A strong, cash-rich balance sheet is always a good thing. It shows that a corporation is healthy and able to invest in its future. But often, companies let cash pile up on their balance sheets, and not even record research & development standing can put a dent in it. When that occurs, it may be prudent to deploy some of that capital, either in the form of buybacks, dividends, or opportunistic acquisitions.
NVIDIA (NVDA) is one of the most cash-rich companies in the technology sector relative to its size. The company has no debt, and in its most recent quarter, the company had cash and investments of $3.130812 billion, which translates to $5.05 per share in cash and investments, based on the company's 618,804,109 outstanding shares as of May 18, 2012. As of the close of trading on June 13, 2012, that means that 41.46% of NVIDIA's market capitalization is in cash, a figure that we think is too high.
We first profiled NVIDIA back in March, arguing that the company is well-positioned in the smartphone and tablet space. We analyzed the company's position in the space, and will therefore focus this article more on NVIDIA's capital position, rather than drill down into the fundamentals product positioning of the company. However, there have been several developments regarding NVIDIA's product lines, and it would be wise to provide a quick overview of what has been going on at NVIDIA.
Discrete Graphics: Transitioning to New Markets, Retaining Old Ones
For some time, the bearish thesis regarding NVIDIA has been centered on two interlinked arguments. The first is that discrete PC graphics are a dying business, and the second is that Intel (INTC) will force NVIDIA out of that business, for competing with Intel is usually a losing game.
NVIDIA, however, is moving to transition away from discrete graphics. As we discussed in detail in our prior article on NVIDIA (linked to above), the Tegra line of mobile chips is key to the company's transformation. However, new uses for discrete graphics, that go beyond personal computing, will play a role in NVIDIA's future as well.
In May, NVIDIA announced several initiatives designed to cement its position in the discrete graphics market. The Tesla GPU line was updated with new GPU's (based on Kepler architecture) for use in supercomputing, with an eye towards the scientific and energy industries. NVIDIA has also unveiled technology to virtualize GPU's in the cloud, with an eye towards their use in data centers and virtualized corporate networks. As NVIDIA works to transition to new markets, it is also working to retain old ones as well. Apple's (AAPL) newly updated MacBook Pros, unveiled at the company's annual Worldwide Developer's Conference, utilize some of the latest in NVIDIA's personal computing graphics technology.
To be clear, NVIDIA is a company that is in transition. The traditional GPU market is not what it once was, and competition is fierce, even if NVIDIA is managing to hold it at bay. The company's results are a testament to this. Earnings in fiscal 2012 were 94 cents per share. The Reuters consensus estimate for fiscal 2013 earnings is 71 cents per share, with fiscal 2014 earnings rebounding to the 94 cents seen in fiscal 2012. NVIDIA's financial position is strong, however, and the company can comfortably weather this temporary decline.
A Look at Operating Cash Flow: More Than Meets the Eye
A company with a cash position would be expected to post great operating cash flows, and do so consistently. Yet NVIDIA's latest quarter saw the company burn $9.208 million in its operations, as opposed to the prior year, where it saw $172.2 million in operating cash flow. How can this be? There are several issues that impacted cash flow in the most recent quarter, and we wish to proactively address this issue.
NVIDIA earned just 10 cents per share in its latest quarter ($60.437 million), compared to 23 cents ($135.219 million) in the prior year. Several factors affected net income this quarter. As the company transitions to Tegra 3, sales of Tegra 2 chips have slowed faster than Tegra 3 is ramping up. However, this issue should be temporary. Tegra 3 phones are now in the market, and more are set to launch this quarter. In addition, NVIDIA boosted R&D spending by over 22% to record levels as the company prepared to launch its new GPU's and chipsets. We do not think that net income will remain at depressed levels, and neither does Wall Street. Presented below are the Reuter's consensus earnings estimates for the next several quarters.
(click to enlarge)As net income returns to normalized levels, so will NVIDIA's operating cash flow. In this most recent quarter, changes in working capital contributed significantly to the reduction of cash flows. NVIDIA prepaid expenses soared by over 97% year-over-year, and of the company's $9.208 million in negative operating cash flow, $48.1 million of that was due to payments for prepaid expenses. Changes in accounts receivable also played a major part, contributing a drag of over $75 million on operating cash flow. We think that this does not present cause for concern, at least not yet. Should NVIDIA post more quarters with negative operating cash flow, we would likely become concerned. But at the moment, we do not think that investors should be concerned.
Capital Deployments: Many Options Available
NVIDIA is beginning to be pressed about deploying capital. On its quarterly earnings call, analysts questioned the company about its cash position and capital plans. CEO Jen-Hsun Huang gave a standard, boilerplate answer, saying that, "we don't have anything to announce today, and that's a topic that we have with the board on a regular basis. But we don't have anything to announce today."
We fully believe that NVIDIA should begin deploying capital, in one of 3 ways: dividends, buybacks, or opportunistic acquisitions. We explore each option below.
- Dividends: NVIDIA should declare, at a minimum, a special dividend, and release at least $1 billion from its balance sheet. That would be equivalent to $1.61 per share, for a yield of 13.22%, which would provide shareholders with a substantial return in quick fashion. The company would be left with over $2 billion in cash & investments, which is more than enough to fund not only all the R&D that NVIDIA needs to succeed, but also provide an ample cushion for the company to ride out any troubles. Given NVIDIA's annual cash flows of around $900 million (for fiscal 2012), the company can afford to pay out a regular dividend as well. A quarterly dividend of 5 cents per share would give the stock a yield of 1.6% at current levels and cost the company $123.76 million each year, based on the current share count (though that cost would rise as NVIDIA increased the number of outstanding shares, net income and cash flow would be expected to rise alongside the share count). A 5 cent yield, based on present figures, would give NVIDIA a payout ratio of just 21.298%, based on fiscal 2012 net income. Such a ratio would leave ample room for future increases, even with NVIDIA's need to invest in R&D.
- Buybacks: Over the past year, NVIDIA has lost almost 29% of its value, due to a variety of worries, such as the PC supply chain and the state of the GPU market. And yet the company's balance sheet has never been stronger. Deploying $1 billion to buy back stock would prove highly accretive to earnings. As of this writing, NVIDIA trades at $12.18, and we will model our buyback based on a price of $13 per share. At that price, NVIDIA could buy back 76,923,076 of its shares which would mean that NVIDIA would be buying back 12.43% of its shares. NVIDIA is set to earn 71 cents per share this year. Based on NVIDIA's latest 10-K, its share count has grown by an average of 3.18% annually over the past 3 years. Such a rate would mean that NVIDIA will end fiscal 2013 with 635,971,598 shares (although an imprecise estimate, it is an educated one, using all available data) That would imply that for fiscal 2013, NVIDIA is estimated to earn $451,539,834. A buyback, however, would drastically reduce NVIDIA's share count, to 559,048,522 and boost EPS to 81 cents per share in fiscal 2013, an increase of over 14% from prior EPS estimates.
- Acquisitions: Historically, NVIDIA has been a prudent acquirer, and has not displayed an acquisitive nature, unlike some companies in Silicon Valley [Oracle (ORCL)]. The company's last major deal was the $367 million takeover of Icera in May 2011. However, with over $3 billion in cash and investments, it is unlikely than NVIDIA is not looking at the market for new deals. Stock prices of many smaller chip companies have been depressed, and that could allow NVIDIA to be opportunistic in the public markets, to say nothing of the private markets. Specifically, ST-Ericsson has been mentioned as being a target of NVIDIA's, and we think that the company should step up and buy the ST-Ericsson before Intel or AMD (AMD) strike. ST-Ericsson would give NVIDIA a new avenue for growth in the smartphone market. In any case, NVIDIA has the cash to make deals, and we believe that if the company will not return capital to shareholders directly, then it should at least become more aggressive in investing for the future.
We fully believe in NVIDIA's potential, and think that now is a good time to add to or initiate a position in this company. Too many people believe that NVIDIA is trapped in the past, when in reality the company is moving aggressively to secure a place in the future of computing. Tegra 3 is giving the company a prominent place in the smartphone and tablet markets, and we believe that the markets are underestimating NVIDIA. And a deployment of capital, a step that we believe NVIDIA should take, would be a catalyst that would likely spark a rally in the stock.