AMD Can't Survive on Split Alone

SAN FRANCISCO -- Advanced Micro Devices ( AMD) made what may have been the most eagerly-anticipated announcement in the chip business Tuesday, providing details on a plan to split the company into two entities.

Investors greeted the news with joy, sending AMD's battered shares up more than 18% in midday trading.

But investors are not under any illusion that the change will instantly fix all the problems plaguing AMD, or put it back on equal footing in its battle with Intel ( INTC), the world's No.1 chipmaker.

AMD has its work cut out for it over the next several months, clearing a slew of regulatory hurdles, before it can even address the challenge of proving its new structure's viability in the market.

But the fact that AMD finally got a deal done, after more than a year in the works, and the immediate liquidity boost resulting from the deal, at least gives the company some more breathing room. And in AMD's dire situation, that alone makes the company better off today than it was yesterday.

"It's instilling confidence that they still can get capital when they need capital. And that's key," says Merritt Capital Management's Shane Merritt, which owns AMD shares.

The fundamental structure of the plan, a complex arrangement involving multiple parties, is essentially as expected, with AMD spinning off its chip manufacturing assets into a separate organization currently dubbed The Foundry Company.

Once again, AMD's lifeline comes from the oil-rich city of Abu Dhabi, capital of the United Arab Emirates.

Last November the Mubadala Development Company, an investment arm of the Abu Dhabi government, invested $622 million in AMD for an 8.1% stake in AMD. That investment has declined in value by 60% since then.

But a chance to become a significant player in semiconductors, sometimes referred to as the oil of the information technology industry, and the vague promise to potentially build a future chip factory in Abu Dhabi, appear to have enticed the city to re-up its relationship with AMD.

This time, two sovereign wealth funds -- Mubadala Development and the Advanced Technology Investment Company of Abu Dhabi -- are stepping to the plate, contributing a total of $1 billion in cash to AMD.

That cash will come with a significant dilution to AMD's existing shareholders - the 58 million new shares AMD will issue represent 10% of its existing float.

That was of little concern to investors, who bid up AMD's stock 78 cents to $5.01 following the announcement.

"At this point the stock is not trading on EPS or dilution. It's trading strictly on the fact that they're not going bankrupt," says Wedbush Morgan Securities analyst Patrick Wang, who rates AMD a Hold.

An extra $1 billion provides a much needed cushion, particularly as the outlook for the global economy worsens. And the fact that AMD will not be required to use that cash -- or any of its capital -- to fund expensive chip fabrication factories from now on will lift a huge burden off of the company.

On the other hand, the deal hardly eliminates all of AMD's problems. The deal transfers $1.2 billion of AMD's debt to the new Foundry company. Yet that still leaves AMD responsible for servicing $4.2 billion in debt.

What's more, AMD will continue to carry Foundry company's financial results on its books, a structure that some analysts suspect relates to the conditions of AMD's x86 microprocessor license with Intel.

Investors will want to see a more detailed timeline about plans to completely spin-off the manufacturing operations, says Wang. Meanwhile, the deal at least provides a bit of a light at the end of the tunnel, he says.

AMD's business has hit a rough road, as intense completion with Intel, as well as its own operational snafus have slowed sales and resulted in more than $5.5 billion in losses.

Many of the gains in market share that AMD made a few years ago have slipped away. Dell ( DELL), the world's second-largest PC maker, which began using AMD chips for the first time ever in 2006, has recently lessened its commitment to AMD chips.

The split-up of AMD's operations represents a significant shift for the Sunnyvale, Calif., chipmaker which has relied on manufacturing as one of its key advantages throughout its nearly 40-year history.

In recent years, chip makers including Texas Instruments ( TXN) and ST Microelectronics ( STM) have increasingly outsourced chip production to third-party manufacturers, eliminating the massive capital expenses required to produce semiconductors.

AMD's new plan allows it to play both sides of the trend, lessening the financial burden of chip manufacturing for AMD, while positioning its foundry organization to serve the many chip players in need of manufacturing services.

The success of AMD's new two-headed business model is hardly guaranteed though.

The relationship with IBM's researchers, a traditional partner to AMD's manufacturing process, is an important asset for AMD's new Foundry company. And the commitment by Abu Dhabi to contribute between $3. 6 billion and $6 billion in future manufacturing funds provide some level of assurance that the new Foundry company will keep up the pace of innovation.

But AMD will now have inherently less control over its manufacturing operations as it competes with Intel, whose chip manufacturing operations are considered the industry's most-advanced.

It's also not clear how well AMD's manufacturing arm will fare as a standalone company in the highly competitive foundry business, which is dominated by Taiwan Semiconductor Manufacturing ( TSM).

AMD's Foundry company will begin with one large customer - AMD. It will need more. That will require AMD to quickly develop skills building chips with the bulk CMOS process used by most chipmakers, in addition to the silicon-on-insulator technology it currently uses to produce its own microprocessors.

The first order of business is simply getting the deal done. Part of the Abu Dhabi funding for the deal appears contingent upon AMD securing subsidies and grants from New York state for a new chip factory. New York previously authorized the subsidies for AMD, not for a joint-venture that's majority owned by a foreign state.

The deal also needs a sign-off from federal regulators, who might be concerned about ceding "sensitive technology" to a foreign government.

AMD executives expressed confidence that the deal would clear all regulatory hurdles.

After more than a year of drawing up a survival plan, AMD now has to make it happen.

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