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Advanced Micro Devices (AMD: Nasdaq)

By JPMorgan ($2.07, Nov. 12, 2015)

We are cautiously optimistic on Advanced Micro Devices’s ramp of new product programs in 2016, but much of the success will depend on the company’s execution, both time-to-market and product performance/power efficiency.

We held investor meetings with Dr. Lisa Su, AMD’s (ticker: AMD ) president and chief executive. After two years of re-focusing development efforts around PC computing, discrete graphics, server, and semi-custom, the company just delivered solid quarter-on-quarter growth in the third quarter, driven by growth in all of its major segments. The team believes that it’s hit a trough in market share losses in computing and graphics. Additionally, with what appears to be a solid roadmap of new products tiered up for 2016-2017 (continued ramp of Carrizo, Zen-based desktop and server platforms, a new graphics processing unit (GPU) product family and ramp of its third semi-customer partner), that market share gains/growth are achievable going forward.

The company’s recent restructuring and refocus efforts are driving a sharp reduction in operating expenses, and we believe the team should be able to sustain operating expenses at the fourth-quarter ($320 million per quarter) run-rate, versus the $350 million run-rate in the second quarter (and $400 million run-rate in 2014) and this should help accelerate the company’s move back to operating profitability. With the cash balance expected to be about $750 million in the fourth quarter, combined with $320 million of cash proceeds from the recent back-end/test joint-venture formation, the team remains comfortable with its current liquidity position.

Fundamental environment in 2016 should play into AMD’s favor. The team’s view on the overall PC market next year is for slight unit shipment declines (versus this year’s about 10% shipment decline). Lower levels of channel inventory burn and [Microsoft ( MSFT )] Windows 10 momentum in the Enterprise PC client segment are believed to be the drivers for the better client PC outlook. In the graphics segment (both discrete GPU and consoles), gaming will continue to be a solid driver and datacenter server pull from hyperscale data center customers will remain strong.

New product roadmaps for 2016-2017 in PC, gaming and server are tracking so far. The team will need to focus on execution. The team’s Carizzo mobile platform continues to ramp into more consumer/commercial platforms and next-gen Zen core architecture is tracking to ramp towards the back-half of next year (high-end desktop) on finFET manufacturing technology (the team has taped out multiple products at 14 nanometer (nm) at Global Foundries and 16nm at Taiwan Semiconductor Manufacturing ( TSM )). The team is focusing on regaining share in the server central processing unit (CPU) market (where they have <1% market share) with its Zen-based next-generation Opteron server CPU product line targeted for full production ramp in 2017. In the discrete GPU segment, the team is building on the early success with its M300 (Fury) GPU platform this year and is focused on launching its next-generation GPU architecture (finFET manufacturing) in 2016. Overall, the company’s served available market (SAM) opportunity in client computing, discrete GPU, and servers is around a $40 billion-$45 billion opportunity in 2016.

AMD is within striking distance of operating profitability over the next 12-24 months. The company needs to drive a combination of 3%-5% points of share gain and continue to remain disciplined on operating expenses. Given the team’s restructuring initiatives and disciplined operating-expenses strategy, we believe 3%-5% points of share gain in the PC client CPU, and discrete GPU markets can drive an incremental $300 million-$400 million of computing/graphics segment revenue per quarter and this should drive a return to profitability in the segment.

Although the enterprise/embedded/semi-custom segment is already profitable, every 1% point of share gain in the server CPU market is $120 million of annualized revenue (and a richer gross-margin mix) -- this represents a potentially large opportunity ($12 billion SAM) as the team ramps its Zen-based Opteron platform in 2017. Additional drivers include the initial ramp of its previously announced semi-custom wins, which should start to add incremental revenue in second-half 2016.

Other potential growth catalysts look promising: embedded markets and monetization of intellectual property (IP). We believe the embedded-processor market is a multi-billion dollar market dominated by Intel ( INTC ), Freescale Semiconductor ( FSL ), Texas Instruments ( TXN ) and Cavium ( CAVM ). On the IP front, the team has amassed a significant patent portfolio (about 10,000 patents) focused on core CPU/GPU technology, and we believe the team has put in place a team of technical/legal/business individuals to try and leverage/monetize this IP.

-- Harlan Sur

-- Bill Peterson

-- Andrew K Lee

-- Grace Chuang

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