Sunday, January 20, 2008

AMD/Intel Q4 2007 Earnings – Where Are We?

AMD's recent performance has been a study in disappointment. Earlier, SSE 5 and microbuffered memory had looked so promising for 2009. Now, it appears that these may not arrive even in 2010. Consecutive quarterly losses, low clocks, and the TLB bug have added to AMD's pain. In contrast Intel has rebuilt its revenues, upgraded C2D to the G0 stepping and delivered the 4-way capable Caneland platform. Intel has had some difficulty with 45nm Penryn but this hasn't mattered much with the G0 65nm quad cores available.

Sometimes things are a bit counter-intuitive. For example, I've seen many assume that AMD's fortunes began to boom in 2003 with the introduction of K8. In reality, 2003 was worse for AMD than 2002. 2004 was better but AMD suffered from volume limitations due to the larger K8 die. AMD's volume share stayed at about 16% from 2002 all through 2004. It wasn't until 2005, fully two years after the introduction of K8, that AMD began making strides in the market. We see the same pattern repeated by Intel where 2006 was far worse than 2005 in spite of the introduction of C2D. To understand just how well Intel is doing we need to compare with 2005, not 2006. The numbers show that Intel is doing well but hasn't quite recovered to what it had in 2005:

Processor Earnings – $28.1 Billion
4th Quarter Cash and Short Term Investments - $12.8 Billion
Average Gross Margin – 59.3%

Processor Earnings – $25.9 Billion
4th Quarter Cash and Short Term Investments - $12.8 Billion
Average Gross Margin – 51.9%

2008 Outlook:
Predicted Average Gross Margin - 57%

Intel's Outlook makes it clear that they do not expect to return to the Gross Margins of 2005. In fact, 57% doesn't even match the 58% Average Gross Margin of 2004. That point is quite puzzling. The common reasoning has been that as Intel switches to 45nm their costs will drop dramatically. This should easily be enough to boost the Gross Margin up from the current 58% to above the 2005 levels. But, Intel says this isn't going to happen and Intel's prediction of an Average Gross Margin of 52% for 2007 was right on mark. Apparently, Intel either expects that ASP's will drop or costs will rise enough to counter the decrease in costs from 45nm. This again goes against common reasoning which assumes that Intel's higher clock speeds insulate them from pricing pressure from AMD. This further goes against Intel's own statements of reorganization which were supposed to result in another round of layoffs in 2008. I think we now have to assume that Intel's reorganization has halted halfway through and that nothing further will be done. This however disagrees sharply with the inclination by many to label Intel as “lean”. Intel cannot be lean with only half of the reorg in place; Intel still has some love handles.

If we look at the facts instead of simply talking from our gut reaction this does make sense. AMD had gained a lot of server share in 2006. However, Intel took most of this share back at the end of 2006 dropping AMD's share by 40%. AMD's server share average for 2007 has been only 14.2% compared to the 23.5% average for 2006. Intel has held onto this share due both to the value of C2D dual core and having a monopoly on quad core. Unfortunately, the problem with being on top is that you can only go down. And, Intel now faces substantial quad core server pressure from AMD. AMD moved some 130K Barcelona server chips in 2007 and this will only increase. Secondly, AMD has substantially undercut Intel in terms of lower clocked quad core offerings. These lower clocked quads are also much more immune to Intel's lower 45nm power draw which is more dramatic as we increase clock. According to AMD, the high volume range for servers is 2.3Ghz. If this is true then Intel is not at all immune to server pricing pressure and we know that servers are Intel's highest ASP. I would expect that AMD will move back up to its 2006 server share in 2008. We also know that AMD's Griffin/Puma mobile platform will be out soon and this should put pressure on Intel's mobile segment which is the second highest ASP. It then begins to make some sense when we realize that the segment where Intel will still dominate will be desktop which is the lowest ASP. Even so, AMD did report some increase in desktop ASP in Q4.

The talk about an AMD takeover or bankruptcy is never ending. A takeover is technically and financially possible except that I can't think of a single company that wants to get into the frontline processor business and slug it out with Intel. Motorola was the last challenger but they divested their processor division as Freescale in 2004. Some might point to VIA. Well, VIA's parent company could pull off the finances but they've never had a frontline processor. Although Cyrix was initially competitive in 1995, Cyrix's position had slipped a generation by the time they were acquired by VIA in 1999. Secondly, VIA never manufactured Cyrix processors; they instead chose the Centaur architecture from IDT which was never frontline. Presumably if VIA had wanted to be competitive they would have worked on a new generation of the Cyrix design which would have been released around 2002 or 2003. This never happened so VIA as buyer is very unlikely.

Some have suggested nVidia or Samsung as a buyer but neither of these companies has any experience with processors. Samsung does memory products which is a long way from the logic intensive design of cpu's. These don't overlap at all in terms of manufacturing or design methodology. NVidia does chipsets and graphics and nVidia would be an obvious monopoly conflict due to AMD's ATI holdings. No doubt someone will mention IBM. However, IBM could never take over AMD's markets since IBM's use of AMD server processors would make it a competitor with its own customers. This would mean giving up the most profitable market segment of AMD's line and would probably impair volume with customers like HP, Gateway, and Dell that also produce servers. In other words, IBM would lose its current R&D support from AMD (the largest of all its partners), lose the technical support that AMD provides to Chartered, and lose AMD support for APM. The loss of volume would also make AMD processors cost more. Thus, IBM would turn a supporting partner and Intel hedge into a money losing niche processor division. Economically, this makes no sense at all. So, an AMD purchase is probably somewhat less likely than, say, striking oil in your backyard.

AMD managed to increase its revenues every quarter in 2007 as well as its Gross Margins. AMD finally managed to trim the quarterly loss to $164 Million. Now, I have to be honest and mention that AMD's current value per share of stock is worse than it was at the end of 2003. Adjusting for the change in number of shares AMD was comfortably higher by about $1.2 Billion but the $1.6 Billion goodwill charge has now brought this about $400 Million under. This is cause for concern if AMD's loss increases again in Q1. Supposedly AMD will break even in Q2. AMD's outlook though is oddly different from Intel's. Whereas Intel predicts a stagnant Gross Margin at a lower value than even 2004, AMD predicts that the current level of 44% will hold during the first half of 2008 but increase to 50% in the second half of 2008. So, why would this be? First of all, by Q3 AMD should finally have at least 2.8Ghz chips. This would cover nearly the entire range since it looks like Intel won't go higher than 3.16Ghz. There is also the question of 45nm from AMD. Statements made by AMD during the Earnings Call include:

“look forward to being able to ramp 45 nanometer aggressively in the second half of this year.”

“Followed on in the second half of the year by 45 nanometer.”

“we’ve got internal samples of our 45 nanometer microprocessors, we’re putting them through their paces currently and we’re on track to, the plans we talked about in the past which is to start our ramp in the first half of this year and ship revenue product in the second half of this year.”

I have seen some attempt to spin these statements to mean that AMD will begin producing 45nm in the second half with actual delivery in 2009. This, however, matches neither what AMD said nor common sense. Someone might mistakenly take Ruiz's comment to mean initial production however this is completely countered by Meyer's statement. Secondly, AMD first produced Brisbane samples in Q2 2006 and delivered product in Q4. If AMD has samples in Q1 then product delivery should by Q3. So, the most reasonable assumption is that AMD will begin production in Q2 and deliver some small amount in Q3. This amount is unlikely to have any effect on revenues but the Q4 volume should be more significant. Likewise, I doubt Intel's volume of Nehalem in Q4 will have any effect on revenues. So, adding in AMD's mobile and higher clocked quad cores in Q3 along with some 45nm in Q4 I could see an increase in Gross Margin in the second half. Finally, this begins to make sense. Right now, AMD overlaps the highest volume range and should increase its overlap during 2008. This would put pricing pressure on Intel with most likely some loss of ASP and this would offset the 45nm savings. On other hand, AMD's ASP's are very low so it can only move up. It also makes sense because 50% Gross Margin would still be significantly below Intel's 57%. This would be consistent with lower ASP's for AMD and higher costs due to a lower ratio of 45nm production. Some might also have noticed that AMD has scaled back its expected 2008 volume from 100 million units to 80-90 million units. This is undoubtedly due to the scale back in the FAB 38 ramp. This in turn has undoubtedly reduced AMD's target of 30% share for 2008.

I guess the bottom line is that as long as AMD can reach break even in Q2 it should be able to start gaining asset value again. And, it looks like AMD will finally get back to the processor revenues that it had in 2006. Judging from the current unit volume though I would say that AMD intends to start gaining again, especially in servers and Intends to get back to what it had in 2006. The really surprising thing is a comparison with 2001. AMD's volume share had been about 16% but this increased to 20% in 2001. With the release of the Northwood P4 and AMD's delay in getting to 130nm, AMD's share tumbled in early 2002. AMD left 2002 with roughly same 16% volume share that it had in 2000. It stayed at this level all through 2004 then creeped up to 18% in 2005. AMD's volume gain in 2006 was much more dramatic rising to 23%. If the 2002 pattern had been followed (as many predicted) then AMD should have lost this share again in 2007. When AMD's volume share tumbled in Q1 2007 many of these armchair experts gave themselves big pats on the back. However, they couldn't have been more wrong. AMD's volume share promptly rebounded and AMD has held onto its 2006 average for the last three quarters. What these self styled experts failed to take into consideration was that when the crash occured in 2002 AMD had only been at its high point for two quarters whereas when the crash came in 2007 it followed five quarters of good volume. In other words, the two are opposites. The high in 2001 was temporary whereas the dip in early 2007 was temporary. According to IDC AMD lost 0.4% unit share and is now at 23.1%. This is about equal to AMD's 2006 average. Overall, I expect AMD to gain back its 2006 server share and go above its previous mobile share while holding onto and increasing its current desktop share. This would mean an increase in unit share from the current 23% to perhaps 26% in 2008. This seems doable but falls quite a bit short of AMD's previous target of 30%.

Intel in 2008 should finally pull ahead of its previous processor revenue high of 2005. It's Gross Margins may not reach what they were but they will still be quite good and I'm sure Intel will continue increasing its cash and doing stock buybacks. By any account this should be good performance and a reasonable rate of growth. Pricing pressure in the second half of 2008 as AMD moves up above 2.6Ghz should produce some good values for buyers. We can look forward to seeing how well K10 scales and whether or not 45nm Shanghai produces any change in speed or any reduction in power draw. We should also be getting reviews of Nehalem in Q4.