AMD Swallows ATI -- But What Does It Mean?

Today, the merger between graphics and core logic specialist ATI and PC processor maker Advanced Micro Devices (NYSE: AMD  ) is in the books, and ATI shareholders should now have some extra cash in their brokerage accounts, possibly along with some AMD stock.

The market for standalone computer graphics solutions looks very different today, with just one credible specialist on the market in NVIDIA (Nasdaq: NVDA  ) . ATI's brand name will live on, but with a new corporate structure behind it.

More consolidation to come?
Hardware enthusiasts and financial analysts alike have been speculating about a pairing of NVIDIA and Intel (Nasdaq: INTC  ) to match the AMD/ATI combination, ever since that deal was first announced. And when you listen to AMD speaking about the benefits of having in-house graphics expertise, it's easy to get pulled into that line of thinking -- it just sounds so good.

AMD wants to "leverage ATI's strength in the consumer market," and to deliver integrated products for "commercial clients; mobile computing; and gaming and media computing," all as soon as 2007. When ATI bought tiny Finnish graphics chip designer Bitboys OY this spring, the Canadian company also got a foot in the door with leading cell-phone maker and heavy Bitboys partner Nokia (NYSE: NOK  ) , and that relationship is now in AMD's pocket.

Looking beyond 2007, AMD also announced a new range of products for late 2008-early 2009, with a combined CPU and graphics processor in a single piece of silicon. Code-named "Fusion," the new products should deliver better power efficiency, lower total production cost, and a smaller combined package to install in tomorrow's smaller, quieter, less power-hungry devices.

We're not necessarily talking about personal computers anymore. Possible targets include set-top boxes in your living room, in-car navigation and entertainment systems, or even next-generation cell phones. It's not the first-ever CPU/GPU combination -- that's a distinction held by the MediaGX processor made by Cyrix, then by National Semiconductor (NYSE:NSM), and sold to AMD in 2003 under the Geode brand name. But it will easily be the highest-performance combo processor made to date, and nobody has tried it in a mainstream processor since about 1997.

However, the ATI acquisition comes with an unwanted side dish in the form of a lawsuit from Silicon Graphics (Nasdaq: SGIC  ) . The digital-image processing pioneer just emerged from bankruptcy, and the stock resumed trading this Monday. As one of its first actions under the new ticker, SGI filed a patent infringement suit against ATI for using certain floating-point optimization features developed by SGI back in 1998.

Not so fast, buster
NVIDIA already licenses the patent in question, so that's not a factor in Intel's decision whether to buy the graphics company. But there are a few other important deterrents that make me think such a deal is unlikely. For one, NVIDIA will cost a lot more than the $5.4 billion AMD spent on ATI. Today's enterprise value sits at $10.5 billion, and Intel would have to pony up a couple of billion on top of that to encourage a positive shareholder vote on the matter. NVIDIA is arguably a better-run company than its rival ever was, but it also doesn't have the deep claws in mobile markets that ATI does.

A hefty price tag would be hard to justify while Intel is in a major cost-cutting mode, firing 10,000 employees and restructuring itself to squeeze out costs wherever possible. And the added corporate complexity of tacking on a major acquisition won't help with the saving process, nor the stated goal of streamlining the corporate decision process and making Intel a leaner, faster-moving company.

In contrast to AMD, Intel already has a graphics division, and is in fact the overall market leader in PC graphics -- not through high-margin add-on cards, but through low-cost, low-performance chips on Intel motherboards. These solutions may not win any gaming benchmark competitions, but they're all you need in a corporate desktop. NVIDIA would be a significant upgrade to this unit, but hardly a new market opportunity the way AMD's deal was.

And NVIDIA isn't even for sale. "While AMD and ATI figure out what their future looks like, we know what ours looks like," says VP of investor relations Mike Hara, and the company will remain a significant supplier of supporting products for systems designed around AMD processors. Another NVIDIA spokesperson said that "NVIDIA GeForce and nForce processors set the standard for AMD systems. AMD's open-platform strategy enables continued partnership aimed at providing customers with a wide choice of industry-leading solutions." That doesn't sound like a prospective Intel subsidiary to me.

Where are we now?
So NVIDIA will remain a strong, independent competitor and the only pure play in the computer graphics industry. AMD will take ATI's talent pool and intellectual property and turn them into titillating new products that will continue to put pressure on 800-pound gorilla Intel. That monkey doesn't need a new partner, especially not an expensive one, and the challenge on its plate is to keep pace with AMD. Competition is good for everyone except established incumbents, and the processor industry is both a brilliant example of this, and a very interesting market to watch as the future unfolds.

Further Foolishness:

Intel is anInside Valuepick. Take a 30-day free trial to see why Philip Durell thinks the fallen giant can rise again. NVIDIA is aMotley Fool Stock Advisorselection, and a free trial of that service is also just a couple of clicks away.

Fool contributorAnders Bylund holds no position in any of the companies discussed here -- darn those trading rules! You can check out Anders' holdingsif you like. Foolishdisclosurestops him from buying the stocks he keeps writing about, but it's all for a good cause.


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