Much has been said and written about Advanced Micro Devices’ (AMD) resurgence in the CPU and GPU markets (and in stock price), which is warranted of course, but what has fallen by the wayside is the company’s dominant position as the king of console chips. AMD’s chips can be found in all major consoles of the last decade and most upcoming ones as well with the exception of Nintendo’s (OTCPK:NTDOY) Switch device, which isn’t exactly a traditional gaming console.
Investors have already known this for quite some time as semi-custom APU sales were the only thing that kept AMD afloat through the dark times, but a new catalyst is on the horizon for console sales and by extension AMD’s console chips.
AMD APUs power the Xbox One, PlayStation 4, Xbox One S, and PlayStation 4 Pro, and will power the upcoming Xbox One X formerly known as Project Scorpio as well. The only major gaming system that doesn’t use AMD is the Nintendo Switch, which uses Nvidia (NVDA) instead, but the consoles from Microsoft (MSFT) and Sony (SNE) are the big fish in the market due to the higher console ASPs and due to a key point that is the subject of this article: the console cycle.
For a while there have been discrete console cycles lasting about seven years where Microsoft, Sony, and Nintendo release competing consoles that duke it out, usually for the same consumers. We usually declare a winner after a year and then update the winner a few years later and then the cycles begins anew. But there is a paradigm shift underway right now that will benefit console makers and their suppliers like AMD. First, I’ll establish how the traditional console cycle affected AMD and then I’ll go into how this new cycle paradigm might be more beneficial to the company.
Looking at AMD’s financials in late 2013 and into 2014, we can see the effects that Xbox One and PlayStation 4 sales had on the company’s overall revenue and margins:
Peak semi-custom APU sales provided one of the few quarters of profitability for AMD over the last few years and provided a quarterly revenue mark that has yet to be matched since. This demonstrates the effect that a discrete console cycle can have on AMD’s revenues and margins, namely that there’s a big buildup in consumer anticipation that comes rushing forward, which causes explosive sales growth that tapers off relatively quickly.
While boom-and-bust revenue cycles are better than no revenue at all, lumpy revenue is never something investors particularly enjoy, and it can be hard for a company to maintain consistent business expenses with long, drawn out cycles like the seven-year console cycle. AMD has been subject to the booms and busts of the console market for years, but the situation is changing rapidly to a new paradigm.
Xbox head Phil Spencer and head of Xbox games marketing Aaron Greenberg have expressed their thoughts on the upcoming console paradigm as being a steady stream of hardware updates rather than a seven-year gap between new consoles. Greenberg even stated that he thinks Xbox One vs. PlayStation 4 will be the last console generation as we know it, indicating that the console market could become similar to the smartphone or PC markets where new hardware iterations are constantly being sold while older generations with worse-performing specs get a discount.
We can already see this playing out with the release of the Xbox One S and PlayStation 4 Pro and the upcoming release of the Xbox One X. I think Greenberg articulates this concept well with the following answer to the question “is this the last console generation?”:
I think it is. … For us, we think the future is without console generations; we think that the ability to build a library, a community, to be able to iterate with the hardware — we’re making a pretty big bet on that with Project Scorpio. We’re basically saying, “This isn’t a new generation; everything you have continues forward and it works.” We think of this as a family of devices.
Microsoft and Sony are getting on board with a new way of selling consoles, so the obvious follow-up question to ask as an AMD shareholder would be the following: is this new paradigm better or worse for AMD? I can’t answer this question definitively as the shift is only just getting underway, but I can provide my best guess and opinion based on some assumptions.
First, we have the obvious difference of timing. Instead of one big burst of sales that lasts a couple of quarters and then tapers off, we’ll see a steadier flow with some spikes and dips in between the various hardware iterations. This has the benefit of making revenue more predictable and likely making the stock price more consistent and steady as well as momentum investors no longer have the incentive to push a stock up prior to or push a stock down following a big catalyst.
This little clip of AMD’s share price before and after the release of the eighth generation of gaming consoles demonstrates the stock price volatility effects that a revenue burst might cause.
There are of course other reasons that could have played into this price movement but I think the rise and fall of semi-custom APU revenue had a large role.
Second, a steadier revenue stream and product schedule also gives a boost to ASPs and therefore margins. There’s a great example of this going on right now with Microsoft’s assortment of Xbox offerings. The Xbox One’s price was slashed by $50 to $299 in 2016 before the announcement of the Xbox One S and to $279 after it was announced, and similarly the price for many Xbox One S bundles were slashed in June of this year by $50 to $249 for 500GB and $299 for 1TB ahead of the announcement for the Xbox One X, which is retailing at a whopping $499.
While in the normal progression of a console generation, ASPs would simply drop linearly over time, with this new paradigm, ASPs will begin to decline in the gaps between hardware iterations and then pop with the release of those iterations. This constant stream of consoles will make for more stable APU-related profit margins for AMD as the amplitude between the highs and the lows of console ASPs shrinks drastically.
Lastly, the shorter duration between console iterations will speed up the price discounting process and offer consumers more choices at various price points. This development could boost overall console sales as opposed to discounting a single console linearly because the consumers that buy premium products and always want the next cool thing have options (like the Xbox One X) and those consumers that want a low priced but powerful console can buy a $280 Xbox One or Xbox One S.
Similar comparisons can be drawn between the PlayStation 4 and the PlayStation 4 Pro. With enough time, the console market will become layered like the PC and smartphone market where one can buy whatever type of product they want: low-priced and low-performance, high-price and high-performance, and all other combinations one could ask for.
Ultimately, I think console makers will benefit from this move to a steadier stream of console releases because, in the end, consumers will buy new products just because they’re new, whether they need them or not. It’s why Apple (AAPL) can make durable, long-lasting smartphones and still sell hundreds of millions of units every cycle. Perhaps console makers should have come to this realization sooner, but regardless, this is where we now stand.
I think the new paradigm for selling consoles will increase total sales, increase ASPs, and smooth out revenue and profit margins for console makers and their suppliers. As the console processor king, AMD stands to reap the benefits of this transition, which I think will be a nice complement to its desktop and server CPU and GPU business segments.
APUs aren’t often talked about with AMD perhaps because so much of focus has been on Ryzen, Epyc, Vega, and other upcoming developments, but this is one area where AMD is dominating and where the company can see consistent, profitable results in the near future due to the shift in console releases currently underway.
APU sales from consoles led AMD to its highest quarterly revenue output in the last three years, demonstrating how significant its success could be to AMD’s recovery efforts going forward. I continue to view AMD stock as a Strong Buy due to Epyc’s potential in the server market, Vega’s promising results in the GPU market, Ryzen’s performance in the desktop CPU market, and, lastly, the paradigm shift in console releases, which I expect to boost AMD’s semi-custom revenue and margins to the benefit of the company as a whole.
Best of luck!
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Disclosure: I am/we are long AMD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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