Taking on Intel: AMD faces off

ATI shareholders agreed to acquisition by AMD in October. That was the easy part.

Even for those people who scoff at superstitious behaviour, company executives must have a special kind of confidence to hold a key shareholder meeting on a Friday the 13th. But that's just what computer graphics processor powerhouse ATI Technologies Inc. did in October, seeking approval for the blockbuster US$5.4-billion cash-and-stock acquisition offer from Advanced Micro Devices Inc. (NYSE: AMD), a microprocessor maker based in Sunnyvale, Calif., bent on unseating Intel Corp. from its dominant position. Shareholders voted nearly unanimously in favour, and ATI (TSX: ATY), one of the few jewels in Canada's tiny and dented technology crown, is that much closer to being pried loose by American hands.

Whether the deal proves to be, in fact, more blessing than curse, depends on what unfolds over the coming months and years. Two of the executives charged with making it work will be Dirk Meyer, AMD's president and chief operating officer, and Adrian Hartog, ATI's chief technology officer, who also heads up its high-profile consumer-products division. In an exclusive joint interview with Canadian Business in late September, Meyer and Hartog laid out the two companies' progress in merging operations, and some of their plans to make it pay off. Meyer was visiting ATI's Markham, Ont., headquarters just north of Toronto for meetings to determine the shape of the combined company, which will have 15,900 employees. Soon, integration efforts will be in full swing. With the ATI shareholder vote out of the way, the company received final court approval four days later, and the deal will likely close the week of Oct. 23.

Then the hard work begins. Proving that the merger can live up to its billing won't be easy. By joining forces, the two companies have thrown the industry's existing alliances into disarray, and no one is sure how the dynamics will now shift. Intel (Nasdaq: INTC) is even rumoured to be considering an acquisition of ATI's main rival in graphics processing, Nvidia Corp., although most think it's an unlikely match. Nevertheless, ATI is already feeling the heat from Intel for its decision to hook up with AMD: on Sept. 6, ATI announced that revenue for its most recent financial quarter would fall US$100-million short of the US$620 million it provided as guidance in June (before the July 24 merger announcement), mostly due to a sudden drop in its Intel-based chip-set business. (Chip sets are components designed for specific central processing units, or CPUs, like an Intel Pentium microprocessor, so they can talk to other parts of the computer.) ATI and AMD executives expected a decline — but not quite so large, or so soon.

AMD — which announced on Oct. 18 strong Q3 results of US$134.5 million in net profit, up 77% from a year earlier — has made a habit of shaking up the industry. For years, Intel was unrivalled in many of the largest markets for computer processors. But AMD has come on strong since 2003, when it launched a new, higher-performance line of chips, and Intel began suffering a series of missteps. (Even Dell Inc., a longtime Intel stalwart, started offering AMD-based PCs and servers this year.) Now Intel appears to be finding its feet again, thanks in part to the July launch of its new Core 2 Duo line, regaining processing performance supremacy. Still, Intel's Q3 earnings, announced Oct. 17, suggest its ongoing price war with AMD continues to hurt sales and margins.

The acquisition of ATI has nothing to do with boosting the performance of AMD's microprocessors. Instead, it's about broadening AMD's product portfolio by using ATI's engineers and intellectual property in graphics processing, chip sets and consumer-electronics markets like mobile phones to create a more multi-dimensional company. The new AMD ought to pose a more substantial competitive threat to Intel on a broad number of fronts. But a lot depends on the likes of Meyer and Hartog making the merger work.

In the weeks following the July 24 announcement, the integration team, a group of seven executives led by Meyer and Dave Orton, ATI's CEO (who will run the ATI business unit), has been visiting Toronto, Sunnyvale and AMD's campus in Austin, Tex., to determine how to best get the two companies to work as one. A starting point has been to break down the corporate structures into about 10 functional areas — sales, marketing, finance, IT, R&D and so on — and figure out how to connect ATI's 4,000-odd employees with the AMD organization.

“There's really very minimum overlap,” says Meyer. “Relative to R&D, it's really more co-ordination and leverage versus organizational integration.” There will be some layoffs, though Meyer says he does not expect it to be a large number. “There will certainly be some people who unfortunately are going to lose their jobs through this transition,” says Meyer. “But this is a deal that isn't about cost reduction, it's about realizing growth.”

The integration team doesn't have time to waste, especially because AMD is already several weeks into its fourth quarter. “We've got to present a common face to the customers, and we've got to close the books at the end of the year as one company,” says Meyer. “Those two things are fundamental.” A top priority in the early weeks is co-ordinating sales and marketing teams on any overlapping customers and retail channels. Some meetings have already taken place to address what the merger will mean for key accounts. On the day of the announcement, for instance, Hartog sat down with Nokia, which uses ATI for the graphics technology in some of its mobile phones.

The earliest manifestation of combined AMD-ATI resources will be new so-called platform products rolling out to PC manufacturers in mid-2007, with more to follow in 2008. It will be virgin territory for AMD. While it is well-known for powerful CPUs — the brain of desktop computers and servers — AMD hasn't yet offered an integrated platform like Intel's Centrino brand of products for notebook PCs. Such platforms are likely the future of computing: ready-made packages containing most of the approximately 25 chips for processing, memory, graphics and communications that together operate a modern computer. “In some cases, our customers want to have a more fully baked platform from us, too,” says Meyer. With ATI's expertise in both graphics processing units (GPUs) as well as chip sets, AMD will quickly vault into that market.

But developing platform products for next year wasn't the rationale for AMD paying US$5.4 billion to buy ATI outright; the two companies could just as well have formed a joint venture or other formal partnership. Instead, AMD's intention is to become a leader in the industry's drive toward squeezing ever more features and functions onto a single piece of silicon. “As we've thought about our capability within AMD, which is specific to microprocessors, we've felt like we would need access to more varied capability in forms of IP [intellectual property],” says Meyer. “We saw in ATI a perfect partner to broaden our portfolio.” In short, AMD is betting that ATI will give it an edge over what Intel is capable of doing in-house, or could do with a partner. Hartog is involved in the co-ordination of R&D efforts so that what is developed for next year and 2008 is done with an eye toward where the new company needs to be by the end of the decade and beyond.

It's a bold gamble, and one that Meyer argues would be too risky as a joint venture. “It's awfully hard to imagine how two [separate] companies do that in a way that generates returns that both companies think are fair,” he says. “It's hard to imagine creating a stable partnership that really stands the test of time.”

Hartog sings from the same song sheet. “We're in a very fast-paced market, with very aggressive competition,” says the ATI exec. “Speed of execution and the ability to act boldly are important.” Adds Meyer: “Partnerships are just intrinsically harder to manage.”

Indeed, the new company may soon discover how difficult it can be. The acquisition of ATI has raised questions about how it, as a business unit of AMD, will continue to collaborate with Intel. The most immediate change, of course, is its Intel-based chip-set business. ATI licensed from Intel the technology to make components that work with Intel processors, which helped Intel fill some of the supply gaps that emerged when it encountered manufacturing problems. “We did have a fairly active business on the chip-set side with Intel, and from that perspective, we expect to transition to be more AMD-focused,” says Hartog. “That process is probably going to start pretty aggressively once the deal is closed.”

In fact, with the pre-announced warning of a $100-million shortfall in ATI revenue, that transition seems to be well underway. But Meyer claims to be unconcerned. “When we went into this deal, we recognized that the ATI-Intel chip-set business was going to go away,” he explains. “That's happening, and we had planned for that. You could argue it's happened a little faster, although frankly, one of the reasons it has is because of AMD's success. We've got business with Dell that we didn't have before, which has freed up some Intel chip sets that they can deploy in other markets, thus hurting ATI's Intel-chip-set business. I don't consider it a major event in the grand scheme of things.”

As for ATI's business making discrete GPUs, Hartog is optimistic that its standing has not changed with Intel, and that it will continue to collaborate on new interface standards.

At the same time, AMD's long-standing connection to Nvidia, ATI's chief rival, also now has a new twist. Prior to the ATI acquisition, AMD's and Nvidia's strategies were completely complementary; they did not compete in any markets. Now, they will compete in some areas — most notably the high-end discrete GPU market — but co-operate in others. And AMD will have to build up Nvidia's trust that sensitive proprietary information isn't leaking out to the ATI business unit. Nvidia has sought assurances that its GPUs would still have equal opportunity to work alongside AMD microprocessors. Meyer says AMD has told Nvidia it won't be locked out. “I think they believe us,” he says. “We're going to need to rethink a little bit the terms of engagement between the two companies.”

It's clear it will be a complex relationship, and a little touchy early on. “The GPU part of our business has to be still very competitive with Nvidia right now,” says Hartog, “while the processor platform part of our business has to continue working with them very closely.”

How will that actually shake out? At a town hall meeting of ATI employees on Aug. 16, Meyer tried to explain it this way: “ATI's got a graphics business that is one of the franchise elements of the company. It's really important to AMD going forward, and we want to win, we want to beat Nvidia. Now, having said that, it's in the best interest of the AMD CPU business to be able to offer a solution to our customer that consists of the best combination of CPU and GPU that you can get. And if that happens to be, at a point in time, an Nvidia GPU, that's what we must offer. If there are occasions upon which Nvidia's got a better solution, that's going to be what we suggest our customers use. We're not going to try to shelter the ATI GPU business from competition with Nvidia. To do that makes you weak in the long term.”

Navigating these waters is not going to be easy. Conflicts are bound to arise both with Nvidia as well as internally with the old ATI. It could make the integration of AMD's new employees — never a simple task in any acquisition — all that much harder. From its founding in 1985 by K.Y. Ho, who retired late last year, ATI has developed a proud history as an independent, entrepreneurial tech company. But Meyer knows a cultural transformation is essential for success. “Based on all of the experience and knowledge that people have given us regarding mergers and acquisitions, it's really important for the resulting entity to think of itself collectively as a single company,” he says. “It's important that employees on both sides [of this deal] think of this as a new and exciting company to be in.”

But ATI won't disappear altogether — it will live on as a brand. The ATI name carries substantial weight in the high-end discrete GPU market segment, for instance, which caters to hard-core PC gamers willing to pay up for leading-edge technology. “We're absolutely going to keep that brand attached to that product segment. There's no question about that,” says Meyer. “Elsewhere, the product brands are still a work in process.”

In fact, Hartog sees a benefit, in certain cases, to ditching the ATI label, such as in the consumer electronics segment, where ATI has had some early success with a new class of customers that make digital television sets and mobile phones. “The AMD brand will probably help us become more broadly recognized,” says Hartog. For several years, it was an often overlooked part of ATI's business, even though the growth in digital displays for television sets and hand-held devices is an obvious opportunity for the company.

ATI's presence in consumer electronics (CE) was a significant factor in AMD's decision to buy the company. “It was certainly an element of why [to acquire] ATI and not Nvidia,” says Meyer. “Nvidia's got a great GPU franchise; ATI does, too. But ATI's got this very exciting CE business.”

It's a chance to broaden AMD's footprint, says Meyer. “Consumer electronics devices represent a big and growing market for processing technology,” he says. “I view the CE business as a natural extension of the new AMD's core technology base, and a big market. Increasingly, what's a PC versus what's a CE device is going to blur.”

Hartog, who plans to continue leading the consumer electronics business, thinks AMD's scale will help make faster inroads. “It's a high-growth business,” he says. “As a bigger company, there is potential opportunity to drive more aggressively.” But he also sees AMD's entrenched position in the PC and server markets as a big plus in helping bridge the traditional computing markets and consumer electronics. “If we can start connecting those dots, both from a customer perspective and from a technology perspective, we can create some unique value proposition for the PC business,” he says. “I also think it gives us ways of expanding our business relationships that we've formed on the CE side. It makes us look that much more strategic, that much more of a global partner.”

After the deal was announced, many of those consumer electronics companies requested meetings with ATI, Hartog says. “They're actually coming to us to ask, How is this going to deepen our relationship, how can we leverage this to actually do more with you going forward?” A case in point: ATI's meeting on July 24 with Nokia. “Through that discussion, we started discussing their networking infrastructure business. As a combined company [with AMD], we have a lot of capabilities to deal with that part of their business as well. I think some light bulbs went off with how we could potentially work together.”

Of course, these are optimistic days, before all the planning and meetings become reality — and unforeseen challenges surface. Mergers and acquisitions in the technology industry are notoriously problematic to make pay off, and integrations rarely if ever go smoothly. In such a fast-paced industry, facing a competitor as large and resilient as Intel, Meyer, Hartog and the new AMD will need as much good fortune as they can get.