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This Underdog is Just Another Dog

Leo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Advanced Micro Devices (NYSE: AMD) is fading fast. The Santa Clara, California-based company, which once nearly tied Intel’s (NASDAQ: INTC) market share for dominance of the CPU market, has lost nearly 60% of its market value over the past five years.

To diversify away from the CPU market, AMD branched out into the GPU (graphics processing unit) business - a market dominated by industry leader Nvidia (NASDAQ: NVDA). Unfortunately, Nvidia has proven to be a formidable opponent, and now AMD is fighting a losing war on two fronts - in microprocessors against Intel and in graphics processing units against Nvidia.

Meanwhile, AMD’s coffers are running dry, as negative profit margins and plunging top and bottom line growth have crippled the company over the past five years. However, the pain has just begun for AMD shareholders, and I believe that the company will need a miracle to survive 2013 without going bankrupt. Let’s analyze the major problems facing this beleaguered former tech giant today.

Losing the war on two fronts

AMD first entered the graphics processing unit business in 2006 with its acquisition of ATI Technologies, which it acquired to manufacture graphics cards as well as CPUs with integrated graphics. The $5.6 billion acquisition, split into a $2 billion loan and 56 million shares of AMD stock, was the largest in AMD’s history, but the company considered it a crucial strategy to control a niche market in the face of Intel’s dominance of the x86 processor market.

In the standalone graphics cards market, AMD released the Radeon series to compete with Nvidia’s flagship GeForce cards. To compete with Intel, which was offering CPUs with integrated graphics processors built with licensed Nvidia technology, AMD released its Fusion series.

Unfortunately, AMD has been fighting a losing battle on both fronts. In the first quarter of 2013, AMD’s graphics card market share declined from 36.3% to 35.7% year-over-year, while Nvidia’s share rose from 63.4% to 65.7%.

Meanwhile, AMD’s share of the CPU market plunged to 16.70%, down from 27.70% a year earlier. Meanwhile, Intel’s CPU market share rose from 72.30% to 83.30% over the same period.

Nvidia turns lemons into lemonade

Even worse, AMD lost its once dominant position in notebook computers, which require more compact, energy-efficient graphics solutions. Between the third quarters of 2011 and 2012, AMD’s share of the notebook graphics business plunged from 52% to 34%, while Nvidia’s share rose from 49% to 66%.

To achieve this growth, Nvidia turned lemons into lemonade. Initial reviews of its Fermi cards, which started with the GeForce 400 series in 2010, were slightly negative due to its lower performance-per-watt compared to AMD’s Radeon cards. However, Nvidia retooled the technology to emphasize higher power efficiency on mobile platforms, which generally value battery life over peak performance, and its strategy paid off.

As a result, Nvidia’s top and bottom lines, as well as margins, have grown at a healthy rate over the past three years.

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Nvidia’s strength in both PCs and notebooks has also given it roughly double the revenue of AMD's graphics processing unit segment.

Costly battles

In a nutshell, AMD is fighting an increasingly expensive losing battle against two industry behemoths, while continuing to cede market share in both graphics cards and CPUs. At this rate, AMD’s weak financials might just endanger its future. Just how scary are the numbers?

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With only $1 billion in cash, AMD is shouldering $2.04 billion in debt with a negative cash flow of $471 million, down 180.7% over the past three years. Meanwhile, expenses have risen 31.97% to a whopping $6.60 billion.

AMD has to post some strong top and bottom line growth to get out of this rut. However, those trends have been overwhelmingly negative over the past three years.

<img alt="" src="http://media.ycharts.com/charts/46ebd96a9b05fe20049823f6ee06b045.png" />

AMD’s top line declined 16.51% over the past three years, while its bottom line has dropped 350%. Operating and profit margins, which are both negative, have plunged 249.1% and 280.1%, respectively, with no signs of improvement.

Not afraid to gamble to gain market share

Unfortunately, AMD’s current strategy is a costly one. To keep up with Nvidia, AMD recently unveiled its “Never Settle” campaign, which bundles ‘triple A’ (high budget) games with their graphics cards.

These bundles include new games such as Electronic ArtsCrysis 3, 2K GamesBioshock Infinite and Square Enix’s Tomb Raider. By bundling these games with cards that sell for less than $200, AMD is willing to absorb these costs - which will heavily weigh on expenses and margins - in order to reclaim lost market share from Nvidia. This is a dangerous strategy, considering AMD’s precarious financial situation, and is an ‘all-in’ strategy to contain Nvidia’s market share.

On the other hand, Nvidia has been offering game credit for popular free-to-play games with its graphic cards, which can be redeemed for in-game items and upgrades. This strategy carries much less risk than AMD’s bold tactic. Analysts believe that Nvidia’s free game credit will help boost its sales in Asia, where free-to-play games such as League of Legends are more popular than ‘triple A’ games, which are generally more popular in North America.

At this point in the game, Nvidia doesn’t need to be aggressive, and with $3.73 billion in the bank, the company can simply wait for AMD to exhaust itself and spend the remainder of its $1.00 billion on its futile effort to halt Nvidia’s gains. Analysts believe that AMD needs at least $750 million in cash to stay operational, so AMD could seriously be digging its own grave with its costly strategy.

Public perception

What concerns me the most about AMD is that its losing battle against Nvidia closely resembles its prior defeat at the hands of Intel. In 2006, AMD held 48.40% of the CPU market, nearly matching Intel’s 51.60%. Since then, those paths have diverged dramatically. I fear that Nvidia has already stricken an Intel-like blow against AMD, and that all AMD can do now is wait for its cash to bleed dry, which will force it into bankruptcy.

The public perception of Radeon cards as ‘second fiddle’ cards to Nvidia’s de facto standard ones is also damaging. Nvidia’s cards have added features, such as 3D vision and PhysX, which make Radeon cards look second rate by comparison. Recent reviews of Nvidia’s GeForce 650 Ti Boost card against the comparably priced Radeon 7790 card have also been heavily in Nvidia’s favor.

The Bottom Line

In my humble opinion, AMD has bitten off far more than it can chew and is spending too heavily to reclaim its lost market shares from Intel and AMD. Negative profit margins, rising expenses and a cash balance that dangerously teeters on the edge of a company shutdown are all reasons to stay far, far away from AMD. In other words, although investors often love underdogs like AMD, this underdog is just another stray dog. Try not to get bitten.


Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Intel and NVIDIA. The Motley Fool owns shares of Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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