Column: ATI and the big picture

by Mathew on August 30, 2005 · 2 comments

Here’s a column I posted at globeandmail.com about ATI:

“By now, anyone who follows the computer-graphics chip market — which is effectively a triumvirate made up of Toronto’s ATI Technologies, U.S-based Nvidia Corp. and computer-chip giant Intel — knows that it can be a roller-coaster of a business. Since both ATI and Nvidia are constantly coming out with newer leading-edge chips, who is on top can change rapidly. In one quarter, ATI will have the hottest chip (which in turn usually commands the highest profit margins) and Nvidia will be playing catch-up; a couple of quarters later, the positions will often be reversed.

Last year, for example, Nvidia was the one who was late to market with a competing chip, and ATI was getting all the glory. Now, ATI looks like it is behind the eight ball on the high end of the graphics market and its margins are suffering as a result, which led to the company’s latest sales and profit warning. Meanwhile, Intel is hammering away at the lower end of the market — “integrated� chips used in laptops and desktops — which has been one of ATI’s core businesses. And since newer chips come out so frequently, older products have little longevity, which means they have to be discounted heavily just to get them out the door.

All of those factors are at play in ATI’s latest revision to its sales and profit estimates, a downgrade that hit the stock price fairly hard on Monday. This is the second time in a row the company has cut its estimates, and it was clear that some investors were spooked by the news: the shares fell by as much as 14 per cent in after-hours trading. They rebounded on Tuesday, however, and by midday were higher than they were on Monday before the earnings announcement. By the end of the day they were up 3 per cent.

Although the news from ATI was worse than expected, several analysts said there are signs that the stream of bad news might be coming to an end soon. By reducing its estimates for the second time and taking a large writeoff on excess inventory, some said that ATI was actually putting itself in a better position for future quarters. When combined with the push from new products such as Microsoft’s Xbox 360 and Nintendo’s Revolution, that could bode well for the next year or so.

In its revised outlook, the company said it is now looking for sales of $465-million (U.S.) to $480-million, which is down substantially from its earlier estimate of between $550-million and $580-million. And that earlier estimate was a downward revision from a previous target of more than $600-million. In its Monday release, ATI also said that its gross profit margins would slide to the single-digit level from the 30-per-cent range, as a result of its $60-million inventory writeoff.

Once those factors are out of the way, however, some analysts say things should start looking up for the company. Bear Stearns reduced its profit targets after the news, but maintained its “outperform� rating on the stock, saying most of the risks are out of the way and that the “risk-reward for the stock is attractive.� Credit Suisse First Boston said the current quarter “looks like a bottom,� and that there’s a good chance ATI will be able to recoup some of its losses in the desktop graphics market over the next couple of quarters.

Deutsche Bank, meanwhile, maintained its “buy� rating on the stock despite the bad news, pointing out that the shares are down more than 40 per cent since the beginning of the year. The firm also noted that there are “multiple positive catalysts� for the coming quarter — including the launch of ATI’s newest high-end desktop chip, the R520 — and that the “kitchen-sinking� effect of the writeoff would also help buoy the company’s results. On a price-to-sales basis, Deutsche Bank said the stock is about as low as it usually gets when it bottoms out.

As bleak as the latest revision makes things seem, ATI’s laptop and other businesses are looking fairly healthy, including its growing line of mobile graphics chips (for use in cellphones and PDAs) and its high-definition TV chips. The losses — in both market share and profit margins — have been primarily in the desktop market. To the extent that mobile devices are becoming more important than desktops, ATI still looks like it could be a potential winner. American Technology Research said that it believes the company “is a turnaround story after its recent problems and is poised for growth heading over the next 12 to 18 months.�

Obviously, the graphics chip roller-coaster could fly off the tracks at some point. But until there are signs of something truly catastrophic happening at ATI, the odds are that it will recover from its latest downturn — and so will its shares.”

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