Advanced Micro Devices (NASDAQ: AMD) recently made an important announcement in the firm's efforts to catch up with Nvidia (NASDAQ:NVDA) in the data center market. The semiconductor company announced that it will acquire the firm ZT Systems in a nearly $5 billion transaction.

So how does this purchase affect AMD’s competitiveness in the data center market, and how should this affect investors' views of Nvidia? Before we answer those questions, let's get a broader overview of AMD’s operations and sources of revenue to put this move in context.

AMD: Growing its Data Center Revenue

AMD breaks down its business into four reportable segments. They are: Data Center, Client, Gaming, and Embedded. All the segments sell similar overarching products: computer processing units (CPUs), graphical processing units (GPUs), accelerated processing units (APUs), and other related products. However, they sell different versions of these products to the different customer segments based on their needs.

The Data Center segment needs the most powerful devices, including AI accelerators. They are used to run AI and machine learning tasks efficiently. The Client segment makes CPUs for personal and enterprise computers, while the Gaming segment makes GPUs for personal computers.

Embedded products are devices that may be put into tools for specialized use within an industry, such as to address computing needs in cars or medical devices.

In 2023, the percentage of total revenue generated from each segment was relatively even. Data Center made up 29%, Gaming was 27%, Embedded was 23%, and Client was 21%. However, through the first six months of 2024, Data Center is taking a commanding lead in revenue share, accounting for nearly 46%.

AMD Looks to Compete with Nvidia’s “Systems Approach”

With this acquisition, AMD is attempting to gain ground on Nvidia in the data center GPU market. In 2024, AMD expects to bring in $4.5 billion in revenue from this product type. This is a far cry from the $100 billion in data center revenue analysts expect Nvidia to bring in.

ZT Systems mainly makes revenue from selling hardware, including custom servers and server racks. The company is vertically integrated to a certain extent; as well as designing its hardware, it also manufactures it. AMD says it will sell the manufacturing part of the business, as this is not an area it wants to be largely involved in.

The crux of the deal seems to be around the know-how that ZT Systems can bring to Nvidia. Nvidia has made buying its technology particularly attractive for hyperscaler companies investing in AI. This is due to the “systems” approach Nvidia takes, where the software, networking tools, and server racks all come packaged together. These bundled products can lower costs for customers and help make sure that all the connected parts work well together.

It also allows Nvidia to have sky-high margins. The company’s operating margin of 60% is higher than 95% of all publicly traded companies in the world, according to Koyfin data. This makes sense. Customers are willing to pay up for these hugely expensive AI investments to ensure reliability, and to make sure they move quickly enough to keep up with their competitors.

Outlook for AMD

AMD is hoping this takeover of ZT Systems can position it as a true alternative to Nvidia. If it can do this, Nvidia’s margins will have to come down due to the increased competition. The quicker AMD can integrate ZT's expertise, the faster it can level the playing field with Nvidia. However, it still has a very long way to go.

The company may have to consider making further acquisitions. One analyst is particularly bullish on the purchase; however, others say AMD still has a significant disadvantage in software compared to Nvidia.

AMD will use around $3.7 billion in cash to finance 75% of the deal, which will come off its balance sheet in the coming quarters once the deal closes. Based on the current cash balance, this would drop the firm's cash to $2.1 billion.AMD brought in an average of $340 million in free cash flow over the last four quarters. So, it would be a while before they could build up enough cash to make a similarly sized acquisition again without using other forms of financing.

For now, investors should stay abreast of reports regarding the integration with ZT and new product offerings it might unveil to compete with Nvidia’s “systems approach." However, Nvidia is still the top dog in the data center space.

Source MarketBeat