samples will be out in a couple of weeks while production samples will be shipped later in Q2. This sounds like Barcelona will only reach the general market right around end of Q2, probably Q3. AMD shipped close to 400,000 quad cores with the ratio of 2:1 (desktop to servers) in Q4. It is difficult to gauge the significance of that quantity in terms of margins but clearly it is just a large number thrown out there to impress people. It appears like it worked.

While it is evident that AMD is trending in the right direction, their strategy remains untested. Revenue may be trending upwards but so was demand in the 2nd half of 2007. The company grew revenue using existing products but their viability is relative to the competition who seems to be executing at a faster pace. AMD’s plan to return to profitability relies heavily on new products which appears to be limited to the mid to low-end segment (tri-core, 65W products). While this was proven to be marginally profitable in a healthy market, AMD needs to prove they can do the same feat in the midst of a price war. One can’t help but wonder if the actions of another entity plays a bigger influence on AMD’s profitability.

Intel's Q4/2007 Report

Intel's Q4/2007 numbers:
• 2007 Operating Income $8.2 Billion, up 45 Percent
• Fourth-Quarter Revenue $10.7 Billion, up 10.5 Percent Year-over-Year
• Gross Margin 58 Percent, up 8.5 Points Year-over-Year
• Operating Income $3 Billion, up 105 Percent Year-over-Year
• Record Microprocessor and Chipset Units and Revenue
• Net Income $2.3 Billion; EPS 38 Cents

Q1 2008 Outlook
• Revenue: Between $9.4 billion and $10 billion.
• Gross margin: 56 percent plus or minus a couple of points.
2008 Outlook
• Gross margin: 57 percent plus or minus a few points.
• R&D: Approximately $5.9 billion.
• MG&A: Approximately $5.5 billion.
• Capital spending: $5.2 billion plus or minus $200 million.

Impressive figures, but unfortunately when a bear market looks for tell-tale signs of an impending recession they always find something negative to focus on. Take for instance Intel missing consensus by around $100M. "Aha!" said the market. "There's your global recession right there!".

Assuredly, the conference call was peppered with leading questions. In order to justify their recent industry downgrade, analysts tried their best to make Paul and Stacey say what they wanted to hear. Several questions focused on the inventory situation, looking for any cancelled orders and then drilled on the relatively flat gross margin prediction for 2008. But the analysts never got what they wanted. Instead, what they heard was exactly the opposite. Inventories are lower than expected; demand, especially in server and mobile, is solid while the market is expected to grow double-digits in 2008. Intel's slightly lower revenue was in fact primarily due to significantly lower memory pricing (a result of a global over capacity), and the charge for the NAND spin-off. While none of the shortfall was attributed to Intel’s computing group, nonetheless, Intel admits it is prudent to be cautious.

As for AMD, the general outlook Intel provided can be taken as positive news. A healthy market relieves pressure on margins going forward allowing AMD time to put things in order. The only problem for the scrappy little company is trying to catch up to a more focused and much leaner competitor. As Intel delivers on Silverthorne, 65nm chipsets, WiMax and Nehalem, 2008 is set to be AMD’s toughest year yet.

AMD delays Phenom because of pesky bugs customers

AMD admits to recent rumours that higher speed Phenoms (9900 and 9600) will be delayed until the second quarter. Luckily for AMD, nobody waits for mid-to-low-end CPUs. So except for a few people at AMDZONE, nobody is really disappointed by this news. AMD vehemently denies that the delay is due to the TLB bug found back in November. “The B3 stepping is not bugged”, according to INQ reporter Charlie Demerjian after speaking to AMD’s Pat Moorehead. Pat Moorehead is the Executive VP of Marketing at AMD who is coincidentally also running the Barcelona Debugging Task Force. If we can take the word of an AMD executive then the company should now be focusing on understanding why their process is producing energy efficient chips instead of 9900 Phenoms.

Energy efficient chips are what our customers want, declares AMD, which is very fortunate because this is all they have anyway. Either this is a profound coincidence or AMD is confusing desktop with OLPC demand. Phenom 9900 and 9600 will be pushed out until next quarter because AMD is now trying to meet the ‘unusual’ demand in this low margin segment using nothing but very expensive parts. While some analyst believe that such a move is void of any logic, some would argue that at least AMD isn’t throwing the CPUs away like McDonald’s with their silly 15-minute rule on burgers. (But if McDonald’s goes into financial trouble and tried to sell cold and stale burgers because they insist it is what the customers what, it would just be pathetic).

Similar to how the tri-core Phenom is targeted at the tiny tetraphobic market in China, AMD believes that there is a healthy market out there for expensive energy efficient processors. Well at least until they figure out a way to fix Phenom.

~$1.5B Anyone?

With the current price AMD’s stock is trading today, all you need is roughly $1.5B to take a majority stake in the company. Of course this is theoretical as such move requires approval from regulators, AMD’s board of directors and a lengthy cross-license negotiation with Intel. Trading at a 52-week low of $5.53, more investors abandon AMD's stock amid fears that a U.S. recession could be the final straw that would bring the company into insolvency.

After several days of trending synchronously with AMD due to a series of sector downgrades, Intel traded up today on a repot from Gold Sachs:
"Intel is very well positioned to continue to gain (market) share, particularly in servers, given AMD's disappointing execution," Goldman analyst James Covello wrote in a report (probably after readings some fierce comments from Sparks).

Meanwhile investors continue to dump AMD probably just for the sake of pissing Hector Ruiz even further. An open letter from Mr Douglas McIntyre (24/7wallst) calls on AMD’s board to dump Mr Ruiz who seems to be the only person in the world who doesn’t understand why the stock continues to slide.
An Open Letter To Frank Clegg, AMD (AMD) Board Member: “As a member of the AMD (AMD) board, you know how deeply disappointed the market is with the performance of the company's CEO Hector Ruiz. AMD shares hit another 52-week low today at $5.77. Wall St. has lost faith in the company's ability to release products on time and improve gross margins.”

When a company loses around $2B in a good year, one of the best the industry has seen in quite a while, just imagine how things could turn out if the economy enters a recession... And just when you thought things couldn’t possibly get worse.

AMD’s Law: “Just when you thought it couldn’t possibly get worse…”

For AMD, 2007 was the year where everything turned south. Just when you thought it can’t possible get any worse, AMD’s management comes out with more bad news. In fact, it’s gone so horrible wrong that I am starting to feel a sense of weariness from too much AMD bashing. To be honest, it was most exciting when AMD’s decline was debatable. Then it was instantaneously gratifying when our analysis turned out to be correct. But today when we finally see closet fanboys re-write our opinions while gobbling up large quantities of crow, you begin to gather a sense of indifference. Have we heard so much bad news about AMD that we’re beginning to feel numb?

Case in point: today Banc of America downgraded AMD’s stocks from “neutral” to “sell”. Frankly, telling someone to sell when they have lost more than half of its value is quite useless especially when the reasons stated aren’t new and profound:
“Irrespective of whether AMD will be able to deliver on its promise to ramp the much-delayed Barcelona platform in volumes by the first or second quarters of 2008, we believe Barcelona will do very little to stem the share losses AMD will likely witness in servers and desktops vs. Intel's more competitive line-up. Furthermore, we believe that AMD's cost structure will be further pressured by higher depreciation and higher material costs associated with the ramp of quad core parts in 2008,"

I’m sure there’s a lot of AMD shareholders who would appreciate such advice right about a year ago! Nonetheless, finding this news completely uninteresting proves my point. On the other hand, an excess of gloom and doom of AMD can only be good for the company. Expect AMD’s stock to tick higher on any news that’s less than disastrous (i.e., see Q3’07 report). Clever management strategy, I say.