AMD’s Surge On Game Console Wins Looks Overdone

In an effort to restructure its business and reduce its dependence on the traditional PC market, AMD (NYSE:AMD) is focusing on increasing its share in additional embedded markets. It recently launched a semi-custom chip business unit where the chip combines AMD’s central processing and graphic capabilities and can be integrated with the customers’ intellectual property. The new unit focuses on high-volume, high-value applications that span a wide range of markets, including gaming. AMD aims to increase the revenue contribution from its embedded business to almost 20% by 2014, from the current level of a mere 5%.

AMD won its first customer design with Sony confirming that it is using AMD’s CPU for the PlayStation 4 (PS4), expected to launch this fall. Earlier this week Microsoft confirmed that it will use an AMD processor, which combines the Jaguar CPU with a graphic chip, to power its next generation Xbox game console. AMD’s game consoles win has been one of the primary factors behind the more than 50% increase in its stock price in the last two months.

With an aim to leverage growth in the local video game market, it looks like AMD is committed to building its relationship with the makers of video game consoles. We believe that providing chips for game consoles is a welcome move for AMD, as it can help the company reduce its dependence on the PC market, which is expected to decline for the second consecutive year in 2013. However, we do not think that it justifies the sudden surge in its stock price.

With a 17% decline in its 2012 revenues AMD suffered a net loss of $1.18 billion in 2012. While the increasing exposure to the gaming console market might increase AMD’s processor shipments, it will not have much of an impact on its bottom line due to the low margins offered in the industry.

See our complete analysis for AMD

Growth Potential In The Gaming Market

Despite stiff competition from other forms of gaming, game consoles account for 42% of the $65 billion global video game market. ^[1] Though the winding down of the current console generation has lowered sales, the broadening of consoles beyond core video games has increased household penetration in the U.S. to 57%, compared to 40% in the previous generation.

Jon Peddie Reasearch valued the PC gaming hardware market at $23.6 billion in 2012, and forecasts the market to cross $30 billion by 2015. ^[2] Being present in both Sony’s PS4 and Microsoft’s next generation Xbox, two leading players in the gaming market), AMD can significantly increase its processor shipments in the future.

Drawback: Declining Margins From Game Consoles

While the game console segment offered good margins for hardware manufacturers such as Nvidia (NASDAQ:NVDA) and AMD a decade back, it has become a very low margin business now. This was perhaps one of the prime reasons for Nvidia backing out of negotiation for Sony’s Play Station 4.

Nvidia’s win of Microsoft’s Xbox in 2002 earned the company good profits in 2002-2003. As per its annual filing for fiscal 2003, Nvidia made 23% profit on $1.9 billion revenues earned from Xbox sales in the year. In total approximately 24 million Xbox consoles were sold globally. In comparison, Nvidia earned $500 million in total royalties from the sale of Sony’s Play Station 3. As of March 2011, 50 million PS3’s were sold worldwide. This clearly implies that Nvidia saw drastic decline in its margins from the game console business over the years. ^[3]

Conclusion

We think that increasing its exposure to alternate growth markets is a good move for AMD as it will help cushion the negative impact of declining PC shipments to some extent. However, since the gaming market does not offer lucrative margins for hardware manufacturers, it might not be a big enough step to turn around the company’s business and help it return to profitability.

Our price estimate of $2.91 for AMD is discount of over 20% to the current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Microsoft: Global video-game market hits $65 billion, and consoles still lead the way, Geek Wire, May 17, 2013 [↩]
2. PC Gaming Hardware Market to Hit $23.6 Billion in 2012, Jon Peddie Research, May 3, 2012 [↩]
3. Nvidia gave AMD the PS4 because console margins are terrible, Extreme Tech, March 18, 2013 [↩]