It was good while it lasted. After Advanced Micro Devices' ( AMD) profit warning on Thursday, there was a sense on the Street that the chipmaker's recent success breaking into Intel's ( INTC) dominant market share is history. AMD's talk of "significantly lower" microprocessor prices served as proof to many investors that the company was feeling the pain of a reinvigorated Intel, which is wielding a new lineup of chips and aggressive price cuts. "It seems like Intel flexed their muscles," said Daniel Morgan, a senior portfolio manager at Synovus Securities, which owns Intel. AMD's miss suggests Intel has regained market share, says Morgan. With AMD's shares off 10.2%, or $2.07, at $18.11 in midday trading, many investors appeared to be of the same mind. Intel shares were up 8 cents to $22. Morgan Stanley and Citigroup both cut their ratings on AMD's stock. AMD said revenue in the fourth quarter of the year will be up a mere 3% from the third quarter's $1.33 billion in sales --
a good deal lower than the 6% to 13% sequential growth that management previously said represents typical seasonal growth in the fourth quarter. Analysts were looking for 8% sales growth. But the beating AMD took in the fourth quarter may not be the dire omen it appears to be. For one thing, says microprocessor analyst Nathan Brockwood, Intel is benefiting from the fact that it is at the beginning of a product cycle, whereas AMD is fielding a stale product lineup. That should change in mid-2007 when AMD releases its quad-core Barcelona processor.
AMD has already had success, winning over new customers such as Dell ( DELL) and Lenovo. New chips will only help. Intel has also used its head start manufacturing chips with 65-nanometer circuitry to undercut AMD on price. AMD only began volume shipments of
65-nanometer chips in December, so it had derived little benefit from the process in the fourth quarter. As the year unfolds, though, says Brockwood, "65 nanometer will play a big role in terms of cost reduction and in terms of enabling new architecture introductions." Of course, any hiccup in moving to 65-nanometer manufacturing will take a toll on AMD's profit margins, which management does not seem to have a solid grip on as it is. AMD framed the third quarter's 51.4% gross margin as a one-time dip, expressing confidence that the company would soon be back to its 55% to 60% margin targets. Many analysts now believe that margins have fallen below the 50% level. Citigroup's Glen Yeung downgraded AMD to a hold, predicting that its fourth-quarter margins have fallen as low as 45.5%. The main culprit, according to Yeung, is a 14% decline in average selling prices for server processors. Citigroup makes a market in shares of AMD and has received compensation for providing AMD with investment banking services in the past 12 months.
American Technology Research analyst Doug Freedman sees margins as lingering at 48% throughout 2007. Given the slower revenue growth, AMD will likely have to cut costs, reckons Freedman, who rates AMD a buy. The ugly finish to 2006 means the stage is set for AMD to mount a comeback in 2007. More than ever, though, the chipmaker cannot afford a misstep.