50% Upside on This Semiconductor Giant

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

The PC semiconductor industry has suffered due to declining PC shipments. Industry giants such as Intel (NASDAQ: INTC) and Advanced Micro Devices (NYSE: AMD) have struggled to cope with the rising trend of handhelds. This decline has forced the leading PC industry players to diversify or develop more energy efficient chips, to target handheld devices.

Late last year, AMD was trading at under $2 due to continuous losses and the bleak outlook of the PC industry. The shares have rallied since then due to AMD’s penetration of the gaming console industry. In the last six months, AMD’s value has appreciated more than 60%, but I believe it will continue to climb due to the factors discussed below.

Gaming Consoles

AMD has always been a force in the gaming segment due to its superior graphics. The company has now embarked on venture that will lead to total domination of the gaming console industry. According to recent reports, AMD will be present in new models of both Microsoft’s (NASDAQ: MSFT) Xbox and Sony's PlayStation. In the recent past, IBM and NVIDIA have been leading chip suppliers for the gaming console industry. All leading consoles used to contain IBM CPUs, and NVIDIA manufactured GPUs were present in the bestselling PS3.

Now, AMD will provide custom APUs to both PS4 and Xbox one. The company will also provide the GPUs for Wii U. With these contracts, AMD has emerged as the leading semiconductor for the gaming console industry. The market expects Sony alone to sell around 16 million units, and Xbox One sales could also be pretty high.

Microsoft has made a lot of changes in its new Xbox offerings that might dissuade customers from purchasing the device. Users will no longer be able to exchange games or continuously use the device online. This will give PS4 an edge over Xbox in the initial device sales. However, in the long run developers will be more attracted to the Xbox platform. This is because the new changes in Xbox will destroy the secondhand gaming market, in turn benefiting the developers more.

Handheld

AMD has made some massive changes to its hardware, in order to make it more competitive with other leading handheld players. The company launched the Temash and Kabini APUs in January. The Temash APU is designed for ultra-low power and small form factor markets. The Kabini targets low-power, netbook, ultra-thin and small form factor markets. These APUs are based on the Jaguar architecture and are superior to current offerings by Intel, i.e. Clover Trail. Research shows that AMD’s Temash is superior to Clover trail in almost every test. Intel will not launch its updated Bay Trail chips until the end of the year. This has been a blessing in disguise for AMD because its chips have an opportunity to cement a place in this highly competitive tablet space.

With a superior APU in the bag, the real challenge for AMD is to find OEM partners willing to use their hardware. These new APUs are already featured in a number of exciting products. The semiconductor giant is advertising AMD APU-loaded tablets from Quanta, MSI and Gigabyte. Acer and HP are also launching new products loaded with the new Jaguar APUs. If the company manages to get more OEMs onboard, it can lead to a significant revenue recovery for AMD and significantly improve its valuations.

Valuations

AMD’s valuation has suffered due to declining sales and the increasingly bleak outlook of the PC industry, its primary breadwinner. The company’s recent incursion into gaming consoles has improved the valuation somewhat. The capitalization has almost doubled compared to valuations late last year. The shares should appreciate further due to improving handheld APU sales and revenues from gaming consoles.

The recent rally has been based on optimism around AMD’s gaming incursions, which are already priced in with AMD trading around $4. However, the market is still not realizing the enormous potential of the Jaguar architecture. The company has an opportunity to cement itself as a major player in the handheld arena before Intel launches Bay Trail at the end of the year.

Taking these factors into account, the high end of 2014’s EPS estimates of $0.4 to $0.44 seems quite achievable. Using a P/E of 15x we can calculate a target price in the range of $6 to $6.6 for the end of next year.

Bottom Line

AMD has suffered in the last few years due to the dominance of Intel and failing fortunes of the PC. The Jaguar APUs and gaming consoles have finally given AMD a chance to turn around its fortunes. The Temash APU can seriously challenge Intel’s ambitions to dominate the handheld industry.

Sony and Microsoft are launching their new gaming consoles this year. Both devices have AMD hardware and a large fan following. Microsoft might face some revenue shortfalls with Xbox because the company has imposed a lot of restrictions that are not consumer-friendly, making Sony PS4 the console of choice. AMD will benefit in either case and offers a significant upside to current valuations. 

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Mohsin Saeed has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Microsoft. 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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