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Investors Sort Out AMD Buy

The acquisition of graphics-chip maker ATI might make sense, but it isn't without risk.

Even after months of rumors about the deal, Advanced Micro Devices' (AMD) - Get Advanced Micro Devices, Inc. Report acquisition of graphics-chip maker ATI Technologies (ATYT) left many on the Street scratching their heads.

For many investors, AMD's $5.4 billion purchase is too much money, at the wrong time, for something with a dubious upside.

"I'm looking at the logic of this and still struggling with why they

AMD need to own it themselves," said one investor, who asked to remain anonymous because he was trading both companies on the news.

ATI's shares surged 18% from the announcement Monday morning. But AMD's stock sank more than 4%, or 82 cents, to $17.44 -- setting a new 52-week low for the Sunnyvale, Calif., microprocessor maker.

AMD will spend all of its reserve of $3 billion in cash and short-term investments as well as taking on an additional $2.5 billion in debt to finance the deal, which has been approved by both companies' boards of directors.

The move will effectively swing AMD into a debt position just as it is facing big capital spending increases to upgrade its chip-fabrication facilities (the company recently announced $2.5 billion in capex next year, up from a projected $1.7 billion for 2006) and tough competition from


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in the microprocessor market.

"One of our major concerns regarding this agreement relates to the heavy debt load that AMD will be taking on to fund the transaction, which is likely to hamper the company's flexibility significantly in the near to midterm," Susquehanna Financial Group analyst Kevin Vassily wrote in a note to investors.

With the acquisition, AMD gains one of the top makers of specialized graphics chips for personal computers. The real significance for AMD, however, is ATI's business of producing chipsets -- the chips that shuttle data to and from the microprocessors that AMD and Intel make.

Intel already manufactures its own chipsets, offering PC makers a complete package. Many of Intel's chipsets even feature integrated graphics capabilities, eliminating the need for a separate graphics chip within the PC.

By offering a complete platform of its own, AMD hopes its chips will be designed into a greater number of PC brands, increasing its market share.

Large computer makers are under heavy pressure to cut costs, says Jon Peddie, an analyst at Jon Peddie Research, an industry consulting firm. One of the ways to do that is for them to reduce the number of different suppliers they purchase from.

After the ATI acquisition, AMD will better be able to meet that need, Peddie says.

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Some investors argue that AMD has managed to do perfectly well without a platform. The company's market share has increased significantly in the past 12 months, and AMD is adding important new customers such as


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, which recently announced would use AMD chips in some of its high-end servers.

But Samir Bhavnani, director of research at Current Analysis, says there's one market that AMD has had trouble penetrating: the corporate desktop and laptop market. Many Fortune 500 companies have policies that require them to purchase only Intel-based systems because of the stable reputation that Intel enjoys, partly by providing complete platforms, says Bhavnani.

"This helps motivate a company like Dell -- not today, not next year -- but a few years down the line, to all of sudden start considering AMD in its Latitude

laptop lineup. This makes


consider using AMD in a few years in the ThinkPad," says Bhavnani.

Given that AMD has cited increasing its position in the corporate PC market as its next big push, any moves that result in the company's product lineup looking more attractive to that sector make a lot of sense.

AMD still will be missing one vital piece of the platform puzzle when it comes to laptops: a wireless communications chip.

And the acquisition does not completely level the playing field with Intel. One key benefit that Intel derives from producing chipsets is the ability to fill up its older generation of manufacturing facilities.

Advanced Intel

As Intel moves its microprocessor manufacturing to the most advanced equipment, it continues to use its depreciated, so-called trailing-edge equipment to make chipsets -- a model that bolsters profit margins.

AMD, however, doesn't have any trailing-edge manufacturing facilities. In May, the company announced that it was upgrading its German facility for advanced microprocessor manufacturing.

By continuing ATI's practice of outsourcing chipset production to third-party manufacturers such as

Taiwan Semiconductor

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, AMD will be operating at an inherent cost disadvantage vs. Intel.

What's more, a good portion of ATI's chipset business is currently tied to Intel, something that is expected to dry up once ATI is incorporated into competitor AMD.

Looking further out, however, some analysts speculated that ATI's graphics know-how will be particularly important as AMD seeks to stay ahead of an emerging market trend.

"Long-term thinkers already know that CPU and GPU

graphics processor unit computations may eventually end up on one piece of silicon," Rahul Sood, president of gaming PC maker


, recently wrote on his blog.

"In the case of CPU + GPU, the possibilities are endless -- imagine a multicore piece of silicon where one core handles massive CPU computations while another handles graphics, and perhaps another handles the traffic between the multiple cores," Sood wrote.

Intel, which already has both multicore and graphics chip capabilities, is already in position to take advantage of the market if it evolves in that direction, says one Wall Street analyst who asked to remain anonymous.

Before purchasing ATI, however, AMD wasn't. Although it definitely has multicore technology, it had no in-house graphics capabilities.

"It all makes some sort of sense," the analyst says. "But the strategy isn't risk-free.

"If the world doesn't evolve that way, they've wasted $5 billion. And even if does evolve that way, it may end up that ATI can't help them," the analyst says, adding that acquisitions often don't work out, and AMD has little history of growing through acquisitions.

Senior writer Troy Wolverton contributed to this report.