AMD Goes Fabless

In what may be considered a turnaround in its manufacturing strategy, Advanced Micro Devices (AMD - Analyst Report) has reworked its wafer supply agreement with GlobalFoundries to effectively do away with its roughly 9% stake in the foundry (valued at $278 million). Investors did not however view the news positively, most likely because of the resultant $703 million it will be taking as charges in the current quarter.

AMD’s cash position will also be impacted through 2012, since it will be paying the remaining $425 million in four installments - $150 million in March, $50 million in July, $50 million in October and $175 million in December.

The old agreement has not been working too well for the company, as purchase commitments with GlobalFoundries combined with low yields at the foundry have been telling on its gross margins. Additionally, AMD also lost some business to archrival Intel Corp (INTC - Analyst Report), as it was unable to push out sufficient volumes of its new processors.

The fresh agreement enables AMD to take specific portions of its business to another foundry, although the specifications were not mentioned in its filing with the SEC. It also brings pricing back to the cost-plus basis. The parties are now contracting for a fixed number of wafers each quarter and previously-agreed-to quarterly payments for the availability of 32 nm capacity have been waived by GlobalFoundries.

AMD estimates that its total costs related to wafer purchases will be $1.5 billion in 2012 plus an additional $71 million in lieu of R&D commitments. In 2011, AMD spent $904 million and $79 million, respectively, on these counts.

It is not clear whether AMD’s choice of a second source will be Taiwan Semiconductor Manufacturing Company (TSM - Snapshot Report), which already manufactures its graphic processors. However, the additional flexibility may enable AMD to cater to demand more effectively.

AMD’s manufacturing strategy is the exact opposite of Intel, which has spent heavily on its next generation capabilities. From Intel’s viewpoint, it makes sense because Intel is a technology leader and not a laggard. However, AMD’s success has come from its value products, so cost minimization makes more sense for AMD.

The Zacks Rank for both AMD and Intel is #3, implying a Hold rating in the next 1-3 months.