For AMD, Game Consoles Are Just the Beginning

For AMD, Game Consoles Are Just the Beginning

It is well known that AMD's long-term plan is to diversify away from the traditional PC market, as it is both dominated by a single, more powerful competitor and in secular decline. AMD has a number of valuable assets, including compelling graphics technology, reasonably good x86 CPU cores, and an increasingly system-on-chip-centric design methodology. While PCs remain a large part of the company's business, the company's diversification efforts should eventually prove to be a more stable source of profitable growth.

Semi-custom is the name of the game
Despite the company's financial woes and competitive issues against Intel in the traditional PC space, it's hard to deny that AMD has plenty of interesting IP. ARM Holdings has largely commoditized computing IP for many segments. AMD's real strengths are that it has its own IP, has no aversion to licensing external IP, and has a willingness to put together semi-custom designs for clients that would really prefer not to build their own system-on-chip designs unless they had to.

Probably the most widely known examples of semi-custom deals are the processors found inside the Xbox One and the PlayStation 4, respectively. These are system-on-chip designs created for each of the major game-console players from off-the-shelf AMD IP. That is, the GPU cores and the CPU cores were already built and paid for via AMD's APUs and discrete graphics processors. That's not to trivialize the integration work, as well as the custom IP blocks supplied by Microsoft and Sony, respectively. But this does illustrate the power of the semi-custom model.

Consoles aren't enough -- investors need more
It's unlikely that the PC market will completely vanish. But the recent announcements from Intel that it would more aggressively pursue the low end of the market -- AMD's domain -- with cost-optimized parts shouldn't leave AMD investors particularly optimistic about the company's chances there. On top of that, while the market likely won't vanish, there is still no bottom in sight as far as the emerging markets go -- although developed markets have stabilized, according to Intel at its recent analyst day. The PC business is not going to be easy for either chip vendor.

That's why more semi-custom deals are needed. The game consoles represent a lifetime opportunity of, perhaps, 160 million -- the combined lifetime sales of the Xbox 360 and the PlayStation 3. The gross margins aren't particularly good here, but according to AMD, operating margin is in the mid-teens. This suggests that with enough deals, the bulk of AMD's business could eventually be moved to these types of "sticky" semi-custom deals.

As more deals are announced, the scope of AMD's semi-custom business should be more fully visible to analysts and investors alike. If the deals roll in faster than the PC business continues to decline, then there may yet be room for some very real optimism for the company's long-term outlook. If not, then the trends in the PC space will dominate both sentiment and the underlying financials of AMD's business.

Foolish bottom line
AMD is a company that continues to execute on its turnaround. The cards that the company has been dealt aren't exactly stellar, but there's enough here that -- properly managed -- the company can sustain a cash-flow-positive state. However, the initial spike in revenue due to game console sales is eventually going to taper off. That means that investors probably shouldn't rely on game consoles as the sole source of success for the company.

As the title suggests, game consoles represent the beginning of what could be a real opportunity and the future of AMD. But these deals alone -- despite their scale -- won't be enough to sustain meaningful and profitable growth for the company. Keep a very close eye on the news for anything and everything related to the company's semi-custom business if you are looking to invest, or currently invest, in AMD.

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Ashraf Eassa owns shares of Intel and Advanced Micro Devices. The Motley Fool recommends Intel. 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.

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Originally published