AMD Surviving, But Can It Thrive? (AMD:NEUTRAL)

AMD’s results and outlook reveal a company still in the depths of a protracted transition, but financials appear to be stabilizing as new products gain traction in consoles, tablets, and inexpensive laptops and hybrids. Richland and Kabini are both shipping, and this puts low-cost, but powerful, APUs into the hands of OEMs at a time when hardware margins have become razor-thin. Temash, the sub-2W SOC for tablets and embedded applications, is ramping now and we expect shipments this quarter to help boost revenues. Investors remain cautious following last year’s disappointing results; can AMD outperform even conservative expectations in 2013?

Revenue strength this year (and likely next) also comes from AMD’s wins in gaming consoles: it has already seen a lift off of its GPU win in the Wii U and is now positioned for growth as Sony’s PS4 ramps this quarter and next. Finally, our checks indicate that Microsoft’s Xbox Next will also be built on a customized AMD APU (yes, CPU and GPU, unlike the Wii), although a less powerful version than that in the PS4, and we expect that to add further momentum to revenue growth in 2H13.

2Q13 Potential: AMD guided to growth of 2% +/- 3%, an unusually wide range, reflecting, we suspect, greater uncertainty in PC and tablet builds in the quarter as opposed to graphics revenues. While AMD has solid design wins for its new APUs, PC demand remains uncertain for back-to-school and Windows and Android tablet demand, while strengthening, remains fragmented compared to the Apple offerings. On the GPU side, the PS4 ramp is slated to begin this quarter (and IDTI’s guidance for 15% Consumer growth attests to that ramp) so we expect GPU segment revenues to grow ~5% Q/Q for AMD. Note that the CPU goes last into the box, so most of the PS4 ramp will appear in AMD’s 2H. This, combined with a weak forecast for PC builds (~up 2.5% Q/Q) points to 3.3% sequential revenue growth for AMD.   We expect this modest revenue growth–and the lower operating costs–to push AMD’s loss per share down to $0.12 in 2Q, from $0.13 in 1Q. This assumes the company delivers its anticipated 39% gross margin. If revenues come in at the top of guidance and gross margin a bit better, AMD likely delivers $0.09 per share in losses for the quarter, and that could drop to $0.08 if that incremental revenue pushes GM closer to 40%. If the PS4 ramp drives stronger GPU growth than guidance suggests, AMD could top its guidance range and drive losses closer to $0.07 per share.

FY13: This remains a transition year for AMD is it attempts to capitalize on design wins in notebooks and tablets, to rebuild market share in graphics (progress through its NeverSettle marketing campaign), and to get serious about embedded programs and its microserver business. Game consoles will help results this year, but ultimately global macro conditions are likely to dominate 2H results. We are maintaining a conservative stance on global PC builds in 2H and therefore see AMD ending the year with $4.77B in sales and a loss of $0.22 per share.

Spending is on the way down over the course of 2013, and cash remains above minimum targets. This quarter could see some pressure on free cash flow, but management comments suggest some flexibility in working capital will keep ending balances above the $1.1B optimal level and well-above the $700M minimum target. But should it threaten to drop below, the company has options to raise secured debt and to monetize IP and additional properties. OpEx will remain elevated through 2Q as new product launches keep spending up, but headcount is being reduced, in  staggered fashion, and that combined with lower marketing expenses in 2H should lead to a solid boost in operating margin and FCF in the back half.

Gross margin remains stubbornly below 40% (excluding a one-time inventory benefit) and this seems unlikely to improve without a substantial boost in volume. We remain concerned that AMD chose to trade margin for wins in the game consoles, but ongoing software licensing associated with those wins may boost margins over time.

The server side of the business is trending at rock-bottom levels, but the company did see a boost in unit shipments for Opteron last quarter. Some of its installed base is taking advantage of the opportunity to upgrade. The SeaMicro potential remains a long way off as ARMH and its licensees work on a 64-bit design. We expect little from that source until late 2014.

Recommendation: AMD’s financials appear to be stabilizing, but growth beyond the boost from game console wins will depend largely on global macroeconomic developments. The data on recovery has become more mixed of late and we are far from sure of seeing a return of IT spending by businesses or of PC spending by households either in emerging markets, or in the industrialized economies. We see limited upside potential in 2Q and have too little visibility into 2H to recommend building a position, even at these levels.