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Business Is Better, but AMD Shares Struggle

The chipmaker's stock has slipped even as its Opteron server chip gains traction vs. archrival Intel.

Long pegged as an also-ran,

Advanced Micro Devices

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should now be able to preen a little. The chipmaker finally turned a hard-won quarterly profit, and its server chip has made some high-profile inroads into a market dominated by


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But investors aren't ceding the company one iota of credit. After falling 62 cents Wednesday, the stock has lost 23% since hitting a near-term peak of $18.29 in mid-November; in the same period, the benchmark Philadelphia Stock Exchange Semiconductor Index is down 6.2%.

"If you look at volume and interest and price direction, what it's telling you about AMD today is the good news has already been discounted," declared Robert Bacarella, manager of the


Monetta Select Technology fund, which recently sold its AMD stake.

The good news may be discounted, but there's been plenty of it. AMD's business has clearly made big strides over the past six months. Its fourth-quarter results marked the firm's first quarterly profit since June 2001 on a 76% year-on-year sales gain.

More importantly, industry watchers say there could be further upside from the company's Opteron server chip, which has already fared well since debuting in April 2003.

Possibly lifting Opteron's profile,


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has just made available a beta version of its Windows XP that's compatible with Opteron's 64-bit capability. That's likely to help AMD if performance tests go well, noted Rick Whittington, an analyst at American Technology Research.



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is rumored to be considering Opteron -- a momentous shift in strategy, since the company had previously seemed wedded to Itanium silicon for its customers' high-end computing needs.

Information technology customers have

so far been reluctant to embrace Itanium, which H-P co-developed with Intel, because it is optimized only for so-called 64-bit applications (i.e., applications that process 64 chunks of data at a time). Because the vast majority of software is still geared toward 32-bit applications, companies would most likely need to spend money to retool their existing software before it could take advantage of Itanium.

Intel also sells Xeon chips, but they work only with 32-bit applications.

By comparison, Opteron works with both 32-bit and 64-bit architectures, eliminating the need for extra investments in software.

H-P won't confirm if it's considering Opteron, but doesn't deny it, either. The company says only that it's assessing its options when it comes to silicon choices.

An H-P addition would bolster a prestigious customer list for Opteron that already includes

Sun Microsystems

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"The enterprise

market is seriously looking at AMD for solutions and innovations that are not

currently available from Intel -- that's something that AMD has never had" before, said Hans Mosesmann, an analyst at Schwab SoundView. "They've had difficulty on the desktop, much less on the server." (He has an outperform rating on AMD; his firm doesn't do banking.)

"Opteron demand is huge vs.

Intel's Xeon," said Larry Singer, senior vice president of global market strategies at Sun Microsystems. "People are looking for more of a path to 64-bit," even if they're not ready to support it yet. Sun will soon begin offering Opteron-powered servers.

"It's fair to say that as Opteron grows in volume, it will take some share that would otherwise go to Xeon," added Shane Rau, an analyst at IDC.

But "to grow your share on a low base is not a difficult thing," Rau said, noting AMD is a relative newcomer to the server chip market.

AMD's David vs. Intel's Goliath

As of the third quarter of 2003, the most recent period for which share numbers are available, he estimated that AMD's share of x86-based PC server processors measured only in the mid-to-low single digits. Intel still owned over 90% of the PC server processor market. (x86 refers to the family of processors first developed by Intel.)

Furthermore, with Opteron volumes still ramping up, server chips probably account for less than 10% of AMD's total sales. "I think the volumes are not big enough this year to really change much in terms of the financial model," said Mosesmann.

There's a cloud on the horizon too: If Intel rolls out a 64-bit extension to its 32-bit chips, as many suspect it will, AMD's cozy niche could quickly vanish.

Still, any traction Opteron gets is bound to help AMD, given the chip's lofty selling prices. IDC estimates that Opteron retailed in the range of $500 to $600 in the third quarter of 2003, again the most recent for which estimates are available.

While cheaper than Intel's Xeon chips, Opteron's price tag is far above the $70 range of AMD's desktop computer chips. "For AMD it's a new market, so it's all gain from their point of view," said Rau. "It helps them fill out their product line and gives more of an impression that they are serious about penetrating the corporate market."

For now, Opteron remains a potential incremental advantage, added Whittington, whose take on AMD is far more bullish than the rest of the Street. Based on cost-cutting and general margin expansion, he thinks the company can post $1.20 in profit per share for the year ending in 2004, compared to the consensus estimate of 37 cents.

Indeed, after AMD's first profitable quarter in years, its stock valuation seems to imply it can stay in the black, said Tim Allen, senior portfolio manager at Wentworth Hauser and Violich, which doesn't own any AMD shares. "If the stock were 40% lower it might be worth a bet. But the risks and rewards are sort of balanced.

"I think what's afflicted AMD is very similar to Intel," Allen added, noting both stocks have declined since reporting strong fourth-quarter results. Momentum investors piled into the shares before the firms' earnings reports, but have been selling because neither could offer hefty enough guidance, he said. Year to date, Intel stock is down 6.2%; AMD is down 5.2%.

Even if AMD manages its own business well, it must contend with the threat of an Intel-initiated price war down the road, Allen added, echoing concerns from a slew of sell-side analysts. For that matter, several believe AMD lost share to Intel in its flagship desktop processors line during the December quarter.

From last summer into the fall, AMD's stock price "got better a lot faster than the fundamentals," Allen said. "I think they generally are discounting a continuation of the extra good second half of

2003 into this year."

In short, for all the hard-won fundamental progress, AMD's shares are likely to see risk to the downside until investors can turn up more evidence that the next six months will be as shiny as the last.