Nvidia Down, But Now Is Not The Time To Sell

| About: NVIDIA Corporation (NVDA)

Nvidia (NASDAQ:NVDA) shares were down more than 5% in late morning trade Tuesday, dropping below $13.20. The last time Nvidia shares traded at that level was in late July. Since that time, Nvidia reported very strong earnings for Q2FY13. Nvidia also forecasted very strong sequential revenue growth and continued strength in gross margins for the current quarter. Thus, the share price has dropped, even as the outlook appears to have improved. I would interpret this development as a buying opportunity rather than a sell signal.

Tuesday's weakness in Nvidia shares was primarily caused by a pair of analyst downgrades. Before the market opened, Patrick Wang of Evercore Partners downgraded Nvidia, along with its competitor Advanced Micro Devices (NYSE:AMD), and simultaneously lowered his estimates for industry behemoth Intel (NASDAQ:INTC). With respect to Nvidia, Wang is worried about potential problems in Tegra sell-through, and future challenges from Apple's (NASDAQ:AAPL) expected iPad Mini. He also noted a slowdown in smartphone design wins for Nvidia.

In general, I have a great deal of respect for Wall Street sell-side analysts, but sometimes they appear to be totally divorced from reality. One could make a reasonable case for weakness in semiconductor stocks this fall (bucking the usual seasonal trend). There is substantial uncertainty about macroeconomic conditions for almost every major economy. However, Wang reports being fairly bullish on the chip sector as a whole, and singles out Nvidia (and AMD) to underperform the sector.

By contrast, I think Nvidia is very well-positioned for both the short-term and the long term. The company finally has a hit product placement for its Tegra line of mobile processors in Google's (NASDAQ:GOOG) Nexus 7. Moreover, Amazon.com (NASDAQ:AMZN) is expected to unveil its next generation Kindle Fire later this week, and as I discussed elsewhere, there is at least a 50/50 chance that Nvidia scored the processor design win. Furthermore, as discussed on the company's conference call last month, Nvidia is just starting to ramp production for its Chinese smartphone design wins. While growth has slowed dramatically in China, this is still a very large market, and one where Wall Street tends to have limited visibility (especially outside of the major coastal metropolises). While Nvidia's flagship products at HTC and LG have indeed struggled this year, sell-through of Tegra 3 smartphones in China has hardly begun. With Tegra designed into 13 phones priced at $300 or less (see slide 8 within link), sales volume in China will likely outweigh more visible disappointments, such as the One X and Optimus 4X.

Furthermore, the slowdown that Evercore sees in smartphone design wins is likely a temporary phenomenon. Today, Nvidia operates at a disadvantage in the U.S. smartphone market vis-a-vis Qualcomm (NASDAQ:QCOM) because the latter has already brought integrated processor/LTE baseband chips to market. Nvidia is moving quickly to create an integrated solution using technology from its Icera subsidiary. While the company has been tight-lipped on the exact timeline, these integrated chips are expected to debut sometime next year. When they do, they will greatly enhance Nvidia's competitiveness in smartphones, leading to a pick-up in design wins.

The threat from a potential iPad Mini product is also overstated. I would be shocked if Apple matches the price of the Nexus 7. The most likely price point is $299 (or perhaps $249) for the base model. Anything lower than $249 would undermine Apple's margins in a manner that is out of character with the company's business model. I have no doubt that the iPad Mini will be a hit, but I think it will expand the overall tablet market more than it will cannibalize Android tablet sales. Nvidia's CEO Jen-Hsun Huang made this point on last month's earnings call: Android tablets will primarily sell to Android phone users. Perhaps some Android phone users will pay a premium for the iPad Mini over an Android tablet, but the vast majority will stay within the Android ecosystem, for obvious reasons of convenience.

Lastly, Nvidia's "legacy" business in discrete GPUs is alive and well. Here, Apple is actually helping Nvidia through its recent focus on "retina" displays. This vast increase in the number of pixels requires more processing power than a typical integrated CPU/GPU can provide. This development is once again extending the discrete GPU's lifespan and market relevance. Over the next year, I expect other PC manufacturers to come to market with high-resolution laptops featuring discrete GPUs in an attempt to catch up to Apple.

More immediately, Nvidia won the MacBook Pro GPU slot back from AMD this year, with the help of its new "Kepler" line of GPUs. Indeed, the introduction of Kepler is helping Nvidia gain market share from AMD across PC manufacturers. Nvidia's Q2 results indicate that share gains outweigh weak PC sales thus far, and can provide earnings upside even in a soft market.

Thus, there seems little cause for alarm in Tuesday's decline. Nvidia is poised for continued growth, and the shares have significant short-term and long-term upside as revenue growth accelerates. With the company holding over $5/share in cash on its balance sheet, there seems to be little downside at this price. On the flip side, if Nvidia scores a design win at Amazon, the stock could rebound almost immediately, with upside as high as $17 through year-end.

Disclosure: I am long NVDA. 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.

Additional disclosure: I may initiate a short position in AMZN over the next 72 hours.