Google Inc.'s (GOOG) highly-anticipated tablet, the Nexus 7, was released late last week to overwhelming demand. The tablet has so far received mainly positive reviews, although it has its detractors (like virtually any gadget).
As of Monday, the tablet was back-ordered at retail partners Staples, Inc. (SPLS), Office Depot (ODP), GameStop (GME), and Sam's Club (Wal-Mart Stores: WMT). In the online Google Play store, it was expected to ship in one-two weeks. Retailers apparently could not get enough units in their initial allotments to meet pre-order commitments, let alone walk-in demand.
However, the gadget's apparent success will have little impact on Google's bottom line in the near term. The 8GB version is likely to break even, while the 16GB will generate roughly $40 profit per device when sold directly through Google (but less when sold through retail channels). Google is apparently trying to use the device to keep individuals within the Google Android ecosystem in the face of strong competition from Apple's (AAPL) iOS and Amazon's (AMZN) services offered via the Kindle Fire.
On the other hand, hardware suppliers for the device are likely to see immediate returns. Nvidia Corporation (NVDA), whose Tegra 3 system-on-a-chip powers the device, is perhaps best positioned to profit from the Nexus 7's success. At $21, the Tegra 3 processor is probably the second most expensive component, after the display. The Nexus 7 may prove to be the first bona fide hit product with Tegra inside. As I wrote earlier this month, gains in the tablet market represent just one of several potential catalysts for Nvidia. However, with Nvidia trading just 10% above 52-week lows, the success of the Nexus 7 could provide a near-term boost for the stock.
It's hard to remember now, but anticipation for the Tegra 2 chip around CES 2011 created a frenzy in Nvidia stock, driving it from lows in the single digits in the summer of 2010 up to highs above $25 in February 2011. The stock subsequently fell out of favor as none of the Tegra "super-phones" could compete with the iPhone (or the vast majority of Samsung phones made with Samsung-designed SoCs), while Android tablets did not live up to their promise. On top of this, Texas Instruments (TXN) got the design win for Amazon's Kindle Fire, by far the most successful Android-based tablet to date.
I was short Nvidia in early 2011 as I felt that expectations for the stock had gotten out of hand. Today, however, expectations for Nvidia are far too modest. Analysts are predicting 14 cents EPS for the current quarter and 22 cents for next quarter, in each case representing a substantial year over year decline. While Nvidia's earnings are being pressured by higher R&D expenses and supply constraints for 28-nm chips, there is substantial upside for both quarters. (I think Advanced Micro Devices, Inc.'s (AMD) warning last week was due to company specific factors, and just highlights the diverging paths of Nvidia and AMD.)
To be profitable, the Tegra business needs a minimum of $1 billion in annual revenue, while Tegra revenue was only $360 million last year. Obviously, Nvidia expects to grow Tegra far beyond $1 billion a year, but until it reaches that milestone, Tegra is causing a drag on Nvidia earnings. However, the Nexus 7 alone could easily provide 10 million unit sales ($210 million based on the expected Tegra 3 selling price) through the rest of Nvidia's FY13. Add that to expected competing devices running Nvidia's Kai platform, persistent rumors that the next generation Kindle Fire will have Tegra inside, and the coming Microsoft (MSFT) Surface tablet running Windows RT, and Nvidia may be poised to deliver on Tegra's promise in the back half of this year.
Nvidia is likely to see substantial demand for Tegra chips concentrated in FYQ3, as Google works to meet current demand and build inventory ahead of the holiday season, and as the Surface goes into production. If that is the case, Nvidia could return to year-over-year earnings growth by Q3 (and YoY growth in Q4 is all but certain).
I don't expect Nvidia to return to its 2011 highs above $25 anytime soon, but I do think that Nvidia will reach $18 by year-end, and may even test $20, depending on the level of success of the new Tegra 3 products entering the market and the resolution of supply problems at Taiwan Semiconductor Manufacturing Company (TSM).
