Equity Research

Advanced Micro Devices

CURIC Authors

YIP Daria Yong-Tong AKHMELVAN Gerald MALHOTRA Samya

CHEUNG Austin

The content and opinions in this report are written by university students from the CityU Student Research & Investment Club, and thus are for reference only. Investors are fully responsible for their investment decisions. CityU Student Research & Investment Club is not responsible for any direct or indirect loss resulting from investments referenced to this report. The opinions in this report constitute the opinion of the CityU Student Research & Investment Club and do not constitute the opinion of the City University of Hong Kong nor any governing or student body or department under the University.

Rating: Underweight Price (5/10/20) $86.15 Target Price: $69.70 Market Cap (5/10/20) $101.17B Enterprise Value (5/10/20) $100.08B

Advanced Micro Devices (AMD:NASDAQ)

Our analysis of Advanced Micro Devices Inc. (hereupon referred to as “AMD”) has been driven by two modelling approaches, including a DCF (discounted cash flow) valuation of a 5-year forecast period ranging from the years ending 31st December 2020E to 2024E, and trading comparables. Console Gaming – Main driver for increase in EESC revenue Management puts more emphasis on Enterprise, Embedded, and Semi-custom (EESC) by securing multiple deals related to supercomputers and highly anticipated game consoles such as PS5 and Xbox series X. With the release of the new consoles in 4Q20, AMD could capture high growth brought by its leading position in the EESC segment. Strong pipeline of Next-Gen CPUs and GPUs AMD has a strong product pipeline which features the CPU powered by “Zen 3” processors core and the GPU powered by RDNA 2 architecture in 2020. The 5nm processing technologies are able to support AMD’s series of future products, e.g. “Zen 4” in 2021/2022, to remain competitive in the market. Data center competition heating up Intel’s decision to outsource to TSMC will potentially help them catch up to AMD and NVIDIA by at least 6 months, which means that the technological edge that AMD has over Intel may be shortened. Intense competition from Intel and NVIDIA threatens their competitive position, with the latter stating that they expect data center revenues to exceed gaming revenues in 4Q21. NVIDIA’s data center GPUs will likely be enhanced through their acquisition with Arm, despite facing regulatory challenges that will need to be carefully observed. On 5 October, NVIDIA announced their new BlueField DPU (data processing unit) which we expect to provide pressure to AMD’s data center market share as well. Our price target reflects our base-case scenario of a 28.5% revenue growth and $1.05 EPS in FY20, which is lower than the firm’s 32% revenue growth rate for FY20 and the street’s expected $1.09 in EPS. Despite forecasted year-on-year (yoy) double digit revenue growth in 2020E to 2024E led by EESC, our base case scenario and model indicates that total revenue growth may be slowing in future years due to increased data center competition from Intel and NVIDIA, and possibly PC segment competition from Intel. We would need to see AMD’s earnings power and cash flow generation ability in the next earnings release to justify buying at these prices. If EESC delivers strong sales in 4Q20 and 1Q21 coupled with data center growth in market share of ~10-15% in the next two years, we may revise our outlook and price target. We remain UNDERWEIGHT with a 12-month price target of $69.70 for AMD.

5 October 2020 United States

Equity Research Semiconductors

Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. Target price is for 12 months. Research Analysts: Daria Yong-Tong Yip Daria.yip1@gmail.com Samya Malhotra smalhotra6-c@my.cityu.edu.hk Gerald Akhmelvan gakhmelva2-c@my.cityu.edu.hk Cheung Yue Tseung, Austin ytcheun6-c@my.cityu.edu.hk

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Table of Contents

Company Overview ........................................................................................................................ 5

Revenue Breakdown ...................................................................................................................... 6

Investment Catalysts & Risks ........................................................................................................ 7

Valuation ...................................................................................................................................... 10

Appendix ....................................................................................................................................... 11

Company Overview Advanced Micro Devices (AMD) is a US-based semiconductor company that develops computer processors and related services for commercial and retail consumers. AMD has a comprehensive and expanding product portfolio which is divided into two main segments, namely Computing and Graphics and Enterprise, Embedded, and Semi-Custom segment (EESC). Original equipment manufacturers (OEMs) and original design manufacturers (ODM) including Apple, Google, Lenovo, Microsoft are the primary customers for the microprocessors, while Sony is a major customer accounting for 10% of AMD’s revenue. AMD became a fabless company in 2009 when GlobalFoundries, the original semiconductor foundry, was spun off. Since then, AMD has been outsourcing its production to Taiwan Semiconductor Manufacturing Company (TSMC) and GlobalFoundries. Ryzen and Radeon are the company’s leading computing processing units (CPUs) and graphics processing units (GPUs) respectively for both desktop and notebook computers. AMD’s EPYC series is designed for servers including, but not limited to, cloud, web, e-mail, print, and on-premise servers, to perform functions such as business intelligence and cloud computing. Ryzen and EPYC series contributed $1.5 billion in revenue growth in 2019 due to increased demand. AMD now operates in 35 locations in 24 countries with approximately 11,400 employees. In 2020, AMD predicts strong EESC segment revenue growth in the next few years and has secured multiple national supercomputer center deployments in the United States, France, Germany, and the United

Kingdom. To capture growth in the data center, AMD plans to launch its first computer-specific graphics architecture and to release a software stack for developers. AMD supports the GPUs for the two major next-generation gaming consoles, PlayStation 5 and Xbox series X, as well as “Zen 3” processor core for notebook and PC computing.

Revenue Breakdown Based on the second quarter results of 2020, the overall performance of AMD has been rather commendable. They reported a $1.93 billion revenue which portrayed a 26% increase yoy primarily coming from the Computing and Graphics segment attributed by strong Ryzen processor sales. From a quarter-on-quarter (qoq) perspective, total revenue was up by 8% driven primarily from EESC segment. Net income was $157 million, comparatively much higher than last year’s $35 million.

EESC revenue was $565 million, which was down by 4 percent yoy whilst being a 62% increase qoq. For the third quarter, AMD expects that revenue will increase to $2.55 billion, which would portray an overall

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Figure 3. Total Revenue (Billions USD)

increase of 42% yoy. Ryzen and EPYC processors are predicted to perform exceptionally well and experiencing increasing yoy and sequential sales. Currently, the company expects revenue for FY20 to grow by 32%, which will mainly be driven from PC, data center products, and EESC, mainly console gaming.

Investment Catalysts & Risks

Catalysts Intel’s delay sparks potential market share growth opportunities for AMD. At the end of July 2020, Intel announced that they identified a defect in their manufacturing process, which subsequently caused a delay in their rollout of 7nm chips. Intel now expects to ship their 7nm processors in 2022. We see that by 2022, TSMC has ample time to be able to produce 3nm chips for AMD. Intel also stated that they would rely on their contingency plans of outsourcing their production to ensure that they will meet their targets. This delay serves as a catalyst to the medium-term performance of AMD, as it opens up the opportunity for AMD to take up Intel’s market share and achieve further revenue growth as long as AMD has the

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Figure 4. Revenue by Product Segments (Billions USD)

Computing & Graphic Enterprise, Embedded and Semi-Custom

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USD/ShareFigure 5: Major Price Movements

20 February 2020: Major stock indices closed at

record highs. AMD closed at a record high at that

time, $58.9.

March: Coronavirus market crash

July 23 2020: Intel announces delay in their next-generation

7nm chips' release

All-time high of $92.18, followed by a market sell-off in the tech sector the

next day.

July 28 2020: AMD announces second

quarter results

4 September 2020: DJIA (-2.8%),

S&P500 (-3.5%), Nasdaq (-5%)

3 October2020: President Trump diagnosed with COVID-19

technological and manufacturing edge over intel and maintains a good price-to-performance ratio for their products. Console gaming to significantly contribute to EESC revenue growth: AMD’s involvement in supplying custom chips for arguably two of the most well-known console products for gaming, the Xbox and PlayStation, allows it to stay one step ahead of NVIDIA in the industry as NVIDIA missed out on the deal. In 2Q20, the EESC segment was down 4% qoq due to lower semi-custom product sales. We believe that with the release of Xbox and PS5 during the holiday season, EESC revenues will likely rise. NVIDIA supplies Nintendo Switch’s (Switch) chips, however, we see Xbox and PlayStation to be bigger than Switch in terms of their brand image despite the popularity Switch garnered during the COVID-19 pandemic. The figure below shows Switch’s and PS4’s hardware and software sales. In terms of software sales, PS4 dominates Switch as they have more downloadable content. Moreover, PlayStation has a superior online gaming platform that enables multiplayer games to be played with peers, which may appeal more to avid gamers. We expect PS5’s sales will exceed Switch’s sales in 2021.

Double-digit growth potential in data center segment: In Q2’s earnings call, Lisa Su, AMD’s CEO, announced that AMD has achieved its goal of double-digit market share in the data center market. Their EPYC processors which are meant for cloud computing and data center operators have been facing a surge in demand during the COVID-19 pandemic from remote working. Several OEMs such as Lenovo and Hewlett Packard have started adopting AMD’s EPYC processors, alongside major companies that also have cloud servers such as Amazon’s AWS and Google’s Google Cloud. Intel has a market share of approximately 90-95% for data center processors, which leaves a lot for AMD to capture. We believe that AMD’s Zen 3 “Milan” EPYC processor - which is expected to be 20% faster than Zen 2 “Rome” - has the competitive capacity to rival Intel products and lead data center segment’s growth. However, with the recent acquisition of Arm, NVIDIA is also joining the fight for data center growth alongside Intel and AMD. NVIDIA expects in 4Q21 data center growth will exceed gaming revenue, a bold statement. Risks AMD’s valuations are hard to justify in these levels unless earnings power manifests: AMD is trading at 168.9x TTM P/E and P/Free Cash Flow (FCF) of 147.5x (both as of 5/10/2020) which makes it expensive compared to its peers and difficult to justify their valuations. Despite their improvement in their forward

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P/E (56.8x), this number is still higher than the median of 20.15x. Although FCF has been continuously growing since 2018, it still falls way behind its competitors. Moreover, AMD has a smaller budget for their R&D and capex, which we also see as a hindrance to growth potential when competing with more established players such as NVIDIA and Intel. We see an increase in AMD’s EPS and FCF in FY20 and going forward driven by high double-digit revenue growth, but if it falls under our and the street’s expectations, we will find it harder to defend their valuations.

Reliance on TSMC means any adverse effect that they face will affect AMD: AMD designs their own chips while they rely on Taiwan Semiconductor Manufacturing Company (TSMC) to make and manufacture their chips. Overreliance on TSMC may be detrimental as negative impacts to TSMC will also affect AMD by extension. For example, should there be another wave of coronavirus cases or any factors that will disrupt TSMC’s supply chains, TSMC may need to halt the production of chips. Geopolitical tensions between the US and China may also potentially have adverse effects as trade wars lead to higher tariff costs which in turn may reduce pricing competitiveness. Moreover, revenue growth may be threatened should Intel go forth with their contingency plan by outsourcing their production to a third party, potentially catching up with AMD and retrieving market share. The key question to be asked here is whether AMD can maintain their lead ahead of Intel in terms of technology and manufacturing schedule.

Dampened spending effect from COVID-19: The Xbox Series X and PS5 are expected to release in the holiday season around December 2020. However, consumers may have less to spend on gaming consoles due to the effects of COVID-19 on employment and income to consumers. Xbox released their price of $299 recently, while Sony stated that the price of PS5 is $399 for its digital edition and $499 for their non-digital edition. The US represents 29% of lifetime global PS4 sales as of August 2020. With a hefty price tag attached to both consoles, there is a risk that consumers may skip their holiday purchase this year.

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Other risk factors that could negatively impact the share price include: (1) COVID-19’s adverse effects on global consumer spending is longer than expected (2) increasingly heavy competition in the data center segment, mainly by Intel’s 11th gen products and NVIDIA’s enhanced data center products from their acquisition of Mellanox and Arm that would threaten or hinder AMD’s expected data center market share growth.

Valuation Our implied share price of $69.7, or a 19.1% downside from the current share price of $86.15 (as of 05/10/20), is derived from the weighted average of two valuation models, namely through Discounted Cash Flow (DCF) valuation and public Comparables. We get a fair value share price of $71.9 from our DCF and $49.9 from our Comparables. DCF valuation was given the higher weighting of 90%, while Comparables receives a 10% weighting as we view comparables to be less reflective of AMD’s value from the high P/Es that some growth-based companies have, including AMD. Expected future growth has AMD trade at a 2.9x premium in current P/E to its peers.

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Appendix AMD’s Income Statement

AMD’s Balance Sheet

AMD’s Cash Flow Statement

Comparables