Sunday, April 29, 2007

The ATI acquisition, for the record

I have written in other posts about the ATI acquisition, but not compiled a definitive opinion on that subject, thus this post.

Vertical Integration is an attractive strategic objective for AMD:

  • AMD processors may have unique features that could benefit from chipsets that fully make use of them, chipsets and processors have synergies.
  • To develop chipsets next to the processors should lead to shorter "times to market", another important thing
  • The chipset business opens up opportunities for AMD to use its Fab capacity in chipsets, or to use the foundry capacity contracted by ATI, depending on the integrated company needs, which increases flexibility and in principle AMD readiness to tackle market opportunities.
  • As it has been profusely written about in this blog, there are specific computation loads such as 3D graphics acceleration that can be better served by specific coprocessors; thus, the future of the processors are as much "multicored" as "multicoprocessored", thus very tight collaboration with coprocessor companies was necessary for AMD.
  • From the point of view of the customer, tight development of chipsets and processors ensure compatibility
  • Access to other markets, through ATI, Consumer Electronics, for instance.
At the moment AMD acquired ATI, there was a conjunction of market conditions that aligned AMD's interests with the interests of the major players in the industry. Why? because Intel, especially in conjunction with a mono-supplied Dell, was as much a vertically integrated monopoly as an horizontal monopoly; then, every AMD processor sold instead of an Intel meant a whole chain of complementary products and services opportunities for all the other companies: nVidia and ATI for the chipset and the integrated graphics card, Sun, HP, or others for the computer itself; Broadcom or Marvell for the ethernet phy or the wireless chipset, and so on. In summary, the whole industry had only one enemy: The Intel-Dell axis.

This used to be a successful stage of the "Virtual Gorilla" strategy that AMD pursued to try to close the economies of scale gap to Intel. Remember that AMD's greatest problem is the economies of scale, the Silicon research and development costs can be viewed as essential (due to the restrictions the x86 license places on the number of processors that can be outsourced, AMD seems forced to fab itself a significant fraction of its designs), and they have a "fixed" nature, thus, the greater the number of units to spread the fixed cost, the better the margin. Furthermore, the Silicon fab process is increasing its scale with every node transition, meaning that the investments grow in size at the ever higher scales of integration. In any case, for the broadest markets both nVidia and ATI were providing excellent chipsets for AMD processors and had adopted technologies of interest for AMD like hypertransport. For supercomputers and specific market niches, Broadcom, Sun, Cray and others were doing an excellent work in making use of AMD's processor features. In summary, right before the acquisition, it can not be said that the market was lacking in support of AMD technologies or initiatives.

AMD thus had every chance to concentrate in Silicon research and development and capacity expansion. Continuing the partnership with IBM for R&D, there only remained the issue of capacity expansion itself that AMD was attending to by securing an excellent offer by the State of New York to build a fab there which included more than 1 giga dollars in bonuses.

With a rising market share, for both ATI and nVidia there wasn't a better long term strategical plan than to increase collaboration with AMD while competing among each other; this ensured that the market of products complementary to AMD processors, due to this competition, was going to evolve faster than Intel lines. To further speed up the development of complementary products, AMD may had enthused the industry with more open specifications like Hypertransport, or even get more directly involved with Joint Ventures with nVidia and ATI simultaneously.

AMD not just had credibility for all of this, AMD wouldn't become a competitor in the chipsets or coprocessors businesses for nVidia or any other industry player that chose to associate tightly with AMD because AMD only had money for one major initiative, if that was to pursue capacity expansion, the opportunity cost paid there would left AMD without the money to turn into a treacherous competitor the way Intel did.

Then, the benefits of Vertical Integration mentioned at the heading of this article were present in the Ecosystem of partners to a large degree. nVidia, for instance, had the nVidia Business Platform, which is still defined around an AMD processor. An aside note, when I first noticed the NBP around early April '06, it surprised me how nVidia addressed a very important concern of the business market, that of platform instability, with a very compelling proposition and yet wasn't promoting it heavily: In hindsight, I think nVidia knew AMD was about to acquire ATI, perhaps what Rahul Sood says is true, that nVidia was the first merger candidate tried and nVidia was already weary of AMD by that time. With nVidia pushing initiatives like this, ATI would have to follow suit.

Since the Vertical Integration was ensured by market circumstances around the time of the acquisition, comparatively the acquisition wouldn't have brought that many benefits. I mean, if If live in a place with excellent public transportation and my house badly needs a larger kitchen, I can defer the acquisition of a car to remodel the kitchen.

The criticism about the ATI acquisition is not a matter of principles, it is a matter of benefit/cost analysis. There were little and few true benefits to the acquisition, as it has been explained, but the costs have been terrible. Like it was explained in "long year", ATI was valued at certain price X by the market because it also had very good access to Intel product cycles, once inside AMD, it lost that access, and just by that fact, ATI, being exactly the same business, necessarily has to be worth much less, unless inside AMD it can participate in business with synergies to compensate. But so far what has been the synergies AMD has announced? A cut of redundant personnel? Fusion? has I have stated multiple times, the development schedule for Fusion is every bit as slow as it would have been in a Joint Venture; it is very clear that for the time being there haven't been any synergies which could justify the loss of value of ATI due to the difficulties to deal with Intel. This is important because Intel-based computers used to be over half of ATI's market.

Thus, AMD paid X plus an acquisition premium of about 20% for a business that is worth much less now that it is inside AMD. But this is not the real problem, the real problem is that AMD paid a dearly high opportunity cost.

While AMD needed its cash and future cash flows to keep expanding production capacity, it distracted both to acquire ATI. This problem gets worsened because:
  • The timing was particularly bad: At the same time AMD's management understood that its declining product competitiveness will hurt AMD's capacity to pull this transaction off, ATI was depreciating even faster because of its own lack of competitiveness, spotty execution and profitabilities. Since Intel already had declined to acquire ATI, AMD may very well have waited for a cheaper opportunity (this is the same argument that dispels the rumor of AMD's leveraged buy-out, why now that the price is becoming cheaper so fast?)
  • Furthermore, AMD needed lots of cash to cover for a "Perfect Storm" that could happen, and happened, forcing it to loans that put a burden of about $1 per share per year just in interests.
  • AMD lost credibility among partners, I see it very hard for the ecosystem to risk any significant investment in AMD-based products if AMD demonstrated that it is not interested in the ecosystem but in imitating Intel's vertical integration model up to its treacherousness
  • nVidia, despite what Rahul Sood and AMD's management says, is not only alienated, but has become AMD's greatest enemy and probably its nemesis.
  • There are no resources for projects that can display ATI-AMD synergies like torrenza coprocessors (no money and no market credibility). Furthermore, AMD is very content with the current model of "graphics supercomputer in an expansion card" model that I demonstrated why it is obsolete. I dare to say that the ATI acquisition, far from easing the adoption of unique features of AMD processors, like their "coprocessability", the prostrated AMD posture is eliminating chances for those product advantages to become competitive advantages and profit drivers. That is, AMD has gotten the opposite it wanted from the deal.
  • The financial damage is extreme: We are talking here of, according to my estimations, of a depreciation of ATI's value of at least 1 giga dollars, plus the 1 giga dollars of acquisition premium paid, plus several million dollars in the commissions and interests of the Morgan Stanley initial loan, plus the commissions, interests and transaction losses due to this recent convertibles issuing, some more hundreds of million dollars in increased risks and credit rating downgrades to be paid the next time AMD goes to financial markets, the financial shackles the Morgan Stanley loan imposed (AMD is forced to dedicate a significant portion of almost any financial activity to repay that loan)
The greatest damage of all I think it was to have destroyed a pro-AMD/anti-InHell alignment of business interests of all the major industry players to commit self-financial-mutilation and to become the primary business enemy of one of the greatest emerging new companies, nVidia.