AMD Stock (NASDAQ:AMD): Key Risks Are Ignored

Advanced Micro Devices (Nasdaq: AMD) is a fabless chip designer who designs semiconductors. AMD stock rose on speculation about artificial intelligence and the potential for improved earnings. At the same time, some of the company's segments appear to be under-earning (such as the customer segment, with -$46 million in operating income), while others may be over-earning. Overall, I'm pessimistic on AMD because I think its $335 billion valuation is exorbitant, especially when one takes into account the risks. There are worrying signs both externally and within AMD.

A monster of good intentions after a huge acquisition

At the beginning of 2022, AMD acquired Xilinx for nearly $50 billion, valuing the company at 16 times sales. As a result, AMD now has $24.3 billion of goodwill and $21.4 billion of acquisition-related intangible assets on its balance sheet. AMD paid a huge premium over the value of Xilinx's physical assets. This usually does not end well. You see, if Xilinx's earnings don't live up to the price AMD paid, AMD will have to write down the value of Xilinx and take a huge loss on its income statement.

Also, if we subtract the aforementioned intangible assets from AMD's equity, the company only has $10.3 billion in tangible equity. This makes AMD's $335 billion market cap look like it's full of air.

Competitive threats

When a company makes big profits on assets that wouldn't cost much to replace, it attracts competitors into the industry. Recently Amazon (Nasdaq: AMZN), Microsoft (NASDAQ:MSFT), hail (Nasdaq: Apple) are developing their own semiconductors, and they have a lot of capital to do so. Apple has hampered AMD's profitability in the PC market, and Amazon and Microsoft could hamper data center profitability in the coming years. I expect competition will get worse for companies like AMD and Intel (NASDAQ:INTEC) and Nvidia (Nasdaq: NVDA).

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China and geopolitical risks

AMD designs the chips, but does not manufacture them. This is why AMD relies on the Taiwanese semiconductor company (New York Stock Exchange: TSM). AMD stated:

“We use third-party wafer foundries to manufacture silicon wafers for all of our products. We rely on Taiwan Semiconductor Manufacturing Co., Ltd. (TSMC) to produce all wafers for our microprocessor and GPU products at 7 nanometer (nm) or smaller nodes.

AMD Annual Report 2023

The problem is that China considers the country/island of Taiwan to be its own. Taiwan values ​​its independence and democracy above all else. Therefore, China has been amassing massive military power and constantly threatening Taiwan with fighter aircraft and military exercises. TSMC's entire operation is currently based in Taiwan, and it has delayed the opening of its US operations to 2027 or 2028.

If the conflict disrupts manufacturing plants in Taiwan, it would be devastating for AMD. And who will make its world-class chips? Although I hope this doesn't happen, and give it a relatively low probability, the potential devastation has no impact on AMD's stock price.

Did I mention that AMD made 15% of its sales in China last year, and that the US is restricting the sale of advanced chips to China (which would likely limit China's military capabilities)? This does not appear to be priced at 15x sales and roughly 400x earnings.

People are AMD's main moat

I think that in technology, especially in non-fiction semiconductors, people can provide a competitive advantage. Why did Nvidia and AMD outperform Intel? Maybe it had a lot to do with their people. CEOs, board members, and employees are really important, but those same people could easily go out and work for a competitor. Therefore, AMD has to pay them a lot of money.

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But how does AMD pay its employees huge sums of money without affecting its cash flows? Three words: stock-based compensation. Not only does this not impact free cash flow, AMD also adds stock-based compensation when calculating “non-GAAP operating income.” The problem, of course, is that these real expenses dilute shareholders.

AMD averaged $2.5 billion in free cash flow over the past three years, but subtract its average stock-based compensation of $0.95 billion, and you get a three-year average earnings power of $1.55 billion. . With a market cap of $335 billion, the company trades at 216 times that amount. Will the future be better than the past? The market certainly thinks so.

Is AMD stock a buy, according to analysts?

Currently, 28 out of 34 analysts covering AMD give it a Buy rating, six rate it as a Hold, and zero analysts rate it as a Sell, resulting in a Strong Buy consensus rating. The average price target for AMD stock is $201.26, indicating a downside potential of 3%. Analysts' price targets range from $140 per share to $270 per share.

The bottom line on AMD stock

AMD risks are not priced. Geopolitical risks around China and TSMC have risen over the past few years, but the market is ignoring the implications when it comes to companies like AMD and Nvidia. Furthermore, there is a high possibility that AMD overpaid for its acquisition of Xilinx, which could lead to future write-downs/losses.

With only $10.3 billion in tangible equity and a market cap of $335 billion for AMD, I think competitors will be drawn into the semiconductor space. Big tech companies have already started participating in the event.

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Finally, after subtracting stock-based compensation, AMD makes very little money compared to its massive market cap. These factors make AMD stock look risky at its current price.


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