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Equity Research

Advanced Micro Devices

CURIC

Authors

YIP Daria Yong-Tong AKHMELVAN Gerald

MALHOTRA Samya CHEUNG Austin

The content and opinions in this report are written by university students from the CityU Student Research & Investment Club, and thus are for reference only. Investors are fully responsible for their investment decisions. CityU Student Research & Investment Club is not responsible for any direct or indirect loss resulting from investments referenced to this report. The opinions in this report constitute the opinion of the CityU Student Research & Investment Club and do not constitute the opinion of the City University of Hong Kong nor any governing or student body or department under the University.

5 October 2020 Equity Research

Advanced Micro Devices (AMD:)

Rating: Underweight Our analysis of Advanced Micro Devices Inc. (hereupon referred to as

Price (5/10/ 20) $86.15 “AMD”) has been driven by two modelling approaches, including a DCF Target Price: $69.70 (discounted cash flow) valuation of a 5-year forecast period ranging Market Cap (5/10/20) $101.17B from the years ending 31st December 2020E to 2024E, and trading Enterprise Value (5/10/20) $100.08B comparables. Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. Target price is for 12 months. Console Gaming – Main driver for increase in EESC revenue

Research Analysts: Management puts more emphasis on Enterprise, Embedded, and Semi- custom (EESC) by securing multiple deals related to Daria Yong -Tong Yip [email protected] and highly anticipated game consoles such as PS5 and series X. With the release of the new consoles in 4Q20, AMD could capture high Samya Malhotra smalhotra6 [email protected] growth brought by its leading position in the EESC segment.

Gerald Akhmelvan Strong pipeline of Next-Gen CPUs and GPUs gakhmelva2 [email protected] AMD has a strong product pipeline which features the CPU powered by Cheung Yue Tseung, Austin “ 3” processors core and the GPU powered by RDNA 2 architecture [email protected] in 2020. The 5nm processing technologies are able to support AMD’s series of future products, e.g. “Zen 4” in 2021/2022, to remain YTD Share Performance - AMD competitive in the market. USD/Share Millions 100,00 300,00 Data center competition heating up 90,00 250,00 ’s decision to outsource to TSMC will potentially help them catch 80,00 200,00 up to AMD and by at least 6 months, which means that the 70,00 150,00 technological edge that AMD has over Intel may be shortened. Intense 60,00 100,00 50,00 competition from Intel and NVIDIA threatens their competitive position,

40,00 50,00 with the latter stating that they expect data center revenues to exceed gaming revenues in 4Q21. NVIDIA’s data center GPUs will likely be 30,00 0,00 enhanced through their acquisition with Arm, despite facing regulatory Jul-20 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Aug-20 Sep-20 Oct-20 challenges that will need to be carefully observed. On 5 October, Volume LHS: Share Price Closing Price RHS: Volume NVIDIA announced their new BlueField DPU () which we expect to provide pressure to AMD’s data center market share as well.

Our price target reflects our base-case scenario of a 28.5% revenue growth and $1.05 EPS in FY20, which is lower than the firm’s 32% revenue growth rate for FY20 and the street’s expected $1.09 in EPS. Despite forecasted year-on-year (yoy) double digit revenue growth in 2020E to 2024E led by EESC, our base case scenario and model indicates that total revenue growth may be slowing in future years due to increased data center competition from Intel and NVIDIA, and possibly PC segment competition from Intel. We would need to see AMD’s earnings power and cash flow generation ability in the next earnings release to justify buying at these prices. If EESC delivers strong sales in 4Q20 and 1Q21 coupled with data center growth in market share of ~10-15% in the next two years, we may revise our outlook and price target. We remain UNDERWEIGHT with a 12-month price target of $69.70 for AMD.

Table of Contents Company Overview ...... 5 Revenue Breakdown ...... 6 Investment Catalysts & Risks ...... 7 Valuation ...... 10 Appendix ...... 11

Company Overview

Advanced Micro Devices (AMD) is a US-based company that develops processors and related services for commercial and retail consumers. AMD has a comprehensive and expanding product portfolio which is divided into two main segments, namely Computing and Graphics and Enterprise, Embedded, and Semi-Custom segment (EESC). Original equipment manufacturers (OEMs) and original design manufacturers (ODM) including Apple, , , are the primary customers for the , while is a major customer accounting for 10% of AMD’s revenue. AMD became a fabless company in 2009 when GlobalFoundries, the original semiconductor foundry, was spun off. Since then, AMD has been outsourcing its production to Semiconductor Manufacturing Company (TSMC) and GlobalFoundries.

Ryzen and are the company’s leading computing processing units (CPUs) and graphics processing units (GPUs) respectively for both desktop and notebook . AMD’s series is designed for servers including, but not limited to, cloud, web, e-mail, print, and on-premise servers, to perform functions such as business intelligence and cloud computing. and EPYC series contributed $1.5 billion in revenue growth in 2019 due to increased demand. AMD now operates in 35 locations in 24 countries with approximately 11,400 employees.

In 2020, AMD predicts strong EESC segment revenue growth in the next few years and has secured multiple national center deployments in the United States, France, Germany, and the United

Kingdom. To capture growth in the data center, AMD plans to launch its first computer-specific graphics architecture and to release a stack for developers. AMD supports the GPUs for the two major next- generation gaming consoles, PlayStation 5 and Xbox series X, as well as “” processor core for notebook and PC computing.

Revenue Breakdown

Based on the second quarter results of 2020, the overall performance of AMD has been rather commendable. They reported a $1.93 billion revenue which portrayed a 26% increase yoy primarily coming from the Computing and Graphics segment attributed by strong Ryzen processor sales. From a quarter-on- quarter (qoq) perspective, total revenue was up by 8% driven primarily from EESC segment. Net income was $157 million, comparatively much higher than last year’s $35 million.

Figure 3. Total Revenue (Billions USD) 10

8

6

8,75 4 6,47 6,73 5,25 2 4,31

0 2016 2017 2018 2019 2020

EESC revenue was $565 million, which was down by 4 percent yoy whilst being a 62% increase qoq. For the third quarter, AMD expects that revenue will increase to $2.55 billion, which would portray an overall

Figure 4. Revenue by Product Segments (Billions USD)

1,60 1,40 1,44 1,20 1,28 1,00 1,12 0,80 0,938 0,831 0,60 0,715 0,40 0,532 0,525 0,441 0,20 0,348 2018 Q1 2018 Q3 2019 Q1 2019 Q3 2020 Q1 Computing & Graphic Enterprise, Embedded and Semi-Custom increase of 42% yoy. Ryzen and EPYC processors are predicted to perform exceptionally well and experiencing increasing yoy and sequential sales. Currently, the company expects revenue for FY20 to grow by 32%, which will mainly be driven from PC, data center products, and EESC, mainly console gaming.

Investment Catalysts & Risks Catalysts

Intel’s delay sparks potential market share growth opportunities for AMD. At the end of July 2020, Intel announced that they identified a defect in their manufacturing process, which subsequently caused a delay in their rollout of 7nm chips. Intel now expects to ship their 7nm processors in 2022. We see that by 2022, TSMC has ample time to be able to produce 3nm chips for AMD. Intel also stated that they would rely on their contingency plans of outsourcing their production to ensure that they will meet their targets. This delay serves as a catalyst to the medium-term performance of AMD, as it opens up the opportunity for AMD to take up Intel’s market share and achieve further revenue growth as long as AMD has the

Figure 5: Major Price Movements USD/Share 100,00 All-time high of $92.18, followed by 4 September 2020: a market sell-off in the tech sector the DJIA (-2.8%), 90,00 S&P500 (-3.5%), next day. Nasdaq (-5%) 20 February 2020: Major 80,00 July 23 2020: Intel announces stock indices closed at delay in their next-generation record highs. AMD closed 7nm chips' release 70,00 at a record high at that time, $58.9. 3 October 2020: President 60,00 March: Trump Coronavirus diagnosed with July 28 2020: AMD market crash COVID-19 50,00 announces second quarter results 40,00

30,00 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20 Sep-20 Oct-20

technological and manufacturing edge over intel and maintains a good price-to-performance ratio for their products.

Console gaming to significantly contribute to EESC revenue growth: AMD’s involvement in supplying custom chips for arguably two of the most well-known console products for gaming, the Xbox and PlayStation, allows it to stay one step ahead of NVIDIA in the industry as NVIDIA missed out on the deal. In 2Q20, the EESC segment was down 4% qoq due to lower semi-custom product sales. We believe that with the release of Xbox and PS5 during the holiday season, EESC revenues will likely rise. NVIDIA supplies Switch’s (Switch) chips, however, we see Xbox and PlayStation to be bigger than Switch in terms of their brand image despite the popularity Switch garnered during the COVID-19 pandemic. The figure below shows Switch’s and PS4’s hardware and software sales. In terms of software sales, PS4 dominates Switch as they have more downloadable content. Moreover, PlayStation has a superior online gaming platform that enables multiplayer games to be played with peers, which may appeal more to avid gamers. We expect PS5’s sales will exceed Switch’s sales in 2021.

Figure 7. vs PS4 Software Sales Figure 6. Nintendo Switch vs PS4 Hardware Sales (Millions) (Millions) 350 25 21,05 300 287,9 20 274,2 268,7 19 20 17,8 16,95 250 234,2 15,05 15 13,5 200 168,72

150 118,55 10 91 100 5,68 63,51 5 3,28 45,59 50,43 2,74 50 1,9 5,46 0 0 FY16 FY17 FY18 FY19 1Q20 2Q20 FY16 FY17 FY18 FY19 1Q20 2Q20 Nintendo Switch PS4 Nintendo Switch PS4

Double-digit growth potential in data center segment: In Q2’s earnings call, , AMD’s CEO, announced that AMD has achieved its goal of double-digit market share in the data center market. Their EPYC processors which are meant for cloud computing and data center operators have been facing a surge in demand during the COVID-19 pandemic from remote working. Several OEMs such as Lenovo and Hewlett Packard have started adopting AMD’s EPYC processors, alongside major companies that also have cloud servers such as ’s AWS and Google’s Google Cloud. Intel has a market share of approximately 90-95% for data center processors, which leaves a lot for AMD to capture. We believe that AMD’s Zen 3 “Milan” EPYC processor - which is expected to be 20% faster than “Rome” - has the competitive capacity to rival Intel products and lead data center segment’s growth. However, with the recent acquisition of Arm, NVIDIA is also joining the fight for data center growth alongside Intel and AMD. NVIDIA expects in 4Q21 data center growth will exceed gaming revenue, a bold statement.

Risks

AMD’s valuations are hard to justify in these levels unless earnings power manifests: AMD is trading at 168.9x TTM P/E and P/Free Cash Flow (FCF) of 147.5x (both as of 5/10/2020) which makes it expensive compared to its peers and difficult to justify their valuations. Despite their improvement in their forward

P/E (56.8x), this number is still higher than the median of 20.15x. Although FCF has been continuously growing since 2018, it still falls way behind its competitors. Moreover, AMD has a smaller budget for their R&D and capex, which we also see as a hindrance to growth potential when competing with more established players such as NVIDIA and Intel. We see an increase in AMD’s EPS and FCF in FY20 and going forward driven by high double-digit revenue growth, but if it falls under our and the street’s expectations, we will find it harder to defend their valuations.

Figure 8. Free Cash Flow

USD Billions 25 21,9

20 16,932 14,251 15 12,183 10,332 10

4,272 4,434 5 2,909 3,143 1,496 0,013 0,276 0,611 0 -0,045 -0,129

-5 2016 2017 2018 2019 TTM AMD NVDA INTC

Reliance on TSMC means any adverse effect that they face will affect AMD: AMD designs their own chips while they rely on Taiwan Semiconductor Manufacturing Company (TSMC) to make and manufacture their chips. Overreliance on TSMC may be detrimental as negative impacts to TSMC will also affect AMD by extension. For example, should there be another wave of coronavirus cases or any factors that will disrupt TSMC’s supply chains, TSMC may need to halt the production of chips. Geopolitical tensions between the US and China may also potentially have adverse effects as trade wars lead to higher tariff costs which in turn may reduce pricing competitiveness. Moreover, revenue growth may be threatened should Intel go forth with their contingency plan by outsourcing their production to a third party, potentially catching up with AMD and retrieving market share. The key question to be asked here is whether AMD can maintain their lead ahead of Intel in terms of technology and manufacturing schedule.

Dampened spending effect from COVID-19: The Xbox Series X and PS5 are expected to release in the holiday season around December 2020. However, consumers may have less to spend on gaming consoles due to the effects of COVID-19 on employment and income to consumers. Xbox released their price of $299 recently, while Sony stated that the price of PS5 is $399 for its digital edition and $499 for their non- digital edition. The US represents 29% of lifetime global PS4 sales as of August 2020. With a hefty price tag attached to both consoles, there is a risk that consumers may skip their holiday purchase this year.

Figure 9. United States Unemployment Rate (%) 16,0 14,7 13,3 14,0 11,1 12,0 10,2 10,4

10,0 8,4 8,0 6,0 3,7 3,6 3,6 3,5 3,5 3,5 3,5 4,4 4,0 2,0 0,0 Aug-19 Oct-19 Dec-19 Feb-20 Apr-20 Jun-20 Aug-20

Other risk factors that could negatively impact the share price include: (1) COVID-19’s adverse effects on global consumer spending is longer than expected (2) increasingly heavy competition in the data center segment, mainly by Intel’s 11th gen products and NVIDIA’s enhanced data center products from their acquisition of Mellanox and Arm that would threaten or hinder AMD’s expected data center market share growth.

Valuation

Our implied share price of $69.7, or a 19.1% downside from the current share price of $86.15 (as of 05/10/20), is derived from the weighted average of two valuation models, namely through Discounted Cash Flow (DCF) valuation and public Comparables. We get a fair value share price of $71.9 from our DCF and $49.9 from our Comparables. DCF valuation was given the higher weighting of 90%, while Comparables receives a 10% weighting as we view comparables to be less reflective of AMD’s value from the high P/Es that some growth-based companies have, including AMD. Expected future growth has AMD trade at a 2.9x premium in current P/E to its peers.

Appendix AMD’s Income Statement

AMD’s Balance Sheet

AMD’s Cash Flow Statement

Comparables