Is AMD Sacrificing Too Much?

Electronic News, July 23, 2001 by Tom Murphy

Price war with Intel yields market-share gain but costs more than $100 million in revenue

Will the attempts to gain market share in microprocessors pay off in the long run for Advanced Micro Devices Inc. (AMD), or will its strategy to reduce margins and cut prices to compete with Intel Corp. result in an operating loss for the third quarter?

A week after AMD (nyse: AMD) announced its second-quarter earnings, Jerry Sanders, chairman and chief executive officer, announced that the company refused to be pushed out of the microprocessor ring by a sumo wrestler, a not-so-veiled reference to Intel (nasdaq: INTC). AMID of Sunnyvale, Calif., spent most of the second quarter fighting a price war with Intel over microprocessors in a market that reacted indifferently to lower unit pricing and new performance offerings.

In a conference call after the earnings announcement, Sanders repeatedly took shots at Intel and its strategy of cutting prices on its flagship Pentium 4 processor. But Sanders also renewed AMD's effort to stay competitive with Intel on price, even though AMD's own flagship Athlon processor is falling behind in the war of clock speeds.

While most of AMD's pain in the second quarter was due to the collapse of flash memory prices, AMD warned that its third-quarter revenues could be flat at best. However, AMD also warned of a loss in the third quarter, still largely due to flash memory. Sanders estimated that AMD lost $115 million in revenues in the second quarter due to its price war with Intel.

The gain for AMD's reduced average selling prices (ASPs) and lower profit margins was approximately half a percentage point in market share against Intel, according to preliminary figures released by Mercury Research of Scottsdale, Ariz. But by increasing market share from 21.5 percent to more than 22 percent, AMD reduced its gross margins from more than 40 percent to 37 percent.

For the third quarter, AMD may report an earnings loss due to further declines in flash memory prices and its continuing policy of lower ASPs for microprocessors. But AMD did move a lot of product toward the end of the quarter in a challenging market and practically reached the limit in its unit capacity with 7.7 million processors.

But if the market recovers, as AMD expects it will sometime in the fourth quarter, will its increased market share equate to a fatter bottom line?

"Intel stands the most to gain when the market recovers," said Kevin Krewell, analyst for Micro Design Resources in San Jose, which is owned by Cahners Business Information, the parent company of Electronic News.

"When the volume picks up, Intel will be able to respond because of its excess capacity. AMD has no excess capacity."

Krewell said that AMD's overall ASP was reportedly around $75, and at the low end, the Duron processors were selling at $50 and below. AMD also reported that its processor shipments were backend loaded, with most of the shipments occurring in the last month of the quarter. While the company said this was largely due to back-to-school demand, Krewell said such moves are usually indicative of a company dumping product.

However, others were more optimistic on AMD's strategy. "We believe that AMD can count on these (market) share gains as 'money in the bank' for the next upturn," said a research note by Eric Ross of Thomas Wiesel Partners. "In our opinion AMD is in the midst of a transformation whereby its superior product, better platform stability and leading-edge process technology are combining to offer Intel its first true competition."

While AMD has committed to an ongoing price war with Intel, Nathan Brookwood, principal analyst with Insight 64 of Saratoga, Calif., said there may be a lack of resolve on the part of Intel. The Santa Clara, Calif.-based company dropped the price on its 1.7GHZ P4 by $200 last quarter in an attempt to increase unit shipments. From Brookwood's standpoint, the move has not reaped the kind of rewards Intel had expected, thus it may back off from further competitive price cuts. Perhaps even more importantly, Intel's price cuts haven't stopped AMD's inroads on market share, Brookwood noted.

So when Intel releases its 2GHz P4 this quarter and it stays in the $600 price range, AMD would most likely maintain higher prices on its desktop processors, Brookwood asserted. This scenario could result in higher revenues for AMD, which, in turn, could prevent the company from taking a loss in the third quarter. In addition, there is the possibility of AMD's notebook, workstation and server processors, which represent new markets for the company, to contribute directly to the bottom line.