AMD Reaching Deep

The Intel rival's new chapter means no easy gains.
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Advanced Micro Devices

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has dazzled investors for the past year by running circles around its larger microprocessor rival

Intel

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.

But as AMD prepares to report its third-quarter earnings, there are signs that the David and Goliath story is entering a new chapter.

Last quarter's

negative preannouncement by AMD was the first hint of change.

And when AMD delivers its financial results after the bell Wednesday, investors might see further evidence that the chipmaker's days of easy share gains are now behind it.

Wall Street analysts expect AMD's third-quarter revenue to be up 6.5% sequentially at $1.3 billion, according to Thomson Financial. Notably, Intel said Tuesday that

its third-quarter revenue increased 9% sequentially, meaning that Intel may have posted stronger sales growth than AMD has -- something that hasn't happened since the first quarter of 2005.

This hasn't scared investors though. AMD's stock is up about 50% since it hit its 52-week low in mid-July, closing at $24.48 Tuesday.

The going may be getting tougher, but investors still believe that AMD has the chops to duke it out with the world's No. 1 chipmaker.

During the third quarter, AMD continued to make important inroads among the world's top PC vendors.

Lenovo

, the world's third-largest PC vendor,

broadened its ties with the Sunnyvale, Calif.-based chipmaker by putting AMD microprocessors inside Lenovo's ThinkCentre desktops (although the vaunted ThinkPad notebook remains Intel-only).

And

Dell

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said it would begin offering AMD-based desktops in September, following its earlier move to offer AMD chips in a small segment of its server line and ending Dell's previously exclusive relationship with Intel.

And there's still plenty of room for AMD to grow.

So far, AMD chips are being offered only in Dell's consumer PCs. But American Technology Research analyst Doug Freedman believes that the chipmaker will redouble its efforts to break into the commercial segment of the market through Dell and other PC vendors.

Part of this plan will be a new technical- and logistical-support program that Freedman expects AMD to debut soon, which could make AMD's technology more palatable to risk-averse corporations.

As it is, AMD's executives have said the company expects to finish 2006 with twice the number of corporate PC models based on AMD chips than it started with.

What's still unclear is whether AMD can keep up this frenzied pace of customer penetration now that Intel has revamped its chip lineup with a new family of microprocessors that boast impressive performance and power-efficiency characteristics.

Even if AMD is able to move greater amounts of chips, the company will be paid less for them in forced response to Intel's aggressive price cuts.

Additionally, the increasing business with large OEM companies such as Dell could have a negative side effect, as Stifel Nicolaus analyst Cody Acree writes in a recent note to investors.

"Our near-term concern is the impact of the mix shift toward the OEMs, where we believe volume price breaks may result in revenue and gross-margin constraints," writes Acree. "This scenario likely becomes a somewhat larger issue through the first half of 2007 as AMD becomes a bigger supplier to Dell."

Wall Street analysts expect AMD to earn 23 cents a share in the third quarter compared with 18 cents a share in the year-ago period (although year-ago results were affected by the $50 million loss of AMD's now-divested memory group).

Pressure Points

With its margins under pressure, AMD is doing all it can to hold the line on expenses. In August, AMD

slashed the co-marketing subsidies it provides to PC makers by one-third. Company guidance for the third quarter projects overall operating expenses to be flat quarter over quarter.

Atlantic Trust Stein Roe analyst Fred Weiss says that Wednesday's earnings report may not truly reflect the issues that will determine AMD's success long term.

That's because the strong seasonality typical of the second half of the year is boosting demand for both AMD and Intel and masking the true competitive dynamics of the microprocessor market.

"They're going to say business is strong -- which is true -- and say 'We're going to have a good fourth quarter,' which is true. But the question is what happens over the next four quarters after that," says Weiss, whose firm currently owns Intel shares, but not shares of AMD.

According to Weiss, investors will have to wait until early 2007 to get a better sense of whether AMD can build upon the roughly 20% market share it now controls, or if AMD's expansion has reached a plateau.

At this point, it's tough to read what's going to happen with market share going forward, he says.

"They may have some guidance, but it's more of a guess than they really know," says Weiss.