How Intel Ruined AMD's Happy New Year

For chipmaker Advanced Micro Devices Inc. (AMD ) and CEO Hector Ruiz, 2004 was something of a coming-out year. Long a perennial also-ran to Intel Corp. (INTC ) in the semiconductor market, AMD knocked its mighty rival back on its heels last year with an innovative microprocessor for servers and personal computers. The company swiped market share from Intel, raked in cash, and saw its stock soar. BusinessWeek even named Ruiz one of the best managers of the year.

In the tech industry, though, you're only as good as your last earnings announcement. On Jan. 10, AMD warned that fierce competition in the memory-chip market would push fourth-quarter earnings well below Wall Street expectations. In a tersely worded release the Sunnyvale (Calif.) company said it expects fourth-quarter operating income to be "down significantly" from the third quarter. The stock plunged 26% the next day, to $14.86. The misstep fanned fears that AMD, for all of its success in 2004, remains the same inconsistent performer it has been in the past, with solid results followed by spectacular washouts.

What happened? Intel lowered the boom. The chip giant got much more aggressive in the market for flash-memory chips, which store data in cell phones and other electronic devices. That contributed to a 30% decline in flash prices in the second half of the year. Such a drop hurts AMD much more than Intel because the smaller chipmaker gets nearly 50% of its revenues from flash-memory chips, while Intel gets only 7%. As if to underscore the giant's advantage, the day after AMD's warning, Intel announced strong results for its fourth quarter. "AMD's head has got to be spinning. Intel just clocked them good," says analyst Richard L. Whittington at researcher Caris & Co., one of the six firms that downgraded AMD's stock on the news.

Ruiz may have a tough time clearing his head right away. Even as growth in the flash market slows this year, Intel vows to keep competing aggressively. That's likely to put a crimp in prices and limit AMD's ability to take back market share. In the third quarter, Intel grabbed the lead in the flash market, with 22.9% share, compared with 22% for AMD, according to researcher iSuppli Corp. "In six months' time I would be very disappointed if we didn't show continued momentum," says Sean M. Maloney, the Intel executive vice-president who oversees the business.

There's no question that Ruiz has AMD on much more stable footing than in the past. Unlike in the aftermath of previous setbacks, analysts believe the chipmaker will continue to turn a profit. Consensus estimates call for 2005 net income of $217 million on sales of $5.24 billion. Ruiz also is racing to wean AMD away from its reliance on the cyclical memory-chip business. He's expanding into the sale of chips for consumer electronics and plans to roll out a new processor for the notebook market, which is dominated by Intel now. And he hopes to bring a huge new manufacturing plant online next year to relieve the manufacturing constraints that have stymied the company's growth. Still, AMD is likely to have to depend on the volatile flash market for at least a third of its revenues for the next two years.

In the end, Ruiz knows it will be customers who decide AMD's fate. At the Consumer Electronics Show in early January, he greeted them by the dozens as waiters plied them with drinks and hors d'oeuvres at a posh restaurant. One thing is clear: This battle is just beginning.

By Cliff Edwards in San Mateo, Calif., with Spencer Ante in New York

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