Earlier this week, Steam, a computer gaming platform, published its monthly Hardware Survey. Among Steam users, Advanced Micro Devices (NASDAQ:AMD) continued to steal market share from incumbent Intel (NASDAQ:INTC) in Central Processing Unit (CPU) chips. AMD stock rose 3% on the news, adding to its 200% gains over the past 12 months.
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But AMD investors shouldn’t self-congratulate just yet. As Nvidia’s (NASDAQ:NVDA) latest RTX 30 Series chips look ready to take the high-end gaming space by storm, AMD’s Graphics Processing Unit (GPU) segment will struggle to grow. Instead, AMD will have to prove itself in the far larger Data Center segment (which uses CPU chips) dominated by Intel. If it can do that, shares could rise by 85%. And if it fails, AMD stock holders could see losses of 30% or more. Investors shouldn’t get careless.
AMD Stock: 7nm Technology to the Rescue
Earlier this summer, I noted that investors could regret selling AMD shares too early. That’s because, in July, AMD gained access to 7nm chip-making technology, an advanced process that neither Intel nor Nvidia could match.
And the technology has since proved itself. Today, AMD chips are both faster and more energy-efficient than its competitors’ 12nm versions. In Q3, AMD stock rose 56% as the company captured a third of the CPU market for the first time in over a decade.
Nvidia Catching Up with 8nm technology
In the hyper-competitive world of computer processors, however, no battle is ever fully won. In September, Nvidia surprised the world by announcing that its new RTX 3080 GPU would use Samsung’s 8nm production process. The process would make the cards twice as fast as its predecessor, the RTX 2080 and superior to most 7nm AMD GPUs.
Nvidia’s resurgence poses an enormous problem for AMD. Faced with a hyper-competitive GPU rival, AMD would have to take the fight elsewhere.
AMD Taking the Fight to Intel
Intel poses a slower-moving target for AMD. Due to production delays, the legacy chipmaker has struggled to bring 10nm technology to market. Its 7nm answer to AMD and Nvidia’s technologies now won’t be ready until at least 2022. At which point, AMD might already have a 5nm chip.
The delays mark a rare stumble for Intel. The legacy chipmaker has been a consistent performer, sitting in the top-15% of companies that I track on its 10-year Return on Capital (ROC). Investors might trace the company’s troubles to 2018 when Intel fired its long-time CEO Brian Krzanich for a “consensual relationship” with an employee. Or the delays could have been down to bad luck – even though Intel fired its chief engineering officer Murthy Renduchintala over the 7nm fiasco,chip miniaturization has always been fraught with technological difficulties.
Whatever the case may be, Intel’s stumbles give AMD a once-in-a-decade opening into data centers, an industry three times the size of gaming.
Can AMD Succeed in Data Centers?
Demand for data centers has skyrocketed in recent years thanks to the growth in cloud computing. Yet, in 2019, AMD held just 8% of the X86 server market. But that could change because of Intel’s misfortunes. With its 7nm “Zen 2” chips, AMD could finally chip away at the incumbent’s lead. And even when Intel finally releases its 7nm chips in 2022, AMD should have “Genoa,” its 5nm chips, ready.
“The fast-growing, high-margin market for data-center and cloud-platform servers is a lucrative target,” reported S&P Global, a market intelligence company, “and one owned almost entirely by Intel.” If AMD succeeds in gaining market server market share, its profit margins could jump. Intel currently earns a stunning 35.0% EBIT margin compared to AMD’s meager 9.5%. (Investors should note that Intel also runs a fab, so we can’t compare EBITDA margins)
Let’s run through some valuation scenarios.
- Bullish. Suppose AMD finds lasting success in the x86 server market. With 35% EBIT margins, its fair value, according to a 2-stage DCF, jumps to $157/share (an 85% upside)
- Bearish. On the other hand, imagine AMD fails to capitalize on Intel’s stumbles, and EBIT margins languish at 13%. In that case, the company’s fair value drops to $49, a -42% downside.
Is AMD Stock a Safe Bet?
My DCF estimates aren’t just for intellectual curiosity – they represent the massive range of outcomes that AMD could face. Remember, AMD stock languished at $2.00 at the beginning of 2016 before the cryptocurrency mining boom sent GPU prices skyrocketing.
So, what will happen?
That all depends on Intel. If the legacy chipmaker continues to struggle, AMD stock looks set to soar – don’t be surprised if the company captures >50% of market share. But if the older chipmaker can build its 7nm technology faster than expected, AMD shareholders should jump ship quickly. In chipmaking, it’s all about the technology.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.
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