Why AMD is putting its chips in one basket

What lies behind the microprocessor mega-merger of AMD and ATI? silicon.com sister site CNET News.com's Michael Kanellos explains the key to the deal is a move towards integrated chipsets.

Why is AMD laying out billions of dollars to get into the often-painful world of making computer graphics chips? Because Moore's Law never sleeps.

If AMD's shareholders approve the $5.4bn purchase of ATI Technologies, AMD will become the largest maker of standalone graphics chips on the planet and one of the largest producers of integrated chipsets. It may also give AMD early access to Intel product plans.

The key to the deal, however, is that it will give AMD the internal know-how to devise processors with integrated graphics and communications capabilities. That so-called system-on-a-chip would effectively provide all the intelligence a handheld device or low-end PC might require. In addition, the company will be able to do chipsets with integrated graphics and video chips for digital TVs - products that Intel makes now.

When it announced the ATI deal on Monday, AMD said it hoped to come out with processors with integrated graphics, and with chipsets with integrated graphics, by 2008. AMD already makes processors with built-in memory controllers that connect the processor to memory.

Dean McCarron, the principal analyst at Mercury Research, said: "They want some of the integration possibilities that ATI gives them. There's a number of reasons against this deal, and there is not as much fit in the short term. But if you look long term, you can make a bigger argument for it."

Hector Ruiz, AMD's chief executive, said during a conference call on Monday with analysts: "Visual computing is playing a larger role in what we are doing going forward."

Graphics integration is inevitable, given the relentless pace of the chip industry, analysts and others said. Under Moore's Law, the number of transistors on a chip should double every two years.

That's a lot of transistor to digest. Many times, designers consume the "new" transistors by increasing the internal memory pool, or cache, or by beefing up the performance of existing blocks on the chip.

But many times, they integrate existing chips into the main processor. Early PCs had a thing called a maths co-processor, which years ago was absorbed into the processors. The 512K cache on the first Pentium IIs consisted of separate memory chips located near the processor and cost $20 to add. The cache on the current Core Duo chips is eight times as large, is part of the larger chip and the whole thing costs less to manufacture.

Graphics have already been put into chipsets, and many in the industry have been waiting for graphics to appear more frequently in processors.

Dave Epstein, a partner at Crosslink Capital, said: "It has always been thought that the graphics chip would get integrated into the processor." Epstein founded Raycer Graphics, which he sold to Apple in 1999.

Where and how you add graphics depends on the market, Epstein added. Putting graphics in the chipset simplifies processor design but the manufacturer then has to make different chipsets for different segments of the market.

While integrated parts don't typically perform as well as standalone chips, the difference often become irrelevant after a few years. Back in 1998, Intel scared graphics chip companies when it decided to sell standalone graphics chips.

The chips sold miserably, and Intel got out of the business the next year. However, it continued to make chipsets with integrated graphics. In a few quarters, Intel became the largest graphics chipset vendor in the world, a title it still holds today.

Other companies have tried similar combinations in the past. Cyrix came out with the MediaGX, which had integrated controllers and graphics. Intel also designed, but never released, Timna in 1999 - which had integrated graphics and a memory controller.

Neither product succeeded but not because integration wasn't a good idea. Cyrix, which got bought by National, rarely landed design wins with customers, and the performance of its processors typically lagged.

Timna was doomed because the integrated memory controller connected to memory based on designs from Rambus. The memory was supposed to become the standard for PC memory but manufacturing problems, high prices and other issues grounded it.

Mercury Research's McCarron said: "Ironically, AMD's product will end up looking a lot like Timna."

Additionally, AMD will also become a graphics chip maker, which can be a mixed blessing. For years, graphics chips have been one of the toughest markets to make money on in the silicon business. According to McCarron and others, chipmakers have had to come up with an entirely new generation of products about every six months, which is faster than processor manufacturers must do.

To make it worse, graphics chips sell for a lot less than others.

In the late 90s, there were more than 40 graphics chip designers. Most lost money. A series of closures and mergers left the market down to two players: ATI and its rival, Nvidia.

The personalities of the two differed. ATI billed itself as the PC manufacturer's friend, coming out with relatively inexpensive chips on time. Nvidia touted itself as the gamers' choice.

Since then, ATI and Nvidia have grown and largely remained profitable but the level of competition hasn't abated. ATI, number one in the internet era, had to delay a few products, and then Nvidia took the lead. Nvidia also got the contract for Microsoft's Xbox game console. Then, whoops, Nvidia fell off the six-month treadmill, and ATI retook the lead.

Margins remain somewhat tight. In its fiscal 2005, ATI sold $2.2bn worth of chips and make only $17m, in part because of inventory write-downs. A lot of ATI chips end up in Intel-based computers, so that business might shrink. In the most recent quarter, ATI sold $652m in chips and made $31m.

Another ancillary benefit of the deal is that it may give AMD early access to Intel product plans. ATI provides Intel-compatible chipsets. To make chipsets, manufacturers have to be briefed early on processor design and other issues. AMD lawyers may argue one day that excluding ATI-AMD from these meetings constitutes an antitrust violation.

Then again, licensing contracts are thick. Many contain change-of-control provisions stating, essentially, that intellectual property licences don't pass to the new owners. AMD already has its own dense, licensing contract with Intel, which gets renewed soon, and that may have a provision neutralising any neutralising clause in Intel's contract with ATI.

Right now, the answer is up in the air.

An Intel spokesman said: "We are evaluating everything. We've got to look at the proposed transaction."

Michael Kanellos writes for CNET News.com