‘Find a Zero: Which Billion Dollar Company Will be Bankrupt by 2020’ ABSTRACT: we contend that Advanced Micro Devices Inc., (AMD) one of Silicon Valley’s semiconductor success stories, will file for bankruptcy by 2020. Since 2008, this legacy company has survived by slashing operating expenses, spinning off its manufacturing business and transitioning away from its core PC business to “growth markets”. While it may be succeeding in marketing its turnaround narrative to the market, we see ADM at a point of no return. We identify a toxic combination comprising an uncompetitive product portfolio, technological leap forwards by competitors, several structural challenges, poor positioning due to an ineffective strategy and a worsening balance sheet. While it is bagging some wins, the clock is ticking and AMD will be unable to drive profitability in industries where product leadership, rather than merely pricing, determines success. Participants: Bardavid, Toby; Pedretti, Ivan; Presa Perez, Aessandro 1 TABLE OF CONTENTS I. COMPANY OVERVIEW 3 II. STRUCTURAL CHALLENGES PUSHING AMD TOWARDS BANKRUPTCY 4 A. INDUSTRY DYNAMYCS: WHERE WINNER TAKES IT ALL 4 B. KEY INDUSTRY TRENDS 5 C. MANUFACTURING CAPABILITIES: ONLY FOR THE DEEP POCKETS 7 D. RESTRUCTURING TRANSITION: ELUSIVE GROWTH AVENUES 8 D. NO TRUCE IN THE BUDGET SEGMENT AS COMPETITION INTENSIFIES 9 III. BUSINESS FUNDAMENTALS FALLING APART 10 A. PRODUCT PIPELINE: NOT MUCH EXCITEMENT AHEAD 10 B. INNOVATION CONSTRAINED: NO R&D, NO PARTY 12 C. TECHNOLOGY BETS – MISUNDERSTANDING THE POTENTIAL 13 D. MICROSOFT & SONY ILLUSORY WIN: A BITE FROM THE WRONG APPLE 14 IV. VALUATION AND FINANCIALS 17 A. LIQUIDITY ANALYSIS 17 B. VALUATION 20 V. CONCLUSION 22 VI. APPENDIX 23 A. DCF MODEL ASSUMPTIONS 23 VII. GLOSSARY OF TECHNICAL TERMS 25 2 I. COMPANY OVERVIEW Advanced Micro Devices, Inc. (AMD) is a global semiconductor company based in Sunnyvale, California, USA that designs, develops and sells microprocessors for computing, communications and graphic visuals for business and consumer markets. It employed 10,149 staff as of September 2014. The company is quoted on the NASDAQ and traded at around $2.4bn as of February 20th, 2015. In view of the awful performance in the past three years, AMD is transitioning away from PC to “growth markets”, aggressively marketing its reorganization narrative to justify a disproportionate valuation. We argue that AMD is a typical example of a legacy company, which still benefits from its past reputation as a technological leader to fuel misconceptions about its survival prospects. Although it plays a systemically crucial role to avoid the complete monopoly of Intel and the likes in certain markets, it is not a sufficient argument to out rule the option of bankruptcy. Surprisingly, many investors are buying into the turnaround story advanced by its recently appointed CEO, Lisa Su, and we do not dispute that AMD still retains some healthy business units. However, we think that AMD, which once reached a valuation of $6.8bn in 2010, is destined to go bankrupt by 2020. 3 II. STRUCTURAL CHALLENGES PUSHING AMD TOWARDS BANKRUPTCY A. INDUSTRY DYNAMYCS: WHERE WINNER TAKES IT ALL In the semiconductor industry, small feature improvements can yield exponential competitive advantages including lower cost, material usage reductions, lower power consumption and greater performance. The semiconductor industry is characterized by extremely short product life cycles (i.e. upgrade frequency of 12-18 months) thus radical supplier substitutions and market share gains are common when chipmakers are unable to meet the future requirements of customers1. Figure 1. Semiconductor Product Lifecyle Management2 Furthermore, this industry is highly cyclical, meaning that semiconductor companies are at the mercy of the end consumer’s needs. For example, following Microsoft’s discontinuation of support for Windows XP in 2014, many companies have updated their computers. 1 Marketline (2014), ‘Advanced Micro Devices, Inc. SWOT and Corporate Finance Report’, Marketline Strategy. 2 Poston, B. and Dury, J. (2006), ‘Semiconductor Product Lifecycle Management: Industry Adoption, Benefits and The Road Ahead’, Kalypso Consulting White Papers. Accessed February 13, retrieved from: http://kalypso.com/downloads/insights/SemiconductorPLM.pdf 4 This ongoing corporate refresh cycle has boosted many companies’ revenues but not really AMD’s, as the company is over-indexed to the volatile consumer PC segment 3. During industry downturns, semiconductor companies focus on R&D and creating innovative products. This means that the companies with the deepest pockets are able to make technological leaps, leaving competitors years behind. Therefore in some markets players can earn quasi-monopoly status, as is the case for Intel in in desktop PCs and servers. B. KEY INDUSTRY TRENDS Historically, consumers that needed more power tended to buy desktop PCs as opposed to laptops. However, with technology advancements, market demand is pivoting away from desktops, even for professionals and intense gamers. AMD has recognized this trend and is refocusing on processors for laptops, but Intel already has a similar range on the market, which is more performant and more power-efficient. Figure 2. Notebook share of revenue growth for AMD (Trefis) 3 Sur, H. and Peterson, B. (2015) ‘Advanced Micro Devices’, J.P. Morgan North America Equity Research. Accessed February 13th through Thomson One Banker. 5 In the fast-growing mobile microprocessor segment, which is proven by the intensively competitive landscape and by companies continually trying to enter this market. Both AMD and Intel are looking to enter this market, but competitor Nvidia already has its popular Tegra line of mobile processors. It is a risky move for AMD to pursue this avenue as they have already tried and failed. In 2012, AMD launched its Hondo series, which promised good performance specifications, but actually lacked power efficiency compared to Intel’s Clover Trail, and was unfortunate enough to be launched for the unpopular Windows 8 tablet operating system. While we believe there are opportunities to grab market share in the semiconductor industry, we do not think AMD is strategically positioned to gain market share. 6 C. MANUFACTURING CAPABILITIES: ONLY FOR THE DEEP POCKETS Figure 3. Number of players with leading edge fab (manufacturing) capabilities4 Since AMD spun off its manufacturing business into GlobalFoundries in 2009, it means revenue is now driven by pre- and post- production value chain activities, while competitors such as Intel and Samsung, being integrated device manufacturers, still retain a production advantage benefitting from in-house supply chain management. For instance, Intel has had a monopoly for nearly 3 years on an advanced manufacturing technology called “FINFET” and the company has used this manufacturing edge to dominate the PC and server markets and try to build a presence in tablets and smartphones5. As GlobalFoundries expands its client base and becomes less reliant on AMD orders, AMD is losing its ability to enjoy any preferential treatment with only two pure, foundry-model players remaining. 4 Smith, S. (2014), ‘Investor Meeting 2014 - Stacy Smith (CFO)’, Intel Corporation, Santa Clara. Accessed February 13th, retrieved from: http://files.shareholder.com/downloads/INTC/3989058672x0x796003/D44A974E-2F17-427C-8339-29B1268E83B1/2014_IM_Smith_Final- 2.pdf 5 Moore, J., Hettenbach, C., Rao, V., Dogra, S. and Lim, A. (2015), ‘What’s Moving Semi Stocks’, Morgan Stanley Research. Accessed February 13th through Thomson One Banker. 7 D. RESTRUCTURING TRANSITION: ELUSIVE GROWTH AVENUES AMD plans to ignite growth by departing from its core PC business – given the failure of its fast-follower, budget-pricing strategy – and avoiding fierce rivalry with Intel. With the PC market likely to be in long-term decline and AMD’s lack of commitment, we see its market share further deteriorating. Essentially, AMD is engaged in a relentless diversification drive, pursuing “growth markets” without being able to create a stronghold in a specific one – apart from the semi-custom business in gaming, which will be addressed later. We concede that it is rapidly expanding its addressable market, around $80bn in 2014 and estimated $100bn exposure by 20181. Yet AMD’s ability to capitalize it is grossly overestimated. Figure 4. Transition away from core business – but where?6 Last quarter AMD hinted at virtual reality as a potential growth channel yet commercial applications of this technology are still years away from materializing. Even if it were, it is very unlikely that this could constitute a promising outlet for its GPU and CPU based semi- custom business. We agree that these may be potential future growth avenues but these are extremely long shots, more suitable for companies with deep pockets, such Samsung Intel - certainly not for an ailing chipmaker. The semi-custom business is more promising but even here, we will explain why AMD chose the wrong path. 6 Su, L. (2014), ‘Investor Presentation’, Advanced Micro Devices Inc. [Online]. Access February 13th, retrieved from: http://ir.amd.com/phoenix.zhtml?c=74093&p=irol-irhome 8 D. NO TRUCE IN THE BUDGET SEGMENT AS COMPETITION INTENSIFIES AMD is no longer the lone budget player, as incumbents want a slice of the cake. The last revenue figures suggest is being further asphyxiated in the PC market as it market share erodes to 19.4% from 26% in 20107. Its historical stronghold in the lower end is under attack by incumbents, which squeezes its margins. Some companies such as Qualcomm have been making new products, such as the SnapDragon 210, to take advantage of the demand in emerging markets. Intel has begun its crusade to crush AMD in the low-end microchip segment with its Bay Trail and Broadwell products. Even in the low end Intel uses 22nm technology, which is more advanced than AMD’ 28nm technology used in its most recent processors. With its slow retreat, we believe AMD’s revenues will take a big hit. 7 Trefis. (2015) ‘Analysis NYSE:AMD’, Trefis Equity Research. Accessed February 14th through Thomson One Banker.