AMD (NASDAQ:AMD) isn't expecting a turnaround in demand for its CPUs anytime soon. Research firm IDC expects PC sales to continue declining in 2014, and Intel (NASDAQ:INTC) continues to widen the technical gap between the two chipmakers.That's why CEO Rory Read has instead focused on lowering overhead costs along with high-growth products that can become consistent profit makers.
The company's wins with Microsoft (NASDAQ:MSFT) and Sony (NYSE:SNE) to make semi-custom SoCs for their game consoles will be a big part of AMDs profits in 2014, but is the division enough to make up for the diminishing sales of its computing solutions division?
Declining CPU and APU business
Last quarter, AMD reported its computing solutions revenue fell 15% year over year and accounted for just 54% of total revenue. Year to date, the division has seen a 25% decline in sales. IDC estimates that PC sales fell 10% in 2013, and will fall nearly 4% in 2014.
Meanwhile, Intel continues to dominate the server business controlling 95% of the market. AMD is poised to get back some of that market share with the acquisition of SeaMicro and there's potential to make deals similar to last quarter's agreement with Verizon. Still, Intel ought to continue dominating the CPU space.
Intel still offers better performance per watt and per dollar with its technological lead over AMD, and that gap should continue widening as Intel spends more on R&D. Intel is also eyeing the low-end PC market, so AMD may face declining revenue as Intel encroaches on its strongest market.
Semi-custom could be the answer
CEO Rory Read indicated that he is looking to generate nearly 50% of revenue from high-growth markets including semi-custom SoCs. That business got a big boost last quarter as the company ramped up production for Sony's PS4 and Microsoft's Xbox One. Continued strong demand for the consoles will be a boon to AMD's semi-custom business.
Although the semi-custom business was to blame for AMD's sequential drop in gross margin, it brought in better than expected operating margin in the mid-teens.As a result, the graphics and visual solutions division posted $79 million of operating profit on $671 million of revenue, and the semi-custom business is estimated to have generated the vast majority of that profit. Comparatively, its computing solutions division generated just $22 million in operating profit on $790 million in revenue.
One reason operating margins are higher for semi-custom SoCs is because Microsoft and Sony, and whoever else is tapping AMD, help to pay for R&D. As a result, AMD's gross margin and operating margin on semi-custom SoCs are relatively close, which means they'll be a consistent profit maker.
Semi-custom growth in 2014 and beyond
With PS4 and Xbox One sales off to a good start, and console sales usually peaking around year three or four, AMD should see strong growth in its semi-custom business in 2014. Additionally, AMD expects to see operating efficiencies lead to higher margins on its semi-custom SoC products, which means that it should be able to maintain strong profitability even as the average selling price declines in the future.
Chief Sales Officer John Byrne indicated that the company is building off the momentum it gained in the game console market and has developed "a pipeline of semi-custom opportunities." The company plans to announce two new design wins in 2014 to begin in 2015, which will generate $250 million to $500 million in additional revenue.
All-in-all the outlook is strong for AMDs semi-custom SoC business.
Is it enough?
AMD doesn't expect things to get better for the PC market in 2014, and that means the computing solutions division will likely lose revenue. If the division can stay close to break-even through cost-cutting -- it's lost $15 million year to date -- I believe the semi-custom division ought to keep AMD profitable as the company transitions to high-growth products.
Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.