Driven by strong demand for its quad-core Tegra 3 processors and the energy efficient Kepler architecture, Nvidia (NVDA) posted record revenues of $1.2 billion and marked a 7.3% year-over-year growth in its net income in Q3 2012. It is set to announce its Q4 2012 earnings on Feb. 13. While Nvidia maintains a cautious outlook for Q4 on account of seasonal factors and the persistent weakness in the PC market, we believe in the company's long-term growth potential. With increasing revenue contribution from the non-PC business segment and its leadership in the GPU market, we feel that Nvidia has strong fundamentals to support a higher valuation (see "Nvidia Is Worth $19 Despite Its Vulnerability To The PC Market").
Increasing Non-PC Revenues
While the slowdown in the PC market has impacted many of its competitors such as Intel (INTC) and AMD (AMD), we think Nvidia's growing focus and success in the mobile computing space has cushioned the negative impact of lower PC shipments on the company's growth rate. Non-PC revenue accounted for 30% of its overall revenue in Q3 2012, compared to 7% three years ago.
Nvidia's Tegra business has increased 50% over last year. While its tablet business has almost doubled, its progress in smartphones remained more or less stable in 2012. Tegra 3 quad-core processors powered many of the world's popular devices in 2012 -- Google's Nexus 7, Microsoft's Windows RT Surface tablet, Lenovo's IdeaPad Yoga 11, Fujitsu's ARROWS X, the world's first Windows RT tablet by Asus, etc.
Last month Nvidia introduced its much-anticipated Tegra 4 processor, which not only offers six times the GPU horsepower of Tegra 3, but unlike its predecessor is also LTE compatible. With an optional chipset, Tegra 4 offers worldwide 4G LTE voice and data support. We believe that the LTE compatible chipset will better equip Nvidia to challenge Qualcomm's (QCOM) growing dominance in smartphones, helping it increase its penetration in the market (see "Tegra 4 Could Spur Nvidia’s Smartphone Penetration"). Apart from tablets and smartphones, Nvidia expects Tegra's use in infotainment and navigation systems of cars will help drive revenue growth from the automotive business as well.
Introduction of Kepler Architecture Will Help Retain GPU Dominance
In mid-March last year, Nvidia launched its new Kepler GPU architecture, which is the first architecture to include virtualization technology built right into the GPU. The company claims that Kepler is its most efficient GPU architecture to date and expects the same to translate into more market share and higher margins. Owing to new Kepler desktop products and Ivy Bridge platform for notebooks, Nvidia's GPU business posted a 10.7% sequential and 14.7% year-over-year increase in Q3 2012.
Nvidia claims to have increased its market share in the premium segment with Kepler as part of the Ivy Bridge design cycle. Additionally, in Q3, it introduced the world's first cloud-based GPU built on the Kepler architecture. Starting with desktops and notebooks, Nvidia intends to roll out Kepler into all of its businesses.
Apple (AAPL) refreshed its desktop offerings with Nvidia's Kepler based discrete graphics solution in October 2012. We believe that given its high-end graphic performance, Nvidia will be able to retain its foothold in its core business of GPUs for both desktop and notebook graphics.
Decline in the Quadro Business Is a Short-Term Trend
Nvidia's professional solution business registered a 4.2% year-over-year decline, on account of weak demand for its Quadro products in Q3 2012. Weakness in the global workstation market on account of macro headwinds and the delay in the Romley platform, which could have held back purchases, are the prime things that contributed to lower revenues from the Quadro products.
Nvidia believes that the softness in demand is on account of enterprise weakness and claims to have witnessed stable ASPs and market share for its professional GPUs. 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 witness strong demand as the workstation market recovers.
We will update our price estimate of $19.14 for Nvidia after the Q4 2012 earnings release.
Disclosure: No positions.