The Tegra tablet/smartphone processor product transition, along with declining PC shipments, negatively impacted Nvidia’s (NASDAQ:NVDA) top-line growth in the first half of fiscal 2014 (ended January 31st). However, despite lower PC shipments, Nvidia’s leadership in visual computing, gaming and professional graphics, as well as its positive performance in data center, fueled growth in the latter part of the year. Additionally, Nvidia’s Tegra revenues more than doubled sequentially last quarter, demonstrating the success of the new Tegra 4 products.
Nvidia maintains a flat outlook for its Q4 2014 earnings, which it will report on February 12. Nevertheless, we believe the company’s long-term growth potential is appealing. Strong sales of its high-end GPUs for PC gaming, increasing acceptance of the Kepler architecture in PCs, rising Tegra revenues, and deeper penetration in the data center, should all drive Nvidia’s future growth.
Our price estimate of $16.42 for Nvidia is almost in line with the current market price. We will update our valuation after the Q4 2014 earnings release.
Nvidia’s Tegra Revenue Will Expand In 2014
Nvidia’s Tegra processor revenues declined significantly in the first half of calendar year 2013. Much of the decline can be attributed to the ramp down of Tegra 3 products and the company’s conscious decision to delay the launch of Tegra 4 by one quarter, in order to pull up the production of Tegra 4i chips. However, Nvidia witnessed 110% sequential growth in Tegra processor revenues in Q3 2014 as it saw a rising number of Tegra-4 powered devices hit the market.
Tegra 4 is the world’s first quad-core processor based on Cortex A15, ARM’s most advanced CPU core, and consumes 45% less power than the Tegra 3 processor. Since the launch of the first phone (Xiaomi Mi3) using its Tegra 4 processor in September 2013, Nvidia has seen the list of Tegra powered devices grow significantly.
After much speculation, Nvidia finally introduced its Tegra Note, a reference platform for Android based tablets on September 18, 2013. A day after that HP (NYSE:HPQ) launched two new Tegra 4 powered tablets — the Slate 7 Extreme and the Slate 8 Pro. On September 23, Nvidia boasted yet another product win by announcing that Microsoft’s (NASDAQ:MSFT) next-generation Surface 2 tablet will be powered by Nvidia’s Tegra 4 processor. Nvidia has also received Tegra 4 orders for Asustek and Toshiba devices.
Last quarter, Tegra 4 shipped in more than 15 different mobile devices including those manufactured by Xiaomi, HP, Microsoft, Asus (OTC:AKCPF), Toshiba (OTC:TSHTF), Acer (OTC:ASIYF) and others. In addition to tablets and smartphones, the company aims to expand its reach to other large markets where visual computing matters such as auto navigation systems, TV set top boxes and new desktop foreign factors like all-in-one and smart monitors. Tegra 4 also powers Shield, Nvidia’s maiden attempt as a gaming hardware provider, which pitches it against console makers like Sony (NYSE:SNE) and Microsoft.
Leveraging its Tegra processors to tap growth in mobile computing is a key long-term growth strategy for Nvidia. Though the company expects Tegra revenue to decline by $200-$300 million in fiscal year just ended, we forecast revenue to grow by nearly 20% next year and cross $1 billion by the end of our review period.
PC Gaming Is Driving GPU Growth In Desktops & Notebooks
Despite Nvidia’s high dependence on the PC market, it has managed to grow its GPU business in the last few quarters. While PC shipments declined by 3.7% in 2012 (fiscal year 2013 for Nvidia), Nvidia’s GPU segment expanded by 2% and it reported a 7% rise in its total revenue. Year to date, the PC market is down 11%, but Nvidia’s GPU business is up 4% compared to the same period last year.
During the UBS Global Technology Conference in December 2013, Nvidia declared that the primary reason that it has managed to outpace the PC market is that it does not, and has not ever, addressed the bottom 70% of the market. Its main focus has been on those vertical segments within a broader computing market where visual computing matters the most, including gaming, PC gaming, professional visualization and design, high-performance computing, and big data analytics.  Its growing presence in the specialty PC and Compute markets (gaming PCs, workstation PCs, and high performance computing) is offsetting the declining trend in the mainstream PC market.
Nvidia sells its PC graphics to two key segments: 1) PC Original Equipment Manufacturers (OEMs), who use Nvidia GPUs to manufacture the final product; and, 2) gaming enthusiasts, who use GPUs in high-end and custom PCs to generate realistic and interactive graphics. While lower-end PC shipments to OEMs have slowed, the robust PC gaming market has contributed to higher GPU shipments, starting in fiscal 2013 and continuing in fiscal 2014 as well.
Nvidia’s GPU gaming revenues are up around 6% year to date compared to the same period last year, while mobile GPU gaming has more than doubled in the last two years. Even as overall notebook shipments have declined, Nvidia’s gaming notebook revenue more than doubled in the last two years.
PC gaming represents almost 40% of the worldwide gaming market, which is higher than consoles, phones, tablets or any other individual gaming segment, and we believe it will continue to drive Nvidia’s GPU shipments. 
- Nvidia’s Management Presents at UBS Global Technology Conference (Transcript), Seeking Alpha, November 22, 2013
- Nvidia’s CEO Discusses F3Q 2014 Results – Earnings Call Transcript, Seeking Alpha, November 7, 2013
Disclosure: No positions