NVidia: Much More Than The Power Behind Gaming Computers

Sep.19.13 | About: Nvidia Corporation (NVDA)

NVidia (NASDAQ:NVDA) , the American tech giant; founded in 1993, publicly listed in 1999 at an IPO of $12 per share, and fourteen years later, trading at $15.80, down from just over $33 prior to the GFC. The company has come far since the release of its pilot product, the NV1 in 1995. Although its first product may have been considered as a failure by many, today NVidia is the undisputed market leader in regards to graphics processing. The days when the company catered solely to the gaming market are long gone; today, NVidia's product mix consists of four product lines supplying advanced computing power to not only gamers, but to researchers, users of motor and aero vehicles alike, and of course mobile devices.

NVidia, depending on who is asked, is commonly associated with gaming power. By the end of 2012, NVidia dominated with a 60% market share of the GPU (graphics processing unit) market - devoted to products associated with desktops and notebooks. While the given market share may be suggestive of the company's value, when one considers the entire market of which NVidia competes in however, it becomes apparent that although NVidia is the undisputed market leader in the sale of GPU segment, it has been slow to react to the changing nature of the computing industry; the rise of the mobile appliances and the continued contraction of the PC market. Overall, NVidia's market share is only 18% as at Q1 2013. In 2013, it is predicted that total desktop and notebook based sales will not substantially surpass a total of 300 million units, down from 340 in 2012, and even though NVidia's 60% market share is impressive, it is nevertheless rather insignificant when compared to the total predicted sale of mobile devices: 2.04 billion units.

See below for an overview of the total graphics chip market:

Market Share Q2

Market Share Q1

Market Share 2012

AMD

21.9%

20.6%

22.7%

Intel

62.0%

61.1%

62.0%

NVidia

16.1%

18.3%

14.8%

Click to enlarge

Source: 1 Jon Peddie Research (JPR)

As the PC market is forecasted to continue its decline, the mobile device market is set to expand by 8% in the coming year. Some may argue that NVidia is set to see revenue relating to GPU sales increase as the PC gaming world adapts to the competition of upcoming consoles. Although gaming has been a strong driver for revenue at the company during the past two decades, the current decade is one of changing demographic and cultural trends, trends that do not demand high end GPU products. A majority of NVidia's fans since the release of the NV1, generation Y, are aging, with the older fans now in their early thirties, many are no longer interested in the latest high end GPUs or pushing the FPS (frames per second) of titles such as Crysis (1,2,3) to their limits. The younger members of generation Y, and generation Z were not brought up in a world dazzled by NVidia's advancements; the transition into the mobile and social markets had already begun. Today, gaming has become increasingly social through a changed focus of the console industry, mobile and online networks such as Facebook, neither of which requires the power of NVidia's flag ship product, the GeForce GTX Titan to meet the needs of their audiences.

Given the changing nature of the market, is NVidia destined to become a specialized leader in a niche market, or will it be able to gain momentum against competitors AMD (NASDAQ:AMD) and Intel (NASDAQ:INTC) in the new mobile world?

Prior to a deeper look into the mobile world, it should be noted that NVidia has recently made a curious decision. The company did not make an offer to either Microsoft (NASDAQ:MSFT) or Sony (NYSE:SNE) in regards to the development of the upcoming, soon to be released, next-gen consoles. Rumor has it, consoles are not worth NVidia's time, and yet, the company produced its own hand-held console (NVidia Shield) this year. The product received a positive review; however, there are not enough gaming titles to suggest that it could possibly compete against products offered by Microsoft, Sony or Nintendo (OTCPK:NTDOY). To date, Sony has sold 79 million PS3 (Play Station 3) units. Although the market is considerably smaller than the PC and mobile markets, it is nevertheless still a product that NVidia profited from as the supplier of the GPU. This article cannot make reference to the arrangement between Sony and NVidia; however, it can be assumed that a licensing agreement in regards to the PS4 would result in revenue far greater than the associated development costs. In considering the contracting nature of NVidia's core market, it is interesting to consider as to why the company foregone the relationship with Sony. AMD was awarded the GPU development contract by both Sony and Microsoft for the upcoming consoles. Although NVidia has commented that the decision was due to the greater profitability associated with the mobile market, does it warrant a complete serve up of existing markets to competitor AMD, and at what impact will it have on its partnership with Sony and Microsoft?

NVidia stated that their focus will be on the mobile market. Samsung (OTC:SSNGY) and Apple (NASDAQ:AAPL) dominate the mobile market; however, neither player is a predominant user of NVidia products. Although NVidia products are seen in a few Apple products, most use Intel and Qualcomm (NASDAQ:QCOM) chips. AMD was awarded the contract for one of Apple's newest products; the Mac Pro. Between the two of them, Apple and Samsung have a collective 32% market share in the mobile phone industry (50% market share in the smartphone arena) and a 60% share in the tablet market. The remaining significant contestant is Nokia (NYSE:NOK). Although they do not hold a significant market share in the smartphone industry, in overall mobile phone sales, they do hold 2nd place, at 14%. Considering that Nokia (hardware) is now a subsidiary of Microsoft, will NVidia's recent decision to not be involved in the Xbox One (produced by Microsoft) development reduce the possibilities that it may one day be a supplier to upcoming mobile phones under the new Nokia management?

Given the brief suggestive comments in regards to NVidia's limited partnership options in the mobile and console industries, what remains to establish the company's value? From a product mix perspective, the declining PC sales relate to the company's GeForce chips and in the mobile market, Tegra. These two product lines are however not the only source of revenue streams for the organisation.

Tesla; parallel processing, the use of a chipset designed to allow the GPU to aid the CPU in high end computing tasks that are not commonly seen in personal devices. The product is used by supercomputers, oil and gas companies, higher education facilities, the military and for medical research. In these sectors, NVidia is virtually unopposed, at an 80% market share. AMD and Intel have far to go, their competing products; FirePro and Xeon are barely in the race; however, AMD has vowed to become a market leader in the PSB segment within the next two decades.

Quadro, high-end professional workstation processing, commonly used to design anything from shoes to aero planes. Again, NVidia is the dominant market leader, with an 80% market share.

In brief, NVidia's products in relation to national consumption appear to be under threat, while products relating to investment and government spending flourish. What impact do the product lines have upon the company's financial position?

See below for an overview of NVidia's P&L statement:
Legend:

GPU = Geforce, PSB = Quadro and Tesla,CPB = Tegra

Click to enlarge

Source: 2 - NVidia 10K 2013, pp. 103

Given its 60% market share of the desktop/notebook market, it is no surprise that the majority of its revenue is sourced from the sale of GPU products. Although it pales in comparison to the GPU income stream, the PSB sale of professional products accounts for 21.62% of total revenue and the CPB - the mobile sector accounts for 14.79%. While it is clear that the revenue originating from the mobile market has substantially increased during the previous year, it is still not turning a profit. It can be speculated that a reason for the trend may be due to high development costs and lack of economies of scale. While the GPU sales do account for the majority of the net revenue, the profit margin in the PSB product lines appear to be significantly greater than that of the GPU product line; 37.94% v. 20.78%.

Representation of total Operating Income

GPU

PSB

CPB

2012

81.15 %

50.58 %

(32.07) %

2011

11.79 %

125.88 %

(59.96) %

2010

(13.63) %

150.54 %

(141.74) %

Click to enlarge

As can be seen in the above table, even though the company's main source of revenue originates from its dominance in the GPU market, NVidia's operating income is primarily derived from the PSB market. It is no surprise that its CPB department is still operating at a loss; it is a well-known fact that it has had a hard time gaining a foot hold in the mobile sector, however, there is a clear observable trend suggesting that the company is well underway in regards to profitably positioning itself in the mobile market. Given NVidia's role as a market leader in some of the industries, it can be speculated that the possibility of increasing its share of the mobile market is conceivable. If NVidia can successfully shift its focus to the PSB and CPB related markets while retaining its position as market leader in a niche GPU segment, it is not unlikely that the company can remain profitable and achieve market dominance in the mobile markets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.