One of the most integral factors in artificial intelligence (AI) is advancements in semiconductor chips. The chip landscape is dense with competition, including Nvidia, with its trillion-dollar market cap, and formidable players like Qualcomm and Taiwan Semiconductor.
Nvidia's top rival, Advanced Micro Devices (AMD 1.31%), has also benefited from the tailwinds of the AI hype. However, the company is not generating anywhere near the growth of Nvidia. While I've previously expressed a bullish stance on AMD, my investment primarily revolved around the stock's valuation relative to its peers.
But just this week, AMD surprised the investment community by announcing its planned acquisition of Nod.ai, an open-source technology platform used for training AI models. I view this deal as a direct move to catch Nvidia and other rivals off guard as the broader AI chess game continues to play out. Let's dig into the specifics and assess if AMD is worth a look for your portfolio.
What is Nod.ai?
Nod.ai is an AI company that specializes in open-source machine-learning software. Its flagship product, Shark, can be deployed across a variety of AMD's services including graphics processing units (GPUs) and processors.
According to the press release on the deal, Nod.ai's architecture "strongly aligns" with AMD's broader AI vision. While this might initially seem vague, management has dropped some clues in the past about how open-source software is playing a major role in the development of its AI road map.
Image source: Getty Images.
Why is this so important?
During AMD's second-quarter earnings call, CEO Lisa Su said:
Our AI strategy is focused on three areas: first, deliver a broad portfolio and multigenerational road map of leadership GPUs, CPUs, and adaptive computing solutions for AI inferencing; second, extend the open and proven software platform we have established that enables our AI hardware to be deployed broadly and easily; and third, expand the deep and collaborative partnerships we have established across the ecosystem to accelerate deployments of AMD-based AI solutions at scale.
Note that Su references AMD's "open and proven software platform." Given that open-source is a core pillar for AMD's AI strategy, the addition of Nod.ai begins to make more sense. And investors should realize that AMD is competing against far more than just Nvidia.
Big-tech firms such as Microsoft, Alphabet, and Amazon have all invested billions into AI start-ups over the last several months. Microsoft is deploying ChatGPT across a wide array of products following a hefty investment in its parent company, OpenAI. And both Amazon and Alphabet have invested in a company called Anthropic, which has agreed to train future generative AI models on chips developed by Amazon.
On top of this, following a failed acquisition by Nvidia, the SoftBank-owned Arm Holdings recently completed an initial public offering, likely looking to capitalize on the euphoria around AI.
There are a couple of variables at play here. First, the attempted takeover of Arm by Nvidia ultimately failed due to antitrust concerns raised by the Federal Trade Commission. Nod.ai is a relatively tiny start-up, having raised only $36 million in venture capital funding, according to several media outlets. I think that Nod.ai was identified as a good fit because its technology fits squarely with AMD's open-source strategy, and given its size, the deal likely will not face too much scrutiny from regulators.
The second thing that might be going on here is that AMD is simply following the broader themes. Given big tech's aggressive investments in AI, companies like AMD that do not have the same balance sheet strength will have fewer options for splashy strategic investments. By acting swiftly, AMD mitigated a scenario in which Nod.ai capitalized on the secular demand of AI and raised outside capital at a valuation that made it much more challenging to acquire.
The last thing I'd like to highlight is AMD's track record in acquisitions. Keep in mind that the company completed a near $50 billion buyout of Xilinx last year. Part of management's rationale behind the deal was to augment its embedded AI portfolio.
According to company filings, AMD has increased revenue in its embedded segment by more than 60% year over year for the six-month period ended July 1, thanks in large part to the addition of Xilinx products. Perhaps even better is that the embedded segment is the only business unit that is expanding operating income through the first six months of the year.
Should you invest in AMD?
Typically when it comes to valuation, I like to benchmark companies against earnings and cash flow. However, given the cyclical nature of semiconductors, the industry as a whole has been significantly affected by a number of challenges including supply chain disruption, inflation, and higher interest rates. For this reason, the profitability profiles of AMD and its peers have been quite volatile for the last several quarters.
The graph below illustrates the price-to-sales (P/S) ratio of AMD benchmarked against Nvidia, Taiwan Semiconductor, Qualcomm, and Amazon. The basic takeaway is that AMD's current P/S of 8 is far above each competitor except Nvidia. This is not entirely surprising given that Amazon is a newer entrant into chips and the company primarily revolves around e-commerce and its cloud segment, AWS.
Moreover, while Qualcomm is a respectable business, the company's current trajectory is simply not commensurate with that of Nvidia or AMD. But when you compare AMD stock to that of Nvidia, the disparity is too obvious to miss.
AMD PS ratio data by YCharts.
I would tell investors that they should avoid thinking that AMD needs to catch up to Nvidia. Information technology research firm Gartner published a report in August suggesting that total-market revenue from AI chips could reach about $120 billion by 2027. The market for AI chips is growing at an exponential pace, and I believe it will continue to expand in the long run as AI becomes more fixated in digital transformation.
For this reason, there likely will be multiple beneficiaries from these trends as opposed to a singular winner. I believe that AMD will find ways to integrate Nod.AI into its business and that it will be a savvy transaction in the long term.
Given AMD's ability to identify targets that fit nicely into its business, coupled with its discounted valuation compared to Nvidia in particular, the stock looks compelling.
