Advanced Micro Devices (AMD -1.04%) finds itself trailing far behind Nvidia in the AI accelerator market. Nvidia has some critical competitive advantages working its its favor. It was the first mover as demand for artificial intelligence (AI) chips exploded, and its CUDA computing platform has become entrenched in academia and industry over the past 18 years.
AMD expects to sell more than $4.5 billion worth of AI accelerators this year, with its lineup headlined by the powerful Instinct MI300X. The company supercharged its AI efforts this week with the $4.9 billion acquisition of ZT Systems, a server-solutions provider with a customer list spanning cloud computing companies and telecom giants.
Why this deal makes sense
When I first saw that AMD was shelling out this much for a server company, it sounded like a terrible idea. The business of designing, manufacturing, and selling server systems is a low-margin affair. Super Micro Computer, which has emerged as a leader in the AI server business, managed a gross margin of just 11.2% in its latest quarter. AMD's gross margin hovers around 50%.
AMD likely isn't paying nearly $5 billion for a server designer and manufacturer because it wants to be in the server business. Instead, the company is aiming to accelerate the adoption of its AI chips.
Some data center customers will buy AI accelerators directly, but others want to buy full AI servers with storage, networking, and everything else included. With Nvidia dominating the market for AI chips and pushing its own AI server solutions, AMD faces an uphill battle getting server designers to build systems around its accelerators.
AMD calls this deal a "strategic acquisition" for good reason. It looks like a means to an end and will likely hurt AMD's gross margin. Notably, the company is looking to get rid of ZT Systems manufacturing operations once the deal closes.
The company noted in its announcement that it's seeking a strategic partner to acquire the manufacturing side of the business. This will leave AMD with ZT Systems' design capabilities and its customer base while allowing it to outsource manufacturing.
AMD sees the market for data center AI accelerators reaching $400 billion in 2027. Even if that estimate is overly optimistic, AMD will have the opportunity to greatly increase its AI accelerator sales if it can break Nvidia's stranglehold on the industry. By bringing AI server-design capabilities in-house, the company will be better positioned to sell cloud and enterprise customers on its powerful AI chips.
Boosting the data center business
AMD's second-quarter results were a mixed bag overall, but the data center segment was a pillar of strength. Data center revenue more than doubled year over year to $2.8 billion, driven by AI accelerator shipments and the company's EPYC server CPUs.
Once the ZT Systems deal closes in the first half of 2025, the business will become part of the data center solutions segment. This segment is now the largest segment for AMD by far and likely has the best long-term growth prospects, thanks to booming demand for AI chips.
From a purely financial perspective, spending $4.9 billion on a server company doesn't make a lot of sense. However, as a way to accelerate the adoption of AMD's AI chips in a market overwhelmingly dominated by Nvidia, it makes all the sense in the world.
