I have to admit, the value investor in me can sympathize a little with Citigroup's ever-so-contrarian upgrade of AMD (NYSE:AMD) on Monday. After all, it's not as easy to find bargains in tech as it was a few months ago. In such an environment, might not lowly AMD, trading, as the Citi analyst noted, at a discount to industry peers on an enterprise value/sales basis, represent an overlooked gem?
Alas, this looks more like a case of Mr. Market giving investors exactly what they're paying for.
One of the key arguments behind Citi's upgrade is that AMD's adjusted gross margin -- which has plunged from 45% in Q3 2008 to 29% in Q2 2009 -- is due for a rebound. And since AMD's shares have typically performed well during times of improving margins ... well, you can connect the dots.
But while a modest snapback in margins is likely as AMD begins selling a greater percentage of chips based on a more advanced manufacturing process, AMD's weak competitive position in its PC and server microprocessor business (77% of revenue) makes it tough to bet on a stronger recovery. In particular:
- AMD's Phenom II line of quad-core desktop processors is simply outclassed by products based on Intel's (NASDAQ:INTC) Nehalem architecture, launched last November. Benchmarks show a 2.66 GHz Nehalem chip outperforming AMD's flagship 3.4 GHz Phenom II chip. And product releases over the next month will begin pushing Nehalem from the high-end desktop market into the mainstream segment.
- AMD's most expensive chips, its Opteron server processors, are also under attack from Nehalem. Benchmarks show that Nehalem products released for dual-processor servers have a clear performance edge over dual-processor Opteron products. Nehalem chips due out later this year or in early 2010 for quad-processor servers are expected to have the same effect on that market.
- In the mainstream notebook market, AMD's Turion and Athlon products haven't kept pace with Intel's Core 2 Duo line in terms of performance. And the first Nehalem-based notebook chips will be out next month.
- In the rapidly growing netbook market, AMD still doesn't have an answer for Intel's low-cost, ultralow-power Atom processor line, which dominates this space. AMD has apparently chosen to ignore the netbook market, releasing its Neo processor, which is too expensive, powerful, and power-consuming for netbooks.
- Apple (NASDAQ:AAPL), which is strictly an Intel shop, accounts for an enormous and still-growing chunk of high-end computer sales. AMD customers Hewlett-Packard (NYSE:HPQ) and Dell (NASDAQ:DELL) haven't had much luck in countering this trend.
Add up all of these issues, and you have a company that will have to compete in most of its microprocessor markets by slashing prices early and often. To be sure, as long as AMD and Intel are rivals there will be a back and forth as they one-up another.
AMD has shown strength in some segments, such as with Istanbul's impressive performance in high-end four-processor servers. Yet despite some areas of success, the overall picture doesn't look encouraging. The technological strengths of Nehalem and Atom will make it tough for AMD to field competitive chips in many market segments, aggressive pricing or not. Which means that the company is likely to continue facing the twin specters of brutal price competition and declining market share.
I don't know about you, but to me, that doesn't sound like a recipe for improving gross margins.
