AMD Enters Rehab

After a massive loss, the chipmaker is coming clean.
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The best thing that can be said about

Advanced Micro Devices'

(AMD) - Get Report

first-quarter meltdown is that at least the company is not in denial.

After reporting a stunning $611 million net loss, AMD's management promised to get immediate treatment for the company.

"We know the only way to get healthy is to fully understand our problems and fix them," AMD President Dirk Meyer told analysts in a postearnings conference call Thursday.

This sober assessment may have kept the stock from collapsing, given the magnitude of the miss. In midday trading Friday, AMD's shares were off 1.8%, or 26 cents, at $14.02.

But while AMD executives ticked off a catalog of interesting ideas to cure the company's various ailments, it's far from clear that any of them are guaranteed to lead to an immediate recovery.

The most pressing need is simply to get some new products out the door. AMD's current predicament is largely attributable to the fact that it's fighting a two-front war against industry leaders

Intel

(INTC) - Get Report

and

Nvidia

(NVDA) - Get Report

with a stale lineup of products.

The toll was obvious in AMD's financial results. Sales in its computing division were down 38% sequentially. And sales of graphics chips, in the first full quarter of results since AMD acquired ATI in October, were below many analysts' expectations.

Though AMD grabbed 25% of the PC microprocessor market in the fourth quarter of 2006, several analysts and investors view that as the peak, and believe that AMD's market share is now heading south again.

"The only way they can combat that trend is with innovative products," says Daniel Morgan, a portfolio manager at Synovus Securities, which owns Intel shares. "You can't play the game of capacity with Intel because they're always going to win."

AMD affirmed that samples of its new Barcelona processor are currently shipping to certain customers, with availability of the chip slated for the third quarter. The microprocessor, which AMD said will be available for both desktop PCs and servers, represents the first significant upgrade to AMD's lineup in several years, hopefully putting it on more equal footing with the slew of new chips Intel has unleashed in the last 12 months.

And AMD will mount its graphics counterattack next month, when it releases its delayed R600 chip. That will finally give AMD an answer to the G8 graphics processor that Nvidia has been shipping since November.

Fixing AMD's other problems will require more structural changes, which the company says it is serious about undertaking.

CEO Hector Ruiz said the company was evaluating a so-called fab light model. AMD has already taken baby steps in that direction, striking a deal with third-party chip manufacturer

Chartered Semiconductor Manufacturing

(CHRT)

to provide extra manufacturing capacity when needed.

By outsourcing even more of its manufacturing capacity to third-party chip manufacturers, AMD could cut back on the huge capital expenditures required to build its own fabs -- a tack

Texas Instruments

(TXN) - Get Report

has successfully taken in the past few years.

But TI is the leader in the market for DSP chips, notes Stifel Nicolaus analyst Cody Acree. That means it can set the pace of innovation, moving to the next generation of manufacturing technology at its leisure.

AMD, on the other hand, must follow Intel when it comes to manufacturing technology -- to stay competitive on cost and performance, AMD needs to keep up with Intel's continual advances in shrinking the size of transistor circuits.

If a third-party manufacturer does not upgrade its manufacturing equipment to the next generation on time, or decides to wait for more demand from its customers before investing in the new equipment, AMD would find itself at even more of a disadvantage against Intel, adds Acree.

"There are positives and negatives in it," says Acree about AMD's potential fab-light plan.

Stifel Nicolaus makes a market in shares of AMD and Intel.

As it stands, many analysts believe that AMD will need to raise more money to fund its capital expenditure requirements.

And a debt or equity offering might not be on terms advantageous to AMD or its shareholders. American Technology Research analyst Doug Freedman estimates that an equity offering could be as much as 50% dilutive to current shareholders.

Ruiz said his company was open to all sorts of financing, and piqued investor interest by raising the possibility that private equity could play a role in the funding.

Private-equity firms have shown a taste for semiconductors of late, leading buyouts of

Freescale

and

NXP

. Whether private-equity firms would want anything to do with AMD, however, is another question.

Private equity firms have tended to favor companies with strong cash flows and little debt, since the deals are typically financed by taking on a large amount of debt.

Neither of those qualities describe AMD, which has $3.7 billion in long-term debt, and a high debt-equity ratio of 70%.

The potential for private equity to pair up with AMD "will fuel further speculation about buyouts and potentially provide short-term support for the stock at these levels," Jefferies analyst John Lau wrote in a note to investors.

Those rumors may help AMD's battered share price in the near term. But when the more likely method of financing occurs, investors may not be so pleased.