While the slowdown in the PC market has impacted many of its competitors such as Intel (NASDAQ:INTC) and AMD (NASDAQ:AMD), we believe Nvidia's (NASDAQ:NVDA) growing focus and success in the mobile computing space has cushioned the negative impact of lower PC shipments on the company's growth rate. Judging by Nvidia's record revenue and margins last quarter, it looks like its investment in new growth strategies is paying off well. (Read Earnings Article: Nvidia's Tegra 3 & Kepler Architecture Fuel Results And Bright Outlook)
While non-PC revenue accounted for a mere 7% of Nvidia's overall revenue three years ago, the percentage contribution has gone up significantly to 30% as of Q3 2013. Nvidia's consumer business marked 27.6% y-o-y growth last quarter primarily on account of robust growth in Tegra shipments.
However, despite Nvidia's growing success in the tablet market, its stock price has declined by over 30% since February this year. Though the company continues to make a mark in the mobile chip business, the GPU segment, with over 60% contribution to its valuation (as per our estimate), remains the most important division for Nvidia. Thus, the company's stock price is highly sensitive to any adverse developments in the PC market.
As per our estimate, the Tegra business accounts for only 5.6% of Nvidia's valuation. While Nvidia's success in the mobile chip business is an encouraging trend, its leadership in the GPU business is what supports a higher valuation for the company.
In this article we analyze Nvidia's current position in the mobile chip market and to what extent success in the market can uplift its stock price.
Growth potential in smartphones and tablets
Research firm Gartner estimates global sales of media tablets to increase by 98% this year, from 60 million units in 2011 to 119 million units in 2012, and reach close to 370 million units by 2016. 
Accounting for 31% of the total mobile devices sale, smartphone shipments stood at 472 million units in 2011, a 58% increase from 2010.  While global mobile phone sales have registered a slight decline (-2%), smartphone sales have shown robust growth (44%) so far this year.   We believe the number of upcoming high-profile launches from key manufacturers later this year will further drive smartphone growth in the future. We estimate the smartphone penetration in the overall mobile device market to reach up to 50% in the next few years.
With the increasing popularity of both smartphones and tablets devices, mobile devices are slated to replace PCs as the driving force for the semiconductor industry in the future.
When did Nvidia enter the mobile chipset market? What percentage of its business does the segment account for?
Last year Nvidia began a focused push into mobile computing with its dual-core Tegra 2 processors, which featured in close to 15 devices. After almost 200% growth in revenue from Tegra processors, Nvidia launched the world's first quad-core mobile computing chip, Tegra 3, this year, which excels more than two times in speed and performance compared to Tegra 2.
Tegra 3 quad-core processors have scored significant design wins so far and power many of the world's popular devices - Google's Nexus 7, Microsoft's Windows RT Surface tablet, Lenovo's IdeaPad Yoga 11, Fujitsu's ARROWS X, World first RT device by Asus, etc. The Tegra3 processor is expected to power around 30 devices in 2012. 
While the Tegra processors business marked 50% y-o-y growth, tablets were up by almost 100% and remain the most important driver for Nvidia's progress in the mobile computing space. When it comes to smartphones, the company's progress remains more or less stable with only a few design wins such as the HTC One X and LG Optimus 4X, to its credit.
In 2011, revenue from Tegra sales accounted for 15% of Nvidia's overall revenue. However, with the slump in PC shipments and high profile design wins for Tegra 3 processors, we expect the revenue contribution to significantly increase this year and estimate the proportion to continue increasing for the rest of our forecast period.
Qualcomm Remains a Big Threat
With most of the high-end flagship smartphones supporting LTE, Qualcomm (NASDAQ:QCOM) continues to lead the smartphone market as it largely dominates the production of LTE chips. While Qualcomm's standalone application processor is similar to Nvidia's Tegra processors, its chips come with integrated wireless capabilities such as LTE. The LTE leadership has allowed Qualcomm to command the majority of the smartphone market. For example, Samsung's Galaxy S III and HTC's One X series had to be launched in the U.S. with a Snapdragon core since rival chipsets did not play well with Qualcomm's LTE basebands.
Additionally, with Qualcomm coming up with its own quad-core S4 Pro chipsets, Nvidia's advantage of offering the world's first quad-core processor might nor sustain for long. While Nvidia expects to ship around 30 million Tegra processors in 2012, Qualcomm shipped 141 million chipsets in its fiscal Q4 2012 alone. 
In addition to Qualcomm, Nvidia also faces competition from leading handset manufacturers - Apple and Samsung - which design their own chips in-house and could end up selling them to other device manufacturers in the future.
Acquisition of Icera Could Help Tackle Competition
During Q2 2012, Nvidia completed its acquisition of Icera, an innovator of baseband processors for 3G and 4G cellular phones and tablets. Icera's high-speed wireless modem products have been approved by more than 50 carriers across the globe. With Icera on board, Nvidia has been focused on developing its 4G LTE application processor.
4G/LTE is the future of wireless connectivity for mobile devices, especially smartphones, and we believe that Nvidia's upcoming LTE chipset integrated into Tegra processors will help the company expand deeper into the smartphone market. Last month Nvidia scored a big win from HTC's One X+ smartphone to be sold by AT&T, which makes AT&T the first US carrier to approve Nvidia'sTegra 3 with 4G LTE for its network.
Nvidia Needs To Increase Tegra Margins
Operating margins from Nvidia's Tegra business have remained negative since 2008. The company is relatively new to this business and has still not established a wide enough sales base to be profitable. However, given the increasing number of product wins by Tegra 3 this year, we expect margins to turn positive next year onwards.
As Nvidia ramps up production volumes of its Tegra chips, we expect it to increase its profit margins for mobile phone graphics. Higher volumes and focus on a single product line will yield improved utilization levels, which in turn would increase profit margins.
The Tegra segment currently contributes a negative 8% to Nvidia's operating profits. However, we estimate the segment to contribute as high as 17% by the end of our forecast period.
How much Of an Impact Does the Mobile Chip Division Have on Nvidia's Business?
We believe that Nvidia is well-equipped to leverage robust growth in the smartphone and tablet market. While the quad-core chipsets have enabled it to make a successful mark in the tablet market, we feel the upcoming LTE integrated application processors will help Nvidia make a deeper foray into smartphones. Additionally, Texas Instruments' (NASDAQ:TXN) exit from the application processor market earlier this year leaves room for Nvidia to win a higher market share in the coming years.
We estimate Tegra processors to surpass the $2 billion revenue mark by the end of our forecast period. We believe that Tegra's contribution to Nvidia's overall revenue could reach up to 28% by 2019 from the current level of around 15%.
However, while we believe that the revenue contribution from the GPU division will decline in the future, we estimate the same to account for a majority (close to 60%) of Nvidia's revenue. Thus, while a significant increase in Tegra sales could cushion the persistent weakness in the PC market, it might not be sufficient to make a meaningful impact on Nvidia's stock price.
Our price estimate of $20.45 for Nvidia is at a premium of over 60% to the current market price. Notes:
Our price estimate of $20.45 for Nvidia is at a premium of over 60% to the current market price.