The misery for Advanced Micro Devices (AMD) started in 1986 when Intel (INTC) decided to cancel its agreement with AMD as a second source microprocessor producer for personal computers (PCs). Ever since then, AMD has been under Intel's thumb, usually finding itself on the losing side against Intel. The company has been dogged by product delays, short of financial resources and lack of innovative ideas. On one hand, Intel has enough engineering talent and capital to put constant competitive pressure by consistently introducing more and more advanced microprocessors generation after generation. As a result, Intel has been successful in fending off AMD from competing in the high end chips such as the ones being used as the brains of computer servers at data centers.
That only leaves AMD to compete for the low margin crumbs. As a result, Intel has been a very profitable enterprise with its gross margin being more than 20% ahead of AMD's. Even after Intel outgunned AMD in R&D and capex spending, it still has money left over to return to shareholders through dividend payments and share buybacks. In contrast, AMD has been treating their creditors and shareholders as its ATM whenever the company could not keep up with its bills or needed money to buy innovation.As we know, even the worst sports team can win a few games. AMD was no exception as it shined briefly for a few quarters with its successful AM386 microprocessors in the 90s and Athlon chips in the early 2000s when it was able to capitalize on Intel's missteps.
Financial Drain
AMD's financial performance mirrored its spotty product history. The company only had three profitable years out of the last 10, during which it lost over $6 billion in total, or $4 billion excluding charges and write-offs, which were once paid in cash or equity. In general, the charge-offs reflect the company's past mistakes that resulted in the destruction of equity value. Struggling companies tend to have more of a history of kitchen sinks than successful ones. Take Eastman Kodak (EK) for instance, extraordinary charges have become a quarterly occurrence ever since the world started to shift from analog cameras to digital ones.
In a free market, how can a company like AMD be allowed to survive for so long? The problem is that the market is not completely free. There are interested parties who love to see AMD limping along than resting in peace. The first group are the PC makers who want to use AMD as a bargaining "chip" against Intel. The second group are the investment bankers who would do anything for a fee. They are more than happy to keep their fee stream alive by providing equity offerings and subprime loans to AMD.
These are the same people who facilitated the subprime mortgage bubble, kept the money losing airlines and many poorly run insurance companies alive at the expense of some not-so-smart investors. The past decade was not particularly kind to AMD shareholders who saw their price declining more than 60% from the low $20s to less than $8 at the end of 2010 and their share count being diluted by 127% from 315 million to 717 million.
Future Prospect
It is unlikely that the suffering, which AMD endured in the past, will end any time soon. If anything, its future is even more bleak as the PC industry has become more mature and more competitive. In the past, Intel has been using innovation to mitigate the falling prices, but it is getting harder and harder to increase computer power by jamming more transistors into a processor. In other words, Moore's law is getting stretched. This means that innovation will be harder and more costly to achieve. It will have a negative implication for Intel and a grave one for AMD.
In addition to the slowing growth of the PC industry, the paradigm shift from desktop computing to the cloud is another troubling sign for the PC industry. The main reason that Microsoft (MSFT) and Intel (Wintel) were so dominant in the operating system (Windows) and the microprocessor market was because many critical apps could only be run on their PC platform. When some of the apps started to shift away from desktops to the web or cloud, it gave non-Wintel device makers a more leveled playing field to compete. Therefore, it is not surprising to see Wintel losing market shares to Apple's (AAPL) Macs.
The increasing popularity of smart phones and tablet computers poses another threat for the PC industry. In general, these mobile devices are more ubiquitous, easier to use and can accomplish a lot of the same tasks that are done on PCs. Microsoft and Intel, which are so dominant in the PC market, could not make a dent in the mobile phone and tablet market even after numerous tries. This was partly because Microsoft and Intel were so fat and happy, and could not focus on the new market with slim profit margins. However, it was a different story for their competitors who had their backs against the wall. Apple Inc., for instance, was almost bankrupt when Steve Jobs returned in 1996. Apple had no choice but to explore a new market. In the beginning, Microsoft treated the new mobile devices as miniature PCs and were not willing to start with a clean slate. As a result, the baggage they carried over from PCs turned out to be too great to overcome. This is because both Windows' operating system and the design of Intel's x86 based microprocessors are a hodge-podge of some old technology and the accumulated fixes over the years. They are not efficient and demand a lot of memory and power to run. This is usually not a big issue for PCs, but a huge one for the new generation of more light weight mobile devices.
Strategy
In summary, AMD has a sustainable competitive disadvantage and faces a tough industry headwind. The management has not been kind to shareholders. It is very hard to value the company in terms of earnings, which were mostly negative. Its tangible book value is only about 85 cents per share, which will not provide much support for the stock. In addition, its joint venture with GlobalFoundaries Inc., which makes chips for AMD, could be a financial drain in the future. The company is the exact opposite of a typical Warren Buffett stock.
Given these factors, AMD makes a great short candidate. The size of the short position should depend on one's portfolio characteristics and risk tolerance. Historically, AMD under-performed the market during the downturns. However, there are some short term risks involved. As a single digit stock in the semiconductor industry, AMD is much more volatile than the general market.
"Short squeeze" is another risk because the short interest is over 10% of its total float, which is fairly high. There is always a risk that the company will make an innovation that can change its future fortunes. This is a risk for shorting any stock. Given AMD's expertise and its current roster of management, this is highly unlikely.
Disclosure: I am short AMD, INTC.
