AMD's Deal Forces Intel's Hand
Chips Ahoy!

PC chipmaker Advanced Micro Devices and graphics chip maker ATI Technologies have merged in a block buster deal. Shares of Nvidia (up $1.66 to $19.43), one of the largest makers of graphics chips for computers and other consumer electronics - and the number one competitor to ATI (up $3.00 to $19.56) - were up nearly 10 percent yesterday. AMD (down $0.90 to $17.36) said that it will spend US$5.4 billion to acquire ATI in a cash and stock deal that is expected to close in the fourth quarter.

Analysts and investors say that the spike in Nvidia's shares could be attributed in part to speculation that Nvidia is in talks with Intel (up $0.28 to $17.43), the number one maker of chips for PCs, to supply graphics chips to the company. But people in the business are divided on whether the news means that Nvidia and Intel will reach an agreement, or whether such a partnership would take the shape of an out-and-out acquisition.

The news of ATI's sale to AMD could be bad news for Nvidia in the short term. That's because Nvidia has done brisk business selling chipsets, or the pairs of chips that surround microprocessors, to AMD, particularly for AMD's popular Opteron server chips. Those ties may have to be severed in light of the deal. AMD has been very good to Nvidia and Nvidia has been very good to AMD. If you were to look at Nvidia's chip set business, it's 20 percent of total revenues, and 90 percent of that is for the AMD platform. They built a very successful premium brand image on the AMD side of the business and very little on Intel.

Intel will have to come up with its own strategy for making high-end graphics processors. Intel currently makes graphic processors, but these are designed for low-end machines, unlike the souped-up processors that Nvidia and ATI make for demanding, graphics-heavy applications such as gaming. Intel has well-documented problems of losing market share and slowing growth, which have caused the chip maker to put up several consecutive quarters of weak performance. That led to a broad restructuring at the company, which is still taking place.

Analysts agree that while AMD's news means Intel will likely need to come up with its own approach to high end graphics processors, buying Nvidia outright is not necessarily the answer. If Nvidia feels threatened by this AMD/ATI partnership, it could form a partnership with Intel, which could really use a reliable partner on the high end of graphics chips. A partnership between Intel and Nvidia in which the latter supplied high-end chips to the former could make sense. The issue with Intel is not on the balance sheet, it's on the income statement. It's lack of growth, issues with profit margins, and competitiveness. The balance sheet is so darn strong, most shareholders would say whatever you need to do to get growing again, do it. Nvidia currently sporting a market cap of roughly US$7 billion, the purchase would be less costly for Intel, with a market cap of roughly US$101 billion, than it was for AMD to buy ATI. AMD's market cap is about US$8.5 billion, while ATI's is about US$5 billion. Intel has disappointed people with lack of growth or not always having a best of breed product. But say what you will, they continue to make a lot of money, and they could spend quite a bit more on Nvidia than AMD spent on ATI and they wouldn't feel it nearly as much.