Shaking the Money Tree
by Robert Metz, talks.com;
Note, statements within "[.]" are my comments, not from Mr. Metz
Lunch Eaters Part I
Is Advanced Micro Devices Eating Intel's Lunch ? [Question Mark]
March 24, 1998 -- Advanced Micro Devices (NYSE: AMD) was once sued by Intel (Nasdaq: INTC) for patent misuse. In effect, AMD was stomped on and left for dead. Almost. Intel has dominated microprocessors since CEO Andrew Grove persuaded Gordon Moore to forsake memory chips and bet the company on computer brains.
Starting in 1986, Intel began selling generations of microprocessors now found in most of every leading manufacturers' desk top computers. "Intel Inside" is, in fact, a promotional slogan far more famous than many of the computers that house the company's devices. Is it possible that in some small way, tiny AMD is moving into the dining room to feast on Intel's share of market? Yes, indeed. But the question is whether Advanced Micro Devices will earn fat profits as it does so. [Good Question]
Advanced Micro Devices has long yapped at Intel's heels with quite similar microprocessors. AMD chairman Jerry Sanders' recent gains versus his arch competitor have been in the low end of the microprocessor business. With computers selling for as little as $1,000 AMD, with a big price edge, has been wolfing Intel's lunch in this market sector with IBM and Compaq. To some extend, Intel has suffered reduced margins and lower profits. It is a battle that goes back to the early days of computers-on-a-chip which I wrote up in the early 1970s in an out of print book, "Future Stocks."
Sanders was always up against superior forces at Intel. So he used stock options to an unusual degree to inspire employees. He made options available to all, with his lowest level workers getting them for nothing.
Intel's three founders, Grove, Moore and Robert Noyce enjoyed a major market advantage derived from the fact that all three men worked together at two previous start-up companies, Shockley and Fairchild.
So they were well-known in their Intel start up years. During the bull market of 1968, the most spectacular stock market gusher prior to this one, people called Moore's wife at home to put money in the infant company.
Lunch Eaters Part II
Intel has ever since used innovative equity-based financing with enormous success in this capital devouring industry. One microprocessor plant these days can cost $2 billion and the more you have, the better it is. Intel invests heavily in plants. Yet this remarkable company with sales of $25 billion in 1997 has debt of only $770 million, a mere 2% of capital. [No Comment]As you may know, Intel has earned exceptionally high gross margins like the ones Apple earned in its halcyon days. In Apple's case, the high margins reflected prices that skimmed the cream off the market. This was possible in that Apple chose not to open its architecture. But that's one reason the company ultimately lost thrust to Microsoft and to Intel's chips. Intel's gross margins of 60% or better (the peak was 64%) on big ticket microprocessors were more reflective of experience curve pricing.
Under this approach, prices are cut fast to thwart rival products. Microprocessor prices have come down the way a rocket goes up. Intel's innovative new chip generations fuel its high profits. But lately, as the focus has moved to low end computers and unit price has dropped, Intel's margins have eased. In this sector AMD has much lower prices. Leading Intel analyst Tom Kurlak of Merrill Lynch has been cautious on Intel since August. He told me he sees no present reason for enthusiasm. Microprocessor or chip conditions are deteriorating.[Tom didn't even mention AMD, why?] At this point, chip prices are falling faster than unit sales are growing. The growth rate is actually slowing. He is concerned that growth in the high-end personal computer market will no longer drive Intel's success the way PCs have in the past. Chip prices are now at about $100. To thrive in the PC market, Intel needs prices "north of $250." So Intel is shifting production to mainframes and to computer servers, which store data for internet libraries, etc.
Chips for servers and mainframes cost $500 to $800 but the market is nowhere near as large as the market for high end PCs. Kurlak says Intel's gross margin has slipped to 53% and Intel acknowledges that gross margins for all of 1998 won't exceed 55% versus 60% last year. None of this kept the Morgan Stanley Dean Witter analysts led by Mark Edelstone from giving Intel a rating of "outperform" on March 5, the day after Intel jolted analysts with a first quarter earnings downer. On that day Edelstone cut his 1998 estimate to $3.25 a share from $4. He noted this will be Intel's first decline in annual earnings since 1989. It reflects "a current inventory correction, the mix shift to lower-priced PCs, and weakness in Asian demand." He looks for $4.25 a share in 1999. Like most high tech stocks, Intel is a volatile holding and Edelstone believes Intel will experience a choppy trading range until the actual first quarter result is released on April 14. (Meantime, the Morgan technical analyst, Philip J. R oth, says Intel's support level is 68-70 on his chart with upside resistance at 93-95 and the next upside resistance level at 100-102.) Edelstone still expects 20% five year growth. (That's down from 39% in the past five years.) He has a 12-month target price for Intel of 100. That calls for a marked gain from today's 75. No one can predict markets, but I, for one, find Kurlak's caution to be appropriate.
Lunch Eaters Part III
AMD would appear to be well positioned to kick derriere. Its shares are five points above the low end of the 12-month range at 22 3/8s, and half its full year high. AMD has indeed been gnawing at Intel's low-end market share with its K6 microprocessors. The K6 sells at a 25% discount to equivalently performing Intel devices. K6s obviously meet the standard for Microsoft Windows operation. Therefore, K6s have won good acceptance in computers priced below $2,000 [Really, I think $1000 is better] and especially those priced below $1,000 [Really?, $800!]. But AMD has been reporting losses of late. (AMD, often a catch up player, nearly failed after the loss years, 1985, 1986 and 1987.) And AMD is a minor player to be sure. AMD sales in 1997 were $2.4 billion. AMD's $736 million debt equals 25% of capital and the dollar sum is close to Intel's. [25% compare to Intel's 2%!]
In January, one analyst said recent losses appeared to be under control. (For the full year 1997, AMD lost 15 cents.) He noted that the quarterly losses did not represent an unplanned crisis, but resulted from management's decision to upgrade its production capability in Austin, Texas. [still 12 month late compare to Intel's]
AMD is doubling in size its main fabricating plant in Austin and converting it throughout to advanced 0.25 micron chips. This has cost $1.5 billion to date, according to Scott Allen, of the public relations department. He adds that a new Dresden, Germany plant will cost AMD $1.8 million. Allen added that Dresden production is to begin in the first half of 1999. The company has had problems getting acceptable yields from 0.25 micron integrated circuits. Ten of the 20 largest PC vendors buy K6s.
Lunch Eaters Part IV
Potentially, AMD's most profitable K6 units are rated at speeds above 233 Megahertz. Compaq is putting 233 MHz AMD K6s in some Presario notebook computers. IBM uses 266 Megahertz AMD K6 devices in certain Aptiva PCs. The quality control problems must be a bitter pill for CEO Jerry Sanders, who has always made a fetish of surpassing quality. Speaking to the quality problems, Merrill Lynch's Kurlak argues that the company cannot take advantage of the window of opportunity. Kurlak says IBM is helping AMD produce chips. But Big Blue then shares in the profits. Heavy trading in AMD may reflect buyout rumors. [Big Blue is a high cost producer, isn't it? Big Blue wants its share's profit, right?]
Kurlak does not favor AMD stock. {Now, he mentioned AMD!]. Edmund Swort of The Value Line looks for $1 a share for 1998.[ AMD $1/share in 1998, I am sharked!] AMD stock offers "wide gains potential to longer term, venturesome investors undaunted by volatile price swings." Value Line rates AMD lowest (four) for timeliness and three for safety. |
