Justin Sullivan
Shares of AMD (NASDAQ:AMD) have fallen victim to a fierce reversal as of late as well, warranting an update as my last take on AMD dates back to the autumn of 2020, after the company announced the acquisition of Xilinx in a massive $35 billion deal, a transaction which only closed at the start of this year.
Some Perspective
AMD announced a huge deal for Xilinx late in 2020 in an effort to create a leading high-performance computing power giant to gain more competitive advantages versus the likes of Intel (INTC), on which it has a lead already. The deal was also driven to become a stronger competitor versus Nvidia (NVDA) which announced the acquisition of Arm at the time, a deal which later fell apart.
With the deal, AMD would boost its positioning in key growth markets, including data center, gaming, PC, communication, industrial, aerospace and automotive. Besides the strategic rationale, there was an estimate for $300 million in synergies down the road, of course, only to be realised after a period of integration of both businesses.
With AMD posting $8.6 billion in sales at the time, the pro forma business would grow revenues to $11.6 billion. Operating income would jump from $1.4 billion to $2.4 billion, as the all-share deal would leave the business with a net cash position of $2.5 billion. Note that the pro forma implications were based on the results in the previous fiscal year, as both businesses have seen strong operating momentum so far in 2020.
The 1.66 billion diluted share count valued the company at $135 billion at $81 per share at the time. Pegging the pro forma net earnings power at around $1.50 per share at the time, valuations were very demanding at 50 times earnings as the business was valued at around 9 times sales. These were huge multiples, but AMD was posting 50% sales growth at a time when Intel was struggling, being a testament to the competitive position of the business.
While AMD’s margins were lagging those of Intel, this was a positive in my opinion as margins could increase from there, yet that would still have to be delivered upon. Once achieved, this could dramatically reduce the forward earnings multiple, of course.
While the valuations were high, investing in quality and winner names matters in such industries, and AMD is certainly a great name after a troubled past. That being said, I felt that the best days were seen already, leaving me to hold a neutral stance.
It was around this time that it was very evident that AMD was chipping market share away from the once all-might Intel, and while this was largely due to some old-fashioned industries like PCs, it was not deterring investors at the time.
Boom-Bust
Shares of AMD have risen in 2021, just like the rest of the market, as shares hit a high of $165 by year-end, having doubled from the November 2020 levels. Ever since, shares have fallen as well amidst demand concerns, exposure to cryptocurrencies (which have corrected), as well as political and macroeconomic concerns. By now, shares are down a hundred dollars, now trading at just $68, marking actual declines versus two years ago.
These declines in the share price were actually seen while the company has seen solid momentum in its operations. In February of this year, AMD posted a 68% increase in full year sales to $16.4 billion (even ahead of the Xilinx deal). Net earnings more than doubled to $3.2 billion, equivalent to $2.57 per share, based on GAAP accounting. The fourth quarter run rate was far more impressive, with revenues posted at $4.8 billion, and earnings power being far stronger as well.
The company guided for 2022 sales at around $21.5 billion, with the Xilinx deal anticipated to close in the first quarter. That deal did close mid-February after regulatory approvals have rolled in across the world. Later that month, the company announced an $8 billion buyback program, partially to take advantage of the decline in the share price and the dilution incurred with the Xilinx deal.
In April, AMD announced a $1.9 billion deal for Pensando, a distribution service platform which includes high-performance, programmable processors and software stack to accelerate networking, security and storage. No financial details on the deal have been announced, as this is truly a bolt-on transaction.
In May, AMD posted very strong first quarter results with revenues posted at $5.9 billion, which includes about half a quarter of Xilinx’s contribution. GAAP earnings were impacted by the Xilinx transaction, with adjusted earnings posted at $1.13 per share, as the earnings number excluding stock-based compensation comes in around a dollar per share, for a run rate of around $4 per share. This comes as net cash balances rose to $5 billion, with shares still trading around the $100 mark at the time.
With the Xilinx deal having closed, AMD guided for second quarter revenues around $6.5 billion and full year sales around $26.3 billion. Second quarter sales were posted in August, and while revenues met expectations at $6.55 billion, adjusted earnings fell to $1.05 per share with margins coming in a bit soft, as earnings fall to about $0.90 per share if we back-out stock-based compensation expenses. The company maintained the full year guidance, calling for third quarter sales of $6.7 billion.
With 1.63 billion shares now trading at $68, AMD’s valuation has fallen to $110 billion, or $107 billion if we factor in net cash. This values operations at just 4 times sales here, as shares trade at 18 times earnings power based on the unleveraged operating asset valuation and $3.60 per share in earnings power.
And Now?
Having just reviewed Nvidia, it is noteworthy that AMD has seen much better revenue and earnings numbers as of recent, as it keeps sequential sales and earnings pretty flat while some other competitors see huge declines, driven by a mix of softer demand, pricing and supply chain issues. The outperformance versus Intel and notably Nvidia is really evident, although AMD is even lagging a bit compared to Broadcom (AVGO), among others, after long having been the strongest relative performer here. With the company historically relying largely on client (PC) and gaming revenues, it is really good and nice to see rapid growth in the data center business and embedded revenues (through the purchase of Xilinx).
Of course, there are many risks to the near-term guidance on the back of pricing pressure, macroeconomic conditions, and the fact that AMD is barred to export GPUs to Chinese datacenters. AMD has reported this impact to be $400 million in the third quarter, about 6-7% of total revenues which is a real substantial number, yet much of the woes are priced in now, at least it seems. Of course, the question is what the run rate going forward will be, for how long the ban will apply, and if there are workarounds. The real long-term threat is that of emergent competitors, among others from China, with focus on semiconductor developments being very fierce.
With earnings power still solid and the business having become a lot more diversified, the company enters this period of turmoil from a position of strength which includes a strong net cash position as valuations have been re-rated a great deal already at just 4 times sales here and a market multiple in terms of earnings. AMD is still well-positioned in the long run, yet the near-term concerns will cause a shadow on the shares for a while, yet on a historical basis, current levels do start to look quite enticing.
After a very strong 2021, fueled by optimism, the pessimistic nature of the market makes me upbeat as a contrarian here.
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