The Day Ahead: AMD gets praise, but will it translate into profits?

The future looks bright for AMD, although it still has a reputation for not producing the goods
Written by Larry Barrett, Contributor on

AMD may have temporarily stolen the limelight from Intel in the ongoing battle for microchip supremacy with its 1GHz Athlon chip. But if history is any indicator, AMD is going to have improve its shaky manufacturing reputation before Intel loses any sleep.

This is not to denigrate what AMD has accomplished in the past year, culminating with its apparent "victory" in the race to deliver microchips capable of executing one billion instructions per second. However, it's important to note that very few people will be running the applications that would require a chip running at such a fast speed. Bandwidth, not clock speed, is the barrier of significance these days.

As a side note, wasn't Intel the company that the Nasdaq exchange was pumping as the company that would be able to deliver that type of performance in its omnipresent television ads?

Anyway, 11 months ago AMD was on the ropes. The company issued no less than three profit warnings in the first quarter of last year, each time lowering its sales estimates and raising its anticipated losses. For long time shareholders and financial analysts, this was no big surprise. AMD's reputation for creating new technology is unquestioned. The problem has always been its inability to ramp up production for the new chips it designs. Profit warnings became a way of life for the company.

Back in 1995, its K6 chip completely missed the market window, allowing Intel's Pentium to take a stranglehold on the market. This marked the beginning of the end for AMD as a viable competitor, ending a 20-year run that saw it hold, at times, as much as 30 percent of the world's microprocessor market. The K6 debacle, which ended with the departure of several top executives, was an embarrassment. The company's attempts to push the performance of the chip backfired, resulting in a mid- to low-end chips riddled with manufacturing problems.

You'd think AMD would have figured out what Intel knew all along: Invention's nice, but execution is king. In that first quarter, AMD lost $128.4m (£79.6m), or 81 cents (50p) a share, on sales of $631.6m (£391.5m). Ugly isn't a strong enough word, considering the $2bn (£1.2bn) a quarter Intel was raking in at the time. Predictably, the stock slipped to a 52-week low of 14 9/16 in April. "The best thing that can be said about the first quarter is that it's over," said chief executive, Jerry Sanders, at the time.

Look forward nine months, though, and we see an entirely different AMD. Fresh off its blowout fourth-quarter earnings, AMD now looks like a legitimate competitor to Intel, something that couldn't be said with a straight face one year ago. The Athlon line is gaining in popularity. Major PC vendors such as Gateway and Compaq Computer are committed to their chips and gross profit margins figure to improve. But those nagging production concerns still linger.

"Production's clearly going to be the key issue down the road," said Mona Eraiba, an analyst at Gruntal & Co. "Everybody will have concerns because of what's happened in the past. The only thing we can say for sure is they're executing right now."

In that fourth quarter, AMD pocketed $65m (£40.3m), or 43 cents (26p) a share, on sales of $969m (£600m). Considering analysts were expecting only a penny a share, that's pretty good execution. But it's not enough.

AMD shares hustled up 6 1/2, or 17 percent, to a 52-week high of 48 on Monday. No doubt, most of that run-up can be directly attributed to the 1GHz announcement. Meanwhile, Intel shares fell 1 7/8 to 117 3/8.

Of course, Intel's going to roll out its own 1GHz model on Wednesday. Let AMD enjoy its symbolic victory for a day or two, and see what happens to important things like average selling prices and margins in the next couple of quarters.

But if you're a PC maker, which company are you going to trust, especially when the PC market heats up this fall? There's a new operating system from Microsoft that figures to drive demand for these faster machines. Corporate clients undoubtedly will be looking to upgrade their systems. Small business and customers dialing up from home will want the fastest machines they can get. Ask Dell if a consistent supply of chips and components is important to its success. This is no small issue to any of the major players in this segment.

Moreover, there are still a good number of households in the US and abroad that have yet to join the online revolution. PC sales will likely grow at between 15 percent to 20 percent this year, depending on which market research firm you ask, and anywhere between 40 percent to 50 percent in the US alone. With so much on the line, do investors believe AMD will be able to meet demand for a new technology in the way that Intel has for so long?

Credit Sanders and colleagues for sticking to their guns and investing huge sums of cash to get NextGen. The K6 wasn't much to shout about, but the Athlon appears to be for real. Sanders knows his company can compete with Intel, at least at some level, and the company has managed to maintain some momentum for a couple of months. But will that continue?

While it may be enticing to believe in AMD, it may be a bit premature. It's often more important to see how a company handles a little success, rather than how it battles back from adversity.

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