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Advanced Micro Devices Remains Behind the Eight Ball


Expect good earnings, but the size of its semiconductors is holding it back.

Advanced Micro Devices (AMD) will be reporting its fiscal fourth quarter tomorrow after the close and, after Intel's (INTC) numbers, it really shouldn't surprise anyone when it reports a big quarter.

However, the stock has been on fire over the last six weeks and it has nothing to do with earnings. Since the announcement of its settlement with Intel, the stock has appreciated more than 70%. The AMD bulls are convinced of the company's viability as well as its investment potential.

I, for one, have never expected Advanced Micro Devices to go belly up; it makes no sense to allow that from a hardware OEM perspective. The Acers, Dells (DELL), and Hewlett-Packards (HPQ) of this world need a foil to keep Intel on the straight and narrow.

That being said, Advanced Micro Devices will continue to exist in Intel's shadow and at the mercy of Intel's pricing until it magically closes a one-year gap in its manufacturing process technology. All of the financial gymnastics last fall related to the creation of GlobalFoundries in conjunction with Advanced Technology Investment Company of Abu Dhabi doesn't change bupkes.

On its last conference call, Advanced Micro Devices indicated that it hadn't yet completed the transition to 45nm wafers (i.e. some production was still taking place at the 65nm node). While the company is pushing to complete that transition, Intel is already ramping production at the 32nm node.

In the world of semiconductors, size equals cost. In order to demonstrate that cost advantage, I created a hypothetical example in the table below. The numbers are fictitious but close enough for government work. More importantly it's their relationship from one process to the next that is critical.

Let's start with your basic 300mm wafer fab that includes about $2.4 billion in equipment (we'll skip the brick-and-mortar expenses for the sake of simplicity) that can handle about 30,000 wafers per quarter. Most wafer fab equipment is depreciated over about four years so we come in with depreciation expenses each quarter of about $150 million or roughly $5,000 per wafer. Now, throw in another $2,000 per wafer for the variable expenses such as labor, materials, and utilities. If our fictitious microprocessor (die) has an approximate area of 200 square millimeters we should be able to get about 307 of these parts on a wafer.

Now nothing is perfect in this world, least of all manufacturing semiconductors, so every possible die isn't going to function as expected. However, because this is a fairly mature process (i.e. we've been doing it for a while) our experience tells us if we adhere to the recipe religiously nine out of 10 die on that wafer should work just fine.

From there the math is quite simple. The expected "good die per wafer" must bear the costs of processing the entire wafer. Each one of those die are going to be sold for $50 to Dell or Hewlett-Packard or whomever. At that price, we have a nice 49% gross margin. Not bad, huh?

Now, let's say my arch enemy is making the same kind of microprocessor and I know that sometime over the next year they will move to the same 45nm process node (i.e. lower cost structure) as I am now. Rather than wait for that to happen, I elect to push my manufacturing capability down to the next level, in this case 32nm, that is, I'm going to be drawing the circuits and the transistors with a much finer "pen".
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