The news that Advanced Micro Devices (NASDAQ:AMD) would supply semi-custom graphics chips to Intel (NASDAQ:INTC) for use in a new product aimed at notebooks was surprising when it broke earlier this month. There had been rumors of an Intel-AMD licensing deal earlier this year, which seemed far-fetched at the time. This deal involves AMD selling chips to Intel, with no licensing of technology or patents, but it still validates the spirit of the rumor.

It originally seemed like a strange move for Intel, which competes with AMD in the PC and server CPU markets. It made more sense a few days later, when Intel announced that Raja Koduri, chief architect of the Radeon Technologies Group at AMD, was jumping ship to Intel. Through its new Core and Visual Computing Group, Intel plans to develop discrete graphics solutions of its own. Putting AMD graphics into Intel products is a stopgap measure, not a long-term strategy.

An AMD chip.

Image source: AMD.

Good for AMD in the short term

AMD's enterprise, embedded, and semi-custom segment is mostly comprised of the semi-custom chips used in the PlayStation 4 and Xbox One game consoles. As those consoles reach the back half of their life cycles, revenue and profits from those chips are set to decline. This deal with Intel to provide semi-custom graphics chips, in addition to AMD's new server processors, can help offset those declines.

AMD launched its own mobile processors recently, called Ryzen Mobile, which feature the company's Vega graphics cores. It's unclear whether AMD is supplying Vega-based graphics chips for the Intel product, or if it opted for the mainstream Polaris. I would assume that AMD wouldn't enable a product that would compete with its new Ryzen Mobile chips directly. There's been some speculation that this Intel-AMD chip is for Apple. If that's the case, it would make a lot more sense for AMD to provide Vega-based chips, as all Macs run on Intel processors.

Either way, this deal will put Radeon graphics in more devices, and it will generate some additional revenue for AMD. Exactly how much revenue depends on where this Intel chip ends up. If Apple uses it across its Mac product line, it could certainly move the needle for AMD. Apple sold more than 5 million Mac units in its fourth quarter alone.

But don't count on this new revenue stream to stick around. Intel's push into discrete graphics makes it unlikely that an Intel CPU paired with an AMD GPU will become the norm.

Bad for AMD in the long term

The market for discrete graphics chips used for PC gaming and accelerating enterprise workloads is dominated by NVIDIA, with AMD attempting to make a comeback with Vega. The duopoly in graphics is a lot like the duopoly in PC CPUs, with Intel dominating and AMD a distant second.

A third player entering the graphics business is unequivocally bad news for AMD. The company has had enough trouble competing with NVIDIA. Another competitor, especially one with the resources of Intel, spells trouble.

The full scope of Intel's plans and the timing of its first discrete graphics product are unclear at this point. Intel plans to build "high-end discrete graphics solutions for a broad range of computing segments," which implies that it will go after both the gaming and enterprise markets. The gaming PC market is an oasis of growth within an otherwise slumping market for PCs, and NVIDIA manages some incredible margins by dominating the high end. NVIDIA also dominates the enterprise accelerator market, with data-center revenue now on a $2 billion annual run rate. That's too big for Intel to ignore.

AMD's task of making a comeback in graphics will get a lot harder once Intel is shipping products. That may still be a few years away, and for now, AMD will enjoy some extra revenue from the Intel deal. But these developments collectively are a net negative for AMD.

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