Can AMD Dodge the Perilous ASP?

The PC chip maker is expected to show rising profits, but will falling chip prices poison its future?
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SAN FRANCISCO -- In ancient Egypt, it was the asp you had to watch out for, a stealthy Cobra that will kill with its venomous fangs. In Silicon Valley, the killer is another ASP -- or the average selling price.

Listen for it when

Advanced Micro Devices

(AMD) - Get Report

Chairman and CEO W.J. "Jerry" Sanders III holds a conference call with analysts today after the market close to report the chip company's fourth-quarter earnings. If ASP drops below $100, it could strike at the heart of what should be an otherwise healthy earnings report.

AMD has been benefiting from steady ASPs, along with strong sales. In the

third quarter, AMD boasted sales of 3.8 million chips, up from 2.7 million in the previous quarter, while keeping the ASP at $100. That helped give AMD its first profit after four straight quarterly losses. It was a mere one-cent-a-share profit, but it surprised investors and analysts alike -- the Street had expected a 13-cent loss. You might say it was one small cent for AMD but one giant penny for low-priced PCs.

This time investors are expecting even better news.

BancBoston Robertson Stephens

analyst Dan Niles expects the company to report sales of 5 million units, or a 35% increase in unit volume. More significant still, profits will be up -- Niles expects earnings per share in "the low to mid 20s." BancBoston has no underwriting relationship with AMD.

The consensus of 23 analysts polled by

First Call

estimates a profit of 18 cents a share for the fourth quarter, compared with a 9-cent loss in the fourth quarter of 1997. The lowest estimate is for a 6-cent profit while the highest puts it at 30 cents.

AMD is in turnaround mode. While the Street is expecting a 1998 loss of 66 cents, it's calling for a $1.06 profit in 1999. To help the turnaround, AMD has been thrashing

Intel

(INTC) - Get Report

on the low-end of the market. In the third quarter, it grabbed 60% of the sub-$1,000 computer market, and -- better yet -- surpassed Intel's share of the overall retail desktop market with a 48% share.

Can AMD keep improving in the first and second quarters? There's only so much more market share the company can eat on the sub-$1000 sector, and moving up to higher priced PC's, where Intel still dominates, isn't going to be as easy.

For AMD to keep winning market share, its chips would have to reach beyond retailers to the direct channels such as

Dell

(DELL) - Get Report

and

Gateway

(GTW)

, says

Nationsbanc Montgomery

analyst Jonathan Joseph. That's unlikely, he says, since those companies have tied their image closely to Intel. Nationsbanc is not an underwriter of AMD.

Meanwhile Intel is starting to growl at its pesky rival at the low end. This month it slashed prices up to 21% on its low-end Celeron chips and cut prices for two of its Pentium chips by 5% and 6%.

Intel has more room to maneuver in pricing than AMD, because its high-end chips -- the Xeon for servers -- are profit machines. Intel can skim some of those margins to subsidize the Celerons simply to make trouble for AMD. AMD can match Intel's price cuts, but each time it does it hurts its ASPs. If ASPs drop below $100 a share, says Niles, investors may bail. "That will be the one piece of information I will try to get the most clarity on in the conference call," he says.

On the upside, there's AMD's forthcoming K-7 chip, which is intended to attack Intel on the high end. Joseph is going to be listening today for news that the K-7 is on track. Even better would be an actual release date. "That would be significant," he says. For now, investors are keeping the AMD faith. Kent Croft, a porfolio manager with

Croft Leominster

, which manages $450 million in funds, bought AMD at $19 a share and doesn't intend to sell now. "AMD is a show-me stock," he says. "I think they have their manufacturing problems corrected and we think they can thrive."