AMD: How Chips Are Changing

Sector

TechnologySemiconductors

Background

Jay Goldberg is a semiconductor industry consultant at D2D Advisory and a Partner at Snowcloud Capital. We cover the rise of custom silicon, AMD's competition with Intel and Nvidia, and whether chip-making is a good business.

Cover

Date

September 7, 2022

Episode Number

73

Key Learnings & Lessons for Investors

1. Importance of Product Cycle and Timing: In semis, success is largely determined by the ability to produce the right product at the right time. Intel's early edge over AMD was primarily due to its better execution on product cycles.
2. Geopolitical Implications of Manufacturing Concentration: The concentration of advanced chip manufacturing in just a few global locations, especially TSMC's plants in Taiwan, poses significant geopolitical and supply chain risks. Need to consider macro-level geopolitical factors looking at semiconductors.
3. Barriers to Entry in the Semiconductor Industry: Despite the impression that an asset-light model might be easy for newcomers to replicate, decades-long relationships, expertise in chip design, and understanding market needs make it challenging. It isn't just about designing a chip; it's about ensuring its relevancy, compatibility, and efficiency for end-users. Established companies like AMD have entrenched relationships.

Key Takeaways & Business Model

1. AMD's Story is a Reflection of US Semiconductor Evolution: AMD's journey from its inception in 1969, competing directly with Intel, provides a lens into the shifts and trends in the semiconductor industry. The initial phase was characterized by innovations in electronics, moving away from a vertically integrated structure (like AT&T) to a merchant semiconductor model where chips were produced separately.
2. Industry Evolution - Moore's Law and Fabless-Foundry Model: The semiconductor industry has been driven by Moore's Law, which essentially states that the performance (transistor density) of semiconductors doubles every 18 months. This has slowed recently to 3-4 years. The immense cost ($7 billion) of building a semiconductor manufacturing plant (fab) led to the rise of "fabless" chip companies (like AMD) which design but don't manufacture chips. This design is handed to "foundries" for production. TSMC in Taiwan and Samsung in Korea are among the very few leading-edge chip manufacturers today.
3. Semiconductors as a Business Opportunity: The semiconductor industry is divided into the manufacturing side and the fabless side (design-focused). While manufacturing is capital-intensive and requires consistent investment, as evidenced by TSMC's $44 billion CapEx, it can be lucrative if executed well. TSMC's monopoly status in leading-edge technology has led to record profit margins and cash flows. On the other hand, the fabless side is capital-light and depends on intelligent design teams. Start-ups can achieve significant success here, designing powerful chips with minimal personnel.
4. The Evolution of Compute Technology: For decades, general-purpose compute, primarily using CPUs, dominated the industry. However, the landscape has been changing. While CPUs, primarily driven by Intel, have been standard for personal computers, GPUs (graphic-focused, spearheaded by companies like NVIDIA) are gaining traction, especially with increasing demands in areas like AI. This transition from a predominantly CPU-based data center to a more mixed setup, termed heterogeneous compute, indicates the growing variety of chip types required for different tasks.
5. Shift to Specialized Chips: The semiconductor industry is undergoing a pivotal shift from general-purpose chips to specialized ones. Major data center companies like Google, Facebook, Amazon, and Microsoft are designing their own customized chips to cater to specific needs, which is more efficient and can save hundreds of millions in operational and capital expenses. For example, Google developed the VCU (Video Coding Unit) to cater specifically to YouTube's video encoding and decoding needs.
6. Customer Becomes Competitor Dynamic: Major consumers of chips, representing a significant share of the market, are becoming self-reliant by designing their specialized chips. This dynamic is turning these major customers into competitors for established chip manufacturers. However, established chip companies like AMD, Broadcom, and Nvidia are adapting by offering support services, understanding that resistance could be detrimental.
7. AMD's Evolution and Financials: In 2021, AMD reported revenue of $16 billion, gross margins of 48%, and operating margins of 20%. Over the past 20 years, the semiconductor industry has consolidated, leading to improved gross margins. AMD, being fabless, doesn't have the capital intensity of owning fabrication units (fabs) like Intel, giving them a financial advantage.
8. Capital Allocation and Acquisitions: AMD has returned a significant amount of cash to shareholders through dividends and buybacks, showcasing efficient capital allocation. In 2021, they purchased Pensando for $2 billion and Xilinx for $49 billion to diversify their product range and adapt to the future of specialized computing.
9. Trend Towards Deconglomeratization: Conglomerates are shifting towards more focused business models. Historically, conglomerates aimed to dominate various sectors, but the current trend is for these businesses to become more specialized. Examples include Raytheon Technologies spinning off Otis and merging with UTX and Raytheon, which Josh believes is a more effective formula. The challenge with vast conglomerates, as observed in GE's history, is that different business segments end up competing for capital which isn’t a conducive model for success.
10. Commercial Aerospace & Pent-up Demand: The commercial aerospace sector is generally tied to GDP per capita trends. However, this relationship has been disrupted due to the COVID lockdowns. As people transition from purchasing products to experiencing moments, there's a pent-up demand for global passenger travel, which might benefit businesses like GE in the long run. Moreover, businesses with high degrees of operating leverage stand to benefit as increased revenue leads to more significant bottom-line growth due to the existence of a high proportion of fixed costs.

Transcript