Stocking Down

If you haven’t noticed, Intel and AMD stock have been pretty much in freefall lately.

This is what is really happening:

Intel will probably report a reasonably OK quarter for chips sales. European CPU sales aren’t particularly strong,
but they haven’t been for a while now. The falling euro has given European Community members a significant price increase on dollar
based CPU prices. So computer sales are going up more like than 7% annually in Europe rather than the world figure of about 15%. It’s nothing
disastrous, and it’s nothing new.

AMD did increase its share of the European
CPU marketplace, but it was very weak in Europe compared to the rest of the world, and their marketshare only
went from 8% to 12% (compared to about 20% worldwide).

Good for AMD, but no catastrophe for Intel. If the euro
remains weak, AMD might really do well next quarter.

World computer demand is perfectly healthy, if not spectacular. Let’s look at the last two years of worldwide computer sales (numbers from IDC Research, in millions):

4Q ’98: 27.8

1Q ’99: 25.3
2Q ’99: 26.3
3Q ’99: 27.9
4Q ’99: 33.2
1Q ’00: 30.4
2Q ’00: 30.1
3Q ’00: 33.4 (projected)

There’s a pretty clear pattern here. Sales on the whole are increasing on the average about 15% yearly. Christmas is the big sales quarter; sales jump up around 20%.
Sales then slump about 10% the first quarter, dawdle around the second, perk up the quarter, and back to Christmas we go.

Overall, that 15% or so sales growth is a bit slower than the slightly better than 20% growth recorded in 1999, but we’re only talking 5%, and that trend has been clear since the end of last year. Again, this is no new sudden development.

Will the Analysts Go Nuclear on Intel?

There’s a bomb sitting in Intel’s bottom line. As those of you who’ve read my pieces on this know, it’s the profits on stock sales.

Probably not too likely Intel made a ton of money selling stock during the third quarter, so overall profits are probably going to tank, even if CPU profits are OK.

The $64 Billion Dollar Question

How do the spin doctor analysts play this one? As I told you before, Intel’s real profits from the CPU business have barely increased the last few years.

The rosy increase in profits have come from stock sales, and up to now, most analysts have pretended that these are a regular part of Intel’s earnings. (Under most circumstances, and certainly in the case of Intel, you shouldn’t.)

What do they do now? Do they now stop looking at overall profits and say that Intel didn’t do too badly? Do they just compare to the profits from a year ago (which didn’t have all these stock profits), and say Intel had a “ehhhh” quarter. Or do they look at overall profits compare them to last quarter, and screech, “Intel profits down by almost half!”

If they do to Intel what they did to Apple and AMD, it’s going to be the last. And things will get ugly.

But they may very well not. It’s not like a lot of these guys are consistent. I’ve seen some of those who included extraordinary profits for Intel not do so for other stocks doing the same thing.

To me, though, the question is: If you’re an Intel shareholder, (or even worse, an AMD or many other tech stock holder), your investment for the next week, and maybe a long time after that, is dependent on which way these guys feel like spinning the numbers. Don’t you feel there’s something wrong with that? Can you say M-A-N-I-P-U-L-A-T-I-O-N?

Burying Your Mistakes

In 1999 and early 2000, the stampede was going towards tech stocks going up, up, up. A lot of analysts, for whatever reason, did not resist that trend and cooked their mental books to justify it.

Now, when the stampede is going the other way, here’s a chance to “undo” your mistake, and look brilliant fixing it.

Of course, you can’t admit to having made the “mistake” in the first place, so you point to a long-standing weakness in a part of the market that is insignificant in the big picture. You pretend that 15% rather than 20% is a horrible decline, even though that “decline” actually began while you were saying how wonderful the prospects of the company were.

(I must be fair. This is a case of “you’re either evil or stupid, which is it?” I may be grossly optimistic, but I’m choosing evil. It could just as well be the other, but if that’s the case, why are you still working?)

You also grab any other excuse you can find. Like AMD price-cutting.

How the Brain-Dead Think

Here’s a couple actual quotes from one of the analysts who triggered the latest decline:

“”We believe AMD has already engaged in a price war.”

Well, no shittin’, Sherlock. That’s up there with saying “We believe the Japanese have attacked Pearl Harbor” in 1942. Still clueless as to why they did it and what it means, though.

“It appears that AMD has engaged in a price war, where it is essentially bidding against itself,” wrote Galvin, noting that Intel has yet to ship large numbers of chips at those speeds.

How dare they ship chips faster than Intel and price them lower? How dare they confuse people who came in to buy a 1Ghz chip with something else?

When Price-Cutting Is Not A Sign of Desperation

If you have excessive inventory, you cut prices to try and get rid of them. If you have a fairly stable level of production, that’s usually bad business news.

That’s not the situation with AMD. AMD is doubling Duron/TBird production this quarter: to 7.2 million chips. Add in a couple million K6-2s, and you’re looking at AMD to go from 7 to 9 million chips produced, an increase of about 30% from the previous quarter. Duron/TBird production alone this quarter will be greater than any previous AMD sales quarter

About forty percent of this new Duron/Athlon production replaces low-margin K6-2 sales. The rest represents increased sales.

This is expansion, not desperation. AMD is bound to make more money than before, no matter what they charge. Maybe not a stunning increase in profit, but they certainly won’t be worse off. Their profit margins may go down, but so what? You can make money stacking ’em high and selling ’em cheap. The damn things only cost $30-40 to make; not like they’re losing money when they sell a TBird for $120 or $150 or $250. Especially when you’re used to getting $50 from most of your chips.

What do you make more money doing?

Something costs you $40 to make. What do you make more money doing?

1) Selling one for $800 or

2) Selling ten for $250?

If you answered “one”, you got the right answer. If you answered “two,” you passed the stock analyst exam.

Intel has always had a bizarre pricing structure. They’ve always charged far more for their top-of-the-line CPUs than the increased performance justified.

Overclocking exists primarily for that reason.

AMD has not only cut prices, it has called that pricing strategy into question. They believe you’re more likely to spend an extra $100 to get a faster processor than an extra $500. Do you know what? Most sane people would agree.

So if they get ten people to pay that extra $100, they’re better off than they would have been getting $500 extra from one. Especially, when five out of those ten wouldn’t have bought anything from the company in the first place.

You’re Joe Blow. You walk into the computer store vaguely thinking you’re going to buy an Intel system. You see a 700Mhz Intel system for $X. You see a 700Mhz AMD system for $150 less. You see a 1Ghz AMD system for the same price. You see that the Intel 1Ghz costs $400-500 more. You’re not made of money. What are you going to do? Pretty good chance one way or the other AMD’s going to get some extra sales.

You’re [H]ard Techie Kid. Dad’s got some money. You walk into the store, and you see a 1Ghz Intel system for $X, and a 1.2Ghz AMD system with a better video card for the same price. No 1.2Ghz Intel system to be seen. What are you going to do?

This is apparently beyond the comprehension of that leading stock analyst.

Does somebody or something get hurt by this? Of course. Profit margins get hurt. But whose making the big profits? Intel. Do you think Intel losing out breaks AMD’s heart?

Mark Mediocre makes $100 an hour at a job. You make $25 at your current job, but can prove you can do better than Mark. Mark’s boss agrees, fires Mark, and pays you $50 an hour to do his job.

You’re happy, you just doubled your pay, and $50 an hour is plenty for you. Mark’s boss is happy, he’s making more money. Mark is very unhappy, but would you say that whole industry is facing disaster?

That’s just what the stock analysts think.

But I’m not dead yet! I’m getting better!

You might want to downgrade Mark’s earnings potential quite a bit now that his job is only worth half of what it used to be. But would you downgrade his more efficient successor just as much or even more?

You do if you’re a stock analyst.

What the stock market has told AMD is the equivalent of a bank officer telling you, “We can’t approve your loan. Hard times are coming. Mark lost his job.” and completely ignoring you yelling, “But I’m the one who got it!”

What’s Bad for Intel is Bad for America?

This is apparently a patriotic belief of most stock analysts. “Oh no! CPUs will cost less money! The world is doomed!” Now I can see you thinking that if you’re an Intel stockholder or an Intel employee, but anybody else?

I bet your boss is going to lay you off just because he spent less money on computers than he expected. He’s going to stop buying computers and tell the salesman, “I will not pay these low prices! Don’t come back until you charge more!”

That’s what the stock market apparently thinks, or at least acts like it’s thinking that. Why else would other tech companies have their stock price drop when Intel’s does?

Now if people were really cutting back on buying computers, that would be one thing, but they’re not. Maybe they’re buying a few less Intel computers, but believe it or not, that’s not the same thing.

Except to the stock market. Except if people read so much about slumping computer sales that they stop buying them, too, just to be part of the crowd.

Aaaaah! Price War!

First, not now. Christmas is coming, remember? Big jump in the number of computers sold? More than any production increase by AMD? Intel’s in for some rough times, but not this quarter.

After Christmas is when you have the problem. The CPU industry will make over forty million CPUs for this quarter. Maybe closer to forty five. After Christmas, figure 33-34 million processors. Big overhang there. So people yell “Price war!!”

Maybe not. Maybe even probably not.

Remember something, now and for at least the next couple years, most people buying computers will have no choice but to buy Intel No matter how much better AMD is. AMD just can’t make enough chips to overtake Intel. AMD knows that, and is cleverly taking advantage of that.

The AMD price cuts are very clever simply because they are so extreme. They give Intel the option of a bad choice or a worse one.

The bad choice is letting AMD grab market share. If AMD can sell all its chips the next quarter, it will go up from about 20% to 30% market share out of Intel’s hide. Certainly will cost Intel a lot of lost profits.

The worse choice is trying to match AMD on price. Right now, AMD chips cost 40%-60% less than Intel’s. If Intel cuts prices to match, that probably will cost them more than making fewer chips.

If Intel does brazen it out, and refuses to cut prices, what do you think will happen to the price of AMD chips, presuming that they’re considered more desirable, and there’s more demand than supply for them?

Why, the price will go right back up to the point where AMD can still sell all its chips while still making more money. Intel becomes the shock absorber of fluctuating demand, at least for a while.

AMD can only get away with this if they have the generally acknowledged better chips available for sale. And they will, for at least a while.

Of course, Intel may decide to suddenly get macho and try to kill AMD, in which case all bets are off and we have a bloodbath. But that’s not inevitable, and I don’t think even very likely. It doesn’t seem to be how Intel executives are thinking.

Disasters Can Be Freeing

If your stock price goes to hell, you’re less concerned about defending it. Intel can come to two radically different conclusions from this.

It can go for AMD’s throat and try to kill it now, at an enormous short-term cost, much greater than if they had done it a year ago. Not only during the battle, but if people get used to paying $50 for high-end CPUs, going to be hard to get them to buy Willys for $500 or more six months from now.

The safer short-term approach is to swallow one’s pride and let AMD have its way with you and get stronger while preserving your price structure. Close down an extra fab or two early for .13 micron migration, take some profit hits for a few quarters, and hope you can counterattack starting the second half of the year with second-generation Willamette and McKinley at the end of the year.

If I had to bet, I’d bet Intel does the second.

Where Does It Go From Here?

Quite a few people are asking me this, and I really feel like telling them, “You shouldn’t be asking me. I’m not crazy.”

It’s intensely frustrating to look at this, make predictions, get every one of them right (actually underestimate to degree of rightness) and the stock market does the absolute opposite of what it rationally should do (at least until recently in the case of Intel).

For right this second? Depends on how the analysts spin the earnings news on Intel next week.

In the medium term? Depends on how long Intel can fool people into thinking the initial release of Willamette is actually significant. If the masses feel like believing it, Intel will rebound sharply, and probably for a while. If the masses don’t want to believe anything good about CPU stocks, it won’t.

AMD? Probably going to drop more based on the Willy factor, even if the Willy factor doesn’t help Intel. You’d think at some point people would wake up, but it doesn’t look like that’s going to happen for a while, and might not happen at all while AMD does have the upper hand.

Please don’t write me and give me good reasons why AMD should do much better than it is now. I know all that, and I agree with you.

What I’m telling you is that none of this matters right now. If it did, AMD would be trading at 50, not 19. If it did, AMD wouldn’t be rewarded for releasing the 1.2Ghz chip, which is indisputably faster than Intel’s best, with a 10% drop in the stock price, like it is today.

Perception is more important than reality, and unless or until a lot people have a sudden attack of sanity, it’s the perception that counts, no matter how wrong or stupid.

Email Ed

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