By Scott Hillis - Analysis
SAN FRANCISCO (Reuters) - A gloomy outlook for Advanced Micro Devices Inc. AMD.N may jeopardize its aggressive expansion plans or send the No. 2 maker of computer microprocessors scrambling to raise cash at an awkward time.
After AMD reported a $574 million quarterly net loss and gave a disappointing revenue forecast this week, analysts questioned its goal of quadrupling microchip production capacity in 2008 from 2005 levels.
“I don’t believe they are not going to have to raise cash, and at the worst possible time, too,” said American Technology Research analyst Doug Freedman. “You don’t want to raise cash when you’re losing money.”
AMD’s plans call for $2.5 billion in capital spending this year, much of it for upgrading facilities in Dresden, Germany, to meet rising demand, in a move some experts say is crucial to the company’s success.
“Showing customers they can meet demand is critical to getting more of these design wins,” said JoAnne Feeney, managing director of FTN Midwest Securities. “They have to have power behind the punch; they have to have the capacity.”
But a price war with larger rival Intel Corp. (INTC.O) and the cost of integrating a $5.4 billion acquisition of graphics chip maker ATI could complicate matters.
Stepped-up competition from Intel, which launched a line of new processors last year and slashed prices on its older ones, has taken a big chunk out of AMD’s gross profit margin, which dropped to 40 percent in the fourth quarter from 52 percent a year earlier.
Analysts don’t see much room for improvement this year, especially since ATI’s graphics chip and chipset operations come with lower margins than AMD’s processor business.
“We feel this margin degradation means that AMD no longer has the cash flow to support its aggressive capex plans, creating a serious issue for 2007,” Friedman, Billings, Ramsey & Co. analyst Chris Caso wrote in a note.
Analysts on average expect AMD to lose another $85 million in its first quarter, excluding the effects of the ATI merger, according Reuters Estimates. Some expect the company to lose money all year.
“They are cash-flow negative so that certainly makes (AMD’s investment plans) very difficult,” Citigroup analyst Glen Yeung said. “They’re on a pretty tight rope here. They can get pushed off the rope if pricing gets hit a little bit more.”
Daniel Berenbaum, an analyst with Susquehanna Financial Group, said AMD could burn through its $1.5 billion cash pile as early as the third quarter, forcing it to hunt for additional funds.
“While we will not speculate what type of financing vehicle AMD might choose, there will almost certainly be some dilution associated with any type of equity or debt deal,” he wrote.
In a conference call after AMD’s earnings, analysts raised the expansion road map with executives, who maintained that plans were still on track and that grants and tax holidays promised by German authorities would help it defray the costs.
AMD would have several options if it found itself unable to pay for its expansion.
It could delay things until business improves, or it could tap Chartered Semiconductor CHRT.OCSMF.SI, a Singapore contract chipmaker, to make more processors on its behalf.
Other alternatives include taking on new debt, although the company raised eyebrows when it said it would fund the ATI deal partly with $2.5 billion in debt.
AMD could also sell its stake in Spansion Inc. SPSN.O, the memory chip unit that it spun off in 2005, or even spin off part of ATI, such as its graphics chips operations.
New products may offer AMD another lifeline.
AMD said a new chip with four processing cores on a single piece of silicon that will debut in the middle of 2007 would outperform a similar product from Intel by 40 percent.
“We think that is going to re-establish a significant lead that is not going to be overcome in the near future,” Randy Allen, vice president for AMD’s server division, told Reuters. “It’s just going to reinvigorate our presence in the market.”
Allen was circumspect when asked how the new chip would affect pricing, but suggested it could give AMD a shot in the arm because the company could price the product consistent with its new value.
First American Funds analyst Jane Snorek said AMD’s strategy was to get big, fast.
“AMD’s strategy right now is going for broke,” said Snorek, whose firm manages $55 billion and owns no AMD shares. “They don’t care how much money they lose.”
But Freedman of American Research Technology suggested there was no rush.
“Toyota didn’t take over market share from GM over a three year period,” he said. “They did it over 10 years, very slowly.”