K.C. Swanson

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AMD Has Fallen and It Can't Get Up

K.C. Swanson

Perpetual underdog AMD (AMD Quote - Cramer on AMD - Stock Picks) is getting precious little sympathy these days.

Reeling from a steep industry slowdown and price bullying from Intel (INTC Quote - Cramer on INTC - Stock Picks), the microprocessor outfit unveiled a plan to bolster its lagging business in early November. It's already winning some decent feedback on its new generation of Hammer chips to be introduced next year. Yet analysts remain leery of the stock.

The analysts point to continuing losses in market share, which will have worsened by the time the delayed Hammer chips hit the shelves, as well as the company's rich history of marketing and manufacturing missteps. Then there are the still-considerable balance sheet concerns. Before the layoff announcement, some analysts speculated the company had enough money to sustain it only for another four or five quarters.

AMD suffered another blow Tuesday morning, as shares skidded 11.6% to $5.76 after it announced plans for a $300 million convertible-bond offering. Following the announcement Standard & Poor's slashed its corporate credit rating on AMD to B- from B -- effectively deepening an existing junk rating -- while maintaining a negative outlook. The news adds to an emerging sense that AMD may not be able to regain the momentum it's lost in the chip downturn.

The offering itself didn't come as a huge shock, in light of the cash drain from AMD's continuing losses. Nor are the actual terms of the deal unreasonable. The size of the convertible bond offering isn't excessive for a company of AMD's size, and the resulting 37% debt to equity ratio is within reason, says Tom Smith, an equity analyst at Standard & Poor's.

But AMD's need for more capital merely reinforces pessimists' worries about its operating viability. "It's kind of an unusual story with a lot of potential and still a lot of fear about basic liquidity," says Smith.

Hammer, Don't Hurt 'Em

The question now is whether AMD can make headway with the Hammer line, particularly on the server front. Not only would that offer some much-needed growth in a more profitable market -- AMD draws most of its sales from lower-margin desktop chips -- but it would help bolster the company's greatly diminished credibility.

While a lot is riding on the Hammer line, the early read on the debut isn't encouraging. AMD took a hit last fall when it pushed back the introduction of the desktop processor by a quarter. Onlookers say consumers are likely to be skeptical of AMD's chips, because on clockspeed (a popular measure of performance) they fall behind Intel's products. Moreover, even if the Hammer doesn't suffer further delays, the company isn't likely to see tangible financial results from the new line until at least mid-2003.

"By the middle of next year, they've got to have units shipping and some OEMs under their belt, though they may not get a top-tier OEM 'til the second half of next year," says Kevin Krewell, general manager at Instat-MDR. Possible customers include Sun, IBM, Fujitsu, NEC and the big cheese, Dell, which has reportedly said it's looking at the chip. (H-P isn't likely to be a big customer, because it's partnered with Intel on developing Intel's Itanium chip).

In an unexpected coup, AMD also won a pledge from Microsoft to design software to support the Hammer's 64-bit architecture (a technology that effectively processes more data at a faster rate). But Microsoft hasn't yet set a schedule for the software to be introduced.

Playing in a Rough Neighborhood

In the meantime, at least until the Hammer lineup starts to show up on the income statement, analysts expect AMD to sustain further market erosion. Picture the skinny kid who gets shaken down for lunch money in the playground: That's AMD giving up share to Intel (INTC Quote - Cramer on INTC - Stock Picks), which seems to keep getting tougher. For a rough profit comparison, look no further than gross margins: In the most recent quarter, Intel claimed 49% to AMD's 11%.

In the past two quarters, AMD has lost around 4% or 5% of share in the microprocessor market, now claiming only about 12% to 13% of the market. UBS Warburg's Thomas Thornhill expects those losses will continue, albeit at a slower pace. "Even in our best scenario estimate, it is unlikely that AMD will recoup the market share loss in 2003, and perhaps in 2004," he says in a note.

Thornhill rates AMD shares sell, with a price target of $5 -- implying some 25% downside from current levels. His firm hasn't done any banking for AMD.

Even after the Hammer debuts, it's not clear AMD can cope with the predictable and incessant price pressure issuing from Intel. Say Intel sells a $600 Xeon server chip that's technologically equivalent to a $400 Opteron chip, and AMD starts drawing customers away. Intel will have no compunctions about slashing its own price to $400 to compete, points out Adam Parker, an analyst at Sanford Bernstein.

He believes the Hammer's introduction is rife with potential for mistakes, betting the company will be able to add only about 1% in share next year based on the new products. "The Hammer, while ostensibly a competitive technology, is a bet on AMD's ability to execute both in manufacturing and marketing. Historically, they have not been particularly successful in those areas," Parker says. Sanford Bernstein doesn't do investment banking.

That's why AMD is a stock to trade, not a stock to own, he says. "If they start to gain a bit of share and the buzz around the Hammer launch is great, investors could probably make some money," he acknowledges. Bottom line, he says: "How much should you pay for a company whose normalized earnings are zero?"

In fact, over the long run, AMD's returns have been astonishingly meager. Over the past 20 years, the company spent $25 billion to reap a $2 billion increase in market capitalization, notes Parker. "They've destroyed $23 billion of value," he says.

Granted, AMD has promised investors that it's shaping up, sketching a plan to break even by the second quarter of next year. But the Street, unimpressed, doesn't expect the company to make money until the fourth quarter of 2004, according to earnings estimates posted on Thomson Financial/First Call.

The interim is destined to be painful, with AMD having just announced layoffs of 2,000 people, or 15% of its staff. The company said Monday that it will take restructuring and other special charges totaling between $563 million and $863 million after taxes. At a Lehman conference Monday, CEO Hector Ruiz acknowledged his company's loss of standing, asking the audience to "be open-minded about our prospects and our future."

But for now, some analysts sound skeptical about AMD's short-term goals. Management's bid to break even by the second quarter of 2003, at a sales level of $775 million, is "likely unachievable," writes Thornhill.

Assuming the company could meet its forecast for 20% sales growth in the December quarter, revenue would have to rise by another 27% over the ensuing two quarters to meet that goal -- a tricky feat given the listing PC market.

That means AMD's shares are likely to stay under pressure. Though the stock has rebounded sharply from its October low of $3.20, closing Monday at $6.52, it's still down about 60% for the year, underperforming the S&P by nearly 40%.