Big deal chips away at Intel

By Robert Walberg

Wall Street rumors sometimes turn into reality. That was the case Monday when Advanced Micro Devices (AMD, news, msgs) ended weeks of speculation with a deal to buy graphics-chip maker ATI Technologies (ATYT, news, msgs). The $5.4 billion price is a premium of nearly 24% over ATI’s closing price on Friday.

Critics suggested that Advanced Micro Devices overpaid for a company with a history of inconsistent sales growth. Just last month, ATI issued a disappointing revenue forecast and the stock had fallen 26% from its early January peak.

But this deal is about the future, not the past. Together, these plucky chip makers create a much stronger whole. Not long ago Advanced Micro Devices was a weak second sister to Intel (INTC, news, msgs). Not today. Cutting-edge products and aggressive pricing have helped it steadily chip away at Intel’s market share.

Stealing share

Similarly, ATI Technologies has spent the past few years in the shadow of the other major high-end graphics-chip maker, Nvidia (NVDA, news, msgs). With this deal, ATI will start stealing share from its bigger rival. In fact, nearly 20% of Nvidia’s total revenue comes from a business that it mostly conducts with Advanced Micro Devices, which will now turn to its new partner.

The marriage will also help Advanced Micro Devices expand its product profile. One advantage Intel had until today was its ability to provide customers with microprocessor, graphic and logic chip sets. This deal erases that edge.

By purchasing ATI, Advanced Micro Devices also enters faster-growth, higher-margin businesses such as cell phones, set-top boxes and game consoles. There may be some integration issues, of course, as management merges the two companies. But with no risk there’s no reward. I’m betting there are at least a few Intel shareholders who wish their management team would take a bold step to revitalize sales by moving into faster-growing markets.

More deals ahead?

There is speculation that the Advanced Micro Devices/ATI deal may spark a similar tie between Intel and Nvidia. With over $7 billion in cash on hand, Intel could make it happen (Nvidia’s market cap is about $6.9 billion). However, a deal could distract Intel from reducing costs, introducing more competitive products and recapturing lost market share. It also doesn’t need a deal to complete its product portfolio the way Advanced Micro needed ATI. While a closer relationship between the two bridesmaids is possible, a deal isn’t likely.

In technology, if you aren’t getting bigger and faster you are simply becoming less relevant. Today’s deal makes Advanced Micro a much more relevant and long-term competitor, and if that’s not the job of management I don’t know what is.

Kudos for boldness

Kudos to Mr. Ruiz and Mr. Meyer, the company’s president and COO, for showing the kind of bold leadership that is hard to find these days. They and their company are the big winners, with Intel a slight loser and Nvidia the big loser (sell into gains).

While some say the price was too high, it appears more favorable when you consider that ATI fetched less than 2-times sales and 1.6-times enterprise value. Nvidia currently trades at 2.5-times sales and 2.2-times its enterprise value.

If management is correct and the deal proves slightly accretive to next year’s earnings and “substantially accretive” in fiscal year 2008, then investors will quickly forget their initial price concerns. Management also forecast cost savings of about $75 million.

Considering Advanced Micro Devices’ big stock-price drop in recent weeks, I’ll take this opportunity to switch out of my Intel position in the Street Patrol portfolio and add Advance Micro in its place.

Robert Walberg is a financial writer based in Chicago, Ill. He was formerly chief equity analyst at Briefing.com. He is a regular guest on CNN's Moneyline. Mr. Walberg ran for Congress in Illinois in 1994.

At the time of publication, Walberg did not own or control shares of companies mentioned in this column.