Better Bad News Buy: Advanced Micro Devices Inc. or Qualcomm Inc.?

By Markets Fool.com

Chipmakers AMD and Qualcomm have certainly seen better days. Shares of AMD have fallen over 40% in the past 12 months, while shares of Qualcomm are down over 10%. On the other hand,Intel-- which competes against AMD in x86 CPUs and Qualcomm in mobile chips -- is up nearly 25%.

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However, bottom-fishing investors might be wondering if AMD or Qualcomm make good contrarian picks. Let's take a look at both companies to see which one is a better "bad news buy."

AMD: Stuck between two giants
A decade ago, AMD realized that it could not compete directly against Intel and its dominant market share in x86 chips. As a result, AMD acquired graphics card maker ATI in 2006 to diversify its top line with high-end graphics cards and APUs. But between the fourth quarters of 2013 and 2014, Nvidiaincreased its market share ofadd-in graphic boards from 65% to 76%, according to research firm JPR. AMD saw its share fall from 35% to 24%.

To avoid being crushed between Intel and Nvidia, AMD focused on strengthening its Enterprise, Embedded, and Semi-Custom (EESC) segment, which includes server and embedded processors, SoC products, engineering services, and royalties. The EESC unit received a major boost when Microsoft and Sony put its SoCs in the Xbox One and PS4, respectively.

Microsoft Xbox One. Source: Microsoft

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As a result, the EESC unit grew as its CPU and GPU businesses faded. But as investors saw during the first quarter, growth in the EESC unit is also slowing down:

% of Revenue
First Quarter 2015

Year-Over-Year Growth

Computing and Graphics

52%

(38%)

EESC

48%

(7%)

Source: AMD Filings

Average selling prices fell across the board. As a result, the computing and graphics unit posted an operating loss of $75 million, down from a profit of $3 million a year earlier. Operating income at EESC plunged 47% year-over-year to $45 million.

Qualcomm: an existential crisis
Qualcomm is one of the largest manufacturers of mobile SoCs and wireless modems in the world. That puts it in a solid position to profit from the growth of the smartphone industry, but it also has a glaring weakness: Qualcomm depends on Appleand Samsungfor roughly half of its revenue.

In the past, Qualcomm provided the wireless modem for Apple iPhones, and SoCs and wireless modems for Samsung flagship Galaxy devices. But both companies are now moving to cut Qualcomm silicon out of their handsets. Apple will reportedly use its own wireless modem or an Intel one in a variant of its next iPhone. Samsung replaced Qualcomm Snapdragon processors with its own Exynos SoC in its latest S6 handsets and installed its own Shannon wireless modem.

Samsung has its own chipmaking business which is also a threat to Qualcomm. Samsung, Apple, and Qualcomm all license mobile chip designs from ARM Holdings. But unlike either company, Samsung has a foundry which accepts manufacturing contracts from other OEMs. Apple, for example, recently contracted Samsung to manufacture its upcoming A9 chips. Meanwhile, the Samsung Exynos processor has found its way into other smartphones fromMeizu and ZTE, which both also use Qualcomm chips.

A few Qualcomm-powered devices. Source: Qualcomm

In response, Qualcomm shifted its focus toward emerging markets with "turnkey" solutions for smaller OEMs. These package deals let OEMs bundle Qualcomm hardware and software together, which reduces the development and manufacturing costs of new phones. However, the pricing power that came with that strategy was considered anticompetitive in China, which resulted in a $975 million fine last year. That fine caused net income to plunge 46% year-over-year last quarter.

Qualcomm does not expect things to improve anytime soon. It recently slashed its full year revenue and earnings outlook, blaming Apple and Samsung for those adjustments.

Prior year

Previous FY15 Guidance

Revised Guidance

Revenue

$26.5B

$26.3B to $28B

$25B to $27B

EPS

$5.27

$4.85 to $5.05

$4.60 to $5.00

Source: Qualcomm

The winner: Qualcomm
It is tough to pick between two losers, but Qualcomm is a safer bad news buy for three reasons.

First, Qualcomm is still profitable. The fine in China took a bite out of its GAAP earnings, but excluding that charge, its non-GAAP net income rose 4% annually last quarter. AMD was not profitable on any basis last quarter. Second, Qualcomm stock is relatively cheap at 14 times earnings, compared to the S&P 500 average price-to-earningsof 21 times and the industry trailing average of 48 times.

Third, Qualcomm could bounce back if it diversifies its top line away from Apple and Samsung. Moreover, the commoditization of the smartphone market -- which harms those leading players -- is a positive development for Qualcomm, since it means smaller OEMs will require turnkey solutions. AMD, however, does not have an easy way to diversify away from its core businesses. Lastly, Qualcomm pays a respectable 2.9% dividend and has raised it for 11 straight years. There is little chance AMD will ever pay a dividend.

The article Better Bad News Buy: Advanced Micro Devices Inc. or Qualcomm Inc.? originally appeared on Fool.com.

Leo Sun owns shares of Apple. The Motley Fool recommends Apple, ARM Holdings, Intel, and Nvidia. The Motley Fool owns shares of Apple and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.