Intense Competition Will Force AMD to Sacrifice Margins In Favor of R&D Spend

Key Takeaways

• Revenue growth will improve and then slow due to cyclical nature of chip demand 
• There will be an inevitable plateau in AI investment
• Competition between CPU and GPU producers will intensify due massive long term potential
• This will result in very high R&D spend by all three, particularly AMD 
• AMD’s revenue growth accelerates then falls into single digits by 2028

Catalysts

Industry Catalysts

CPU Demand Will Accelerate in 2024 and 2025, but Decelerate Again by 2028 

CPU sales for the client segment is likely to accelerate rapidly as inventories have fallen and a new replacement cycle is overdue. Within the datacenter segment growth will be more measured.

These cycles are likely to slow after 2026 in line with typical demand cycles. Gaming segment revenue growth will remain steady in the high single digits.

PC Shipments By Brand 2009 to 2023   Image Credit: Statista 

The Current Boom In AI Investment Will Reach A Plateau In The Next Few Years

The current massive levels of AI investment will inevitably result in overcapacity. Many companies will face challenges monetizing their investments, and pause those investments while they work through the challenges.

By 2027 or 2028 the industry is likely to be in a cyclical downturn which will be reflected in growth rates across the industry.

Competition between AMD, Intel and Nvidia Will Intensify, Leading to Very High R&D Spend

There is tremendous long term growth potential for high performance chip demand, underpinned by AI, automation, robotics and IoT. AMD, Nvidia and Intel are competing on several fronts for product leadership, while Alphabet and Amazon are now producing their own datacenter chips.

In 2022, AMD, Nvidia and Intel spent 21%, 27% and 28% of revenue on R&D. This is likely to continue as all three companies prioritize long term market share across multiple product areas. This is the right strategy given the opportunity, but is likely to impact margins in the medium term.

R&D Spending by AMD, Nvidia and Intel,  2018 to 2023    Source: Company reports

Company Catalysts

AI Accelerators - AMD Will Miss Out On the Current Cycle

AMD is launching its MI300X AI accelerator at the end of 2023. This chip is specifically designed to power LLMs with 192GB of memory. This will be will be a welcome alternative to Nvidia's H100, but it’s likely to take a few years for it to gain traction. So AMD is likely to miss out on the current boom in AI investment - but will become a key AI chip provider for the longer term.

AMD’s R&D spending Will Need to Remain Very High For It To Remain Competitive

To maintain its position in the GPU and CPU market, AMD will need to maintain the current level of  R&D spending. With less revenue, AMD will need to spend a higher percent of revenue to achieve equivalent investments compared to Intel and Nvidia.

AMD Earnings Breakdown Source: Simply Wall St

Assumptions

Key Segments Will See Strong Growth in 2024 and 2025 Before Slowing Dramatically

Segment revenue projections:

• Datacenter revenue growth will average 18%/year, reaching $13.6 bln in 2028.
• Client revenue growth will average 20%/year, reaching $12.3 bln in 2028.
• Gaming revenue growth will average 8%/year, reaching $8.7 bln in 2028.
• Embedded revenue growth will average 11%/year, reaching $8.5 bln in 2028.

This totals $43.2 bln in revenue for FY 2028.

Gross Margin and SMGA Costs Will Benefit From Increased Scale

With increasing scale, AMD’s gross margin will continue to increase, reaching 53% in 2028. The Sales, Marketing, General and Administrative expenses will also decline as a percent of revenue, from the current ~10% to 8%.

R&D Spend Will Remain High

To remain competitive, AMD will need to keep R&D costs at 25% of revenue resulting in an overall operating margin of 20% in 2028. Assuming an effective tax rate of 15% and negligible debt, the net income margin will be 17%.

The P/E Multiple Will be 30x or lower in 2028 

Lower than hoped margins and slowing growth will result in the share price trading at no more than 30x EPS. I’m assuming that AMD won’t need to issue new shares and the share count will remain flat.

Risks

The following scenarios could result in revenue growth exceeding my projections:

• AMD continues to gain market share from Intel in the CPU market.
• The recovery in CPU demand lasts longer than I expect.
• AMDs AI accelerators gain traction quickly.

Margins could be higher than I expect if:

• Intel and Nvidia don’t maintain their rates of R&D spending, and AMD follows suit, or, 
• AMD decides to prioritize profitability over the next five years rather than long term product leadership.