Despite being in-line with changing consumer trends and performing relatively well in the tough macro environment, Nvidia’s (NVDA) stock price has declined by close to 24% since February this year. While the company continues to post higher earnings quarter over quarter, the uncertain PC end market demand and rising operating expenses have restricted its growth rate.
Though Nvidia seems to be faring well in the rapidly growing tablet market, it remains highly sensitive to any adverse development in the PC market as it derives a majority (85%) of its revenue from the PC segment. However, we feel that the current slump in the stock value gives Nvidia a valuation hard to ignore. With a price estimate of $19.14, we believe that Nvidia has all the right ingredients to support a higher valuation.
Decline in Quadro Business Is a Temporary Phase
With around 27% contribution to Nvidia’s valuation, the professional graphics solutions segment is the most important division in the company’s portfolio. Though the business was up 12.5% sequentially in Nvidia’s Q3 2013 earnings, due to the first shipment of its Kepler-based Tesla products, the segment registered a 4.2% y-o-y decline on account of weak demand for its Quadro products.
Nvidia believes that the softness in demand is on account of enterprise weakness led by the weakness in the global workstation market and the delay in the Romley platform, which could have held back purchases. Nevertheless, amid the soft macro conditions, the company claims to have witnessed stable ASPs and market share for its professional GPUs.
Accounting for 80% of the market, Nvidia remains the dominant player in professional GPUs. While we estimate a slight decline in its market share over the years, we expect the company to retain its leadership in the segment for years to come.
With the upcoming Kepler Quadro products and new capabilities like Maximus, which enables both modeling and simulation in one workstation, we believe the company will see strong demand as the workstation market recovers.
Discrete Graphics Remain A Popular Choice For High-End Gaming
While many might argue that the significant improvement in Intel’s integrated graphic chipsets might threaten Nvidia’s dominance in discrete desktop and notebook graphics, we feel the increasing popularity of high performane GPUs for high end gaming will enable Nvidia to retain its foothold in the GPU market.
Though integrated graphics turn out to be cheaper and might provide an enhanced battery life, discrete graphics remain the preferred choice for gaming applications as the games become more advanced. Better image quality and higher performance are important criteria for gamers, and we expect Nvidia’s leadership in these qualities to help the company retain its foothold in the growing gaming market.
Nvidia and AMD (AMD) are the two main players in the discrete graphics market. Though Nvidia remains the market leader in both dektop and notebook discrete GPUs, we feel that the close competition between the two companies would make any significant market share gain by either unsustainable in the long run. Thus, we estimate Nvidia to retain its market share till the end of our forecast period.
Potential Risk – Downward Pressure On Prices
While we have assumed stable pricing for the professional as well as discrete desktop and notebook GPUs over time, there is a possibility that the prices may not rise as much as expected in the current year and might even slightly decline next year onwards. With PC shipments being fueled by growing demand from emerging markets, AMD is likely to resort to some price competition in order to gain a stronger foothold. Thus, to retain its market share, Nvidia might resort to price cuts in the future.
Expanding Footprint In The Mobile Computing Market
Mobile devices are the fastest growing segment in the computer industry. 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 total mobile devices sales, smartphone shipments stood at 472 million units in 2011, a 58% increase from 2010.  The smartphone penetration in the overall mobile device market is expected to further increase in the future.
Nvidia did well with its standalone dual-core app processor, Tegra 2, to capture significant non-iPad tablet market share in 2011. However, the launch of Tegra 3, the world’s first quad-core processor, is what gave the company’s mobile computing plan a significant push by scoring high profile design wins this year - Google’s Nexus 7, the world’s first $199 quad-core 7-inch tablet, Microsoft’s Windows RT Surface table, World first RT device by Asus, etc.
Nvidia’s Tegra business has witnessed a 50% y-o-y growth so far this year. However, tablets continue to remain the most important driver for Nvidia’s success in mobile computing as its progress in the smartphone market remain more or less stable. However, we feel that might change soon as the company is expected to showcase its new Tegra system-on-chip (Tegra Grey), which features built in 3G and 4G/LTE communication technologies, along with the next generation Tegra 4 processor, at the 2013 Consumer Electronic Show in January.
4G/LTE is the future of wireless connectivity for mobile devices, especially smartphones, and a dominance in the production of LTE chips has enabled Qualcomm (QCOM) to lead the smartphone market so far. We believe that Nvidia’s upcoming Tegra LTE chipset integrated into Tegra processors will help the company increase its penetration in the smartphone market. Additionally, the upgraded Tegra processors could help it score additional design wins as manufacturers continue to roll out new tablets designs in the coming year.
We forecast Nvidia’s Tegra revenues to cross the $2 billion mark by the end of our forecast period.
Potential Risk – Increasing Competition & Lower Margins
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 not 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, Marvell, MediaTek (which recently unveiled its first quad-core chipset) and the relatively new entrant Intel (INTC), Nvidia also faces competition from leading handset manufacturers – Apple (AAPL) and Samsung (OTC:SSNLF) – which design their own chips in-house and could end up selling them to other device manufacturers in the future.
Also, the intense competition in the market puts a downward pressure on margins. Operating margins for 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, 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 will increase profit margins.
Nvidia’s Expected Entry in the PC Microprocessor Market
The estimated revenue stream from Nvidia’s expected entry in the PC microprocessor segment contributes close to 6% to our current price estimate for the company. Nvidia is developing ARM-architecture based CPUs (code-named Project Denver), which could challenge the x86 CPU architecture that currently dominates the desktop, notebook and server CPU markets. Nvidia’s ARM-based CPUs are expected to come to market in 2013 and, if successful, could be an industry disrupting move by the company.
We see Nvidia’s share in the PC microprocessor market reaching 1.6% by the end of our forecast period.
Potential Risk – One of the primary risks is the failure of project Denver. If the project does not take off in 2013 or fails to reach the expected market share of 1.6% by the end of our forecast period, we could see some downside to our price estimate.
Our price estimate of $19.54 for Nvidia marks our valuation at a close to 50% premium over the current market price.
- Gartner Says Worldwide Media Tablets Sales to Reach 119 million Units in 2012, Gartner Press Release, April 10, 2012
- Gartner Says Worldwide Smartphone Sales Soared in Fourth Quarter of 2011 With 47 Percent Growth, Gartner Press Release, February 15, 2012
- Nvidia still has a lot to prove in the mobile market, CNET, November 9, 2012
Disclosure: No positions