Game Consoles Can't Make Up for AMD's Problems

AMD saw its shares slump after reporting earnings, with market share losses to Intel causing PC chip sales to decline faster than the PC market as a whole. While game consoles provided a boost in revenue, the rest of AMD's business doing poorly.

Jan 29, 2014 at 1:30PM

Shares of AMD (NASDAQ:AMD) slumped after the company reported in-line earnings, with investors focusing on share losses in the PC business to Intel (NASDAQ:INTC). The launch of the PlayStation 4 and Xbox One boosted revenue significantly, but AMD's core CPU business is still in rough shape.

A look at the results
AMD reported revenue of $1.59 billion for the quarter, up 38% year-over-year; this was due mainly to the launch of the PlayStation 4 and Xbox One. Annual revenue fell 2% to $5.3 billion, with weak PC chip sales causing the decline. AMD managed to turn a profit in the quarter, with an operating income of $135 million and a net income of $89 million. This is a significant reversal from the same period last year, when AMD reported an operating loss of $422 million.

The computing solutions segment, which includes both PC and server chips, declined by about 13% year-over-year, but AMD was able to turn a $323 million operating loss in the fourth quarter of last year into just a $7 million operating loss in the fourth quarter of this year. While the continued decline is troubling, suggesting that competitor Intel is stealing away some of AMD's market share, the company appears to be doing a better job at keeping costs in check.

Marketing, general, and administrative costs fell by 12.4% year-over-year. R&D spending also decreased, generally not a good sign for a company trying to compete in an industry where a technological advantage is extremely important. While both Intel and graphics chip competitor NVIDIA (NASDAQ:NVDA) have been increasing R&D spending, AMD has been doing the exact opposite. While this may boost short-term profitability, it may spell trouble in the long term.

AMD's PC strategy
AMD's computing solutions business shrunk compared to last quarter as well as year-over-year, declining by 8.6% sequentially. In the third quarter, AMD managed an operating income of $22 million for the segment, compared to the operating loss of $7 million in the fourth quarter.

With Intel having vastly greater resources than AMD, there's really no way that AMD can compete effectively in the CPU business. AMD is spread too thin, trying to compete in too many businesses, and Intel's lead is at this point insurmountable. AMD has bet on better graphics instead of faster CPUs, with its recently released Kaveri line of processors enabling modern games to be played without a discrete graphics card.

AMD's high-end Kaveri processor, the A10-7850K, retails for around $179. This is far less expensive than a comparable Intel CPU combined with a discrete graphics card, and benchmarks have shown that Kaveri is perfectly capable of playing most modern games at low settings. Kaveri is aimed at the casual PC gamer, as it can't touch even a mid-range discrete graphics card in terms of performance, and it allows for a low-end gaming PC to be built for less than an Intel-based system with a low-end discrete graphics card.

This isn't a bad strategy for AMD. In fact, it's likely the only one that makes sense, since competing with Intel on CPU performance is a non-starter. There's certainly a market for budget gaming PCs, and AMD seems right on the money with Kaveri. But any market with the word "budget" in the name isn't going to be a source of high margins, and it remains to be seen if Kaveri can propel AMD's computing solutions division to meaningful profitability.

Any GPU share gains may not last
AMD's graphics and visual solutions segment, which includes both the GPU business and the console chip business, grew from $326 million to $865 million in revenue year-over-year as both the PS4 and Xbox One saw strong demand. The release of new GPUs toward the end of the year also drove sales, with high-end cards reportedly selling out due to demand from cryptocurrency miners.

AMD may have picked up market share from NVIDIA in the fourth quarter, although we won't know for sure until NVIDIA reports its earnings in mid-February. NVIDIA's next GPU architecture, Maxwell, is expected to be unveiled in the next few months, and any market share gains that AMD may have enjoyed will likely evaporate at that time. With NVIDIA, a company solely focused on graphics, outspending AMD in terms of R&D, AMD is running the risk that NVIDIA pulls ahead of it in the graphics department much like Intel has pulled ahead of it in the CPU department.

The bottom line
AMD is in the middle of a turnaround, and while the company has largely stopped the bleeding, I'm not convinced that AMD can return to consistent profitability. The fourth quarter was helped tremendously by the release of the game consoles, and while AMD will continue to get revenue from the PS4 and Xbox One going forward, the core business is still doing poorly.

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Timothy Green owns shares of Nvidia. The Motley Fool recommends Intel and Nvidia. The Motley Fool owns shares of Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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