Reevaluating Nvidia Amidst Stock Stagnation

| About: NVIDIA Corporation (NVDA)

Over the last few months, Nvidia (NASDAQ:NVDA) has seen plenty of change and growth within the business. The company has improved on a slew of products, including the all-important Tegra chip, and has expanded its presence into new markets such as mobile gaming with Project Shield. Though the company has seen substantial change, this has not been even remotely reflected in its share price, which has spent five of the last six months bound between $12 and $13. As part of Capital Ladder Advisory Group's effort at providing the most insightful and accurate analysis available, this sideways motion in the stock price of such an active company warrants a serious examination as to why investors have not seen any significant performance and what to expect in the future.

Nvidia's primary business is broken down into two groups - desktop/notebook GPUs and Tegra. The first group includes the GeForce, Quadro, and Tesla GPU lines. To try and make sense of NVDA's recent price activity (or lack thereof), it's critical to understand exactly what the company has been doing over the last six months, delving into any developments division by division.

Currently, the GPU division is by far the larger of the two. In the last fiscal quarter, this accounted for over $800 million in revenues, or a whopping 75% of total sales. Traditionally, this space has included three different products.

Perhaps the most recognized of Nvidia products, GeForce refers to a line of GPUs that get placed into consumer desktops or notebooks. While the company produces a wide array of products to meet varied general demand, the bulk of the business comes from high-end, high margin chips sold to PC gamers. Of the $2.4 billion in revenues desktop and notebook GPUs brought to Nvidia, almost 60% were high performance chips sold individually to gamers. The most prominent of these is the GeForce GTX Titan, which derives its name from the Titan Supercomputer that it powers (the fastest one in the world) and was released on February 25th. Not only does this behemoth sell for a hefty $1,000 - and is probably one of the higher margin products of a company that sees 50% gross margins on average - but it is completely sold out. Almost a month and a half after its launch, the Titan is consistently unavailable at most online vendors, including the mighty Amazon, as gamers keep fighting to get their hands on one or more of these GPUs.

The Titan is proof that Nvidia products are in constant demand not only by gamers, but also scientists. The same technology, as mentioned prior, is currently powering the fastest computer in the world, and for any scientist who needs the raw computational power that the Titan provides without other features that "similar products" provide, the $1,000 price tag is a bargain. Of course, this brings us to the next part of Nvidia's GPU division - the similar products just mentioned. Nvidia' Tesla line of GPUs are optimized for complex computing, granting professionals worldwide the power needed to run options pricing or oil exploration models.

Up until recently, and even today to a certain extent, Tesla is not a large part of the company. In the third quarter, Tesla brought in only four percent of revenues, or roughly $48 million. However, Tesla revenues actually grew by 68 percent over the 2012 fiscal year. More importantly, with the explosion of high powered computing, which is being supported by computer platforms such as CUDA, Tesla could become one of the company's major growth drivers, and a wonderful insurance policy against fears of a declining PC market. In fact, the company seems to believe that this division serves an addressable market worth $1 billion.

Even more importantly, Nvidia has very limited competition in this department. Recently, Intel (NASDAQ:INTC) has announced its new Xeon Phi chip, which is designed to go toe-to-toe with Tesla. While Intel's chip architecture allows for easier adoption among Windows PCs, the Tesla has a solid reputation as a powerful, dependable chip, and Tesla still outperforms Xeon Phi in most performance tests. It is reasonable to believe that Intel will gain market share in this division, but even if Nvidia drops to 50 percent market share in a division it nearly monopolizes now, the company is still looking at ten-fold growth in the next few years.

While a high profile GeForce chip or anticipated Tesla growth are nice, the real headlines regarding the company's GPU segment involve the recent addition of two new product lines -Shield and GRID.

Shield is a handheld gaming device that will run on Tegra 4. This device, when unveiled at CES (Consumer Electronics Show), was met with plenty of skepticism and pessimism. However, while Shield may not be the company's next billion dollar idea, the beauty of the device from an investor standpoint is that it doesn't need to be. Because most of the technology (i.e. Tegra) was developed independently of Shield, the device itself cost a mere $10 million to develop. If these are sold for a 25% profit margin (which is quite conservative given the company's 50% margins) at a price of $100, the company needs to sell 400,000 devices to break even.

Yet even this is a pessimistic model of the device's potential. Because Shield runs on a Tegra chip, the device is compatible with Nvidia's Tegrazone - an online platform with free and premium games that any Android device run by Tegra can operate. For a company that makes products that remain hidden in other devices, producing a handheld device not only improves brand awareness and solidifies Nvidia's position as a gaming powerhouse, but encourages the adoption of a Tegra ecosystem, so that individuals can play the same games on their phones, computers and handheld devices.

Moreover, the largest and most important development by far is the development of GRID. Essentially, GRID is a visual computing appliance that allows individuals to access massive amounts of graphics processing power remotely, through an online network. Consumers or small businesses no longer have to invest in professional workstations and spend over $2,000 on Quadro GPUs; they can run as many "workstations" as they'd please, on whatever computer they have. GRID represents the next logical step in cloud computing. Initially, the cloud allowed people to share files on any device, store as much information as they need, and effectively render their hard drives useless. Now, thanks to this technology, individuals can not only share whatever they'd like, but create and consume anything they choose to as well. Gamers can play the most graphics intensive games on a low-grade netbook; professionals can design, edit and animate on a MacBook Air in a Starbucks as effectively as they could from their workstations at their desks.

According to President and CEO Jen-Hsun Huang, GRID has the potential to bring in $10 billion annually. For a company making 40 percent that, without having made a red cent off of GRID, this is massive. Huang estimates that the market for cloud gaming alone is $2 billion; enterprise needs, particularly in a time of increasing globalization, can bring another $5 billion. Most importantly, this is not a large, mature market with plenty of competition. This is a market Nvidia practically created out of thin air. Cloud services exist, and there are multiple providers of various services, but the focus on visual processing power is revolutionary, and the potential market size will grow exponentially as GRID and eventual competition become adopted by individuals and businesses.

In spite of how much the company is innovating in these fields, investors and consumers are becoming increasingly interested in one thing only - Tegra. Anybody who's used a computing device recently can tell you that PCs are giving way to tablets and smartphones; it's the very reason Nvidia shares have been struggling recently. If one subscribes to the theory that it's just a matter of time before Nvidia's PC business dies out, they must have absolute faith that Tegra will succeed to remain interested and invested in Nvidia.

Nobody doubts that the potential is there. According to IDC, we have reached the point in smartphone development that smartphones will outship feature phones for the first time this year, with almost 1 billion expected smartphones shipped. Even more importantly, they report that tablets, which are expected to ship 190 million units this year, will outsell PCs next year. For Nvidia, this is a huge deal. With the Tegra 3, the company managed to get a footing in the tablet market, securing high-profile wins such as Microsoft's (NASDAQ:MSFT) Surface RT and Google's (NASDAQ:GOOG) Nexus 7, and has the second most market share among tablet processor manufacturers, at 17 percent market share, behind Apple (NASDAQ:AAPL). Such success with the Tegra 3 has allowed the division to gain $723 million last year, effectively recovering all R&D costs.

This success comes with almost no penetration into the smartphone market, something that will soon change. While Tegra 3 has managed to win a few smartphone contract designs, it was crippled from a competitive standpoint because of a lack of an integrated LTE solution. Fortunately, the Tegra 4i is not only a substantially more powerful chip than its predecessor, but it has built-in LTE capabilities that smartphone manufacturers find so crucial. It's no surprise that thanks to these improvements, the Tegra 4 family (Tegra 4 for tablets and Tegra 4i for smartphones) has already won more contracts than the Tegra 3. If Nvidia manages to grab 10 percent of the sales after the launch of Tegra 4 - representing less than half of their market share in tablets - they will manage to sell just shy of 100 million units in a market they were never contenders in before.

Of course, the quantity of design wins takes a back seat to the quality of design wins, and with rumors that the new Nexus will instead house a Qualcomm (NASDAQ:QCOM) Snapdragon, skepticism has begun to rise again. But with numerous independent groups reporting that the Tegra 4 is faster than the flagship Snapdragon 800, it is reasonable to assume that Nvidia will manage to carve out at least a modest stake in the smartphone market over the next few years.

While the promise of exponential, unprecedented growth and revenues are nice, they mean little if growth is factored into share price, or if the financial stability of the company is not strong enough to secure proper execution of its plans. One look at Nvidia's balance sheet can confirm that neither of those phenomena are occurring. As of Wednesday's close, shares traded at $12.78, giving the firm a market cap of $7.88 billion. Last quarter, the company made $562 million on $4.28 billion in revenues, giving the company a non-remarkable P/E of 14.22. However, the company holds almost $5 billion in assets, comprising over 60 percent of the company's market cap. Without those reserves, the company trades at a revised P/E of 5.5, suggesting that the stock is subject to some overwhelming bearish reception. If, in the next three years, Tegra and GRID both capture 10% of their addressable markets, resulting in $2 billion in revenue, and all other sectors remain unchanged, assuming a compressed 40 percent gross margin, Nvidia stands to double their bottom line. To receive such a low P/E when the growth potential is so clear is somewhat baffling.

Even better, it seems that Nvidia is willing to put its cash to good use for shareholders. In the fourth quarter of 2012, the company announced the initiation of a 2.35% dividend, and has since returned $100 million to shareholders through this dividend and $200 million through share buybacks. More importantly, the company has announced that they will return $1 billion to shareholders this year. The dividend will remain unchanged, meaning that Nvidia still plans on spending another $750 million on share repurchases. Such a buyback program will reduce the float by 10 percent in the course of this fiscal year, returning plenty of capital to shareholders, bolstering earnings per share, and catalyzing share price appreciation.

In short, there's undoubtedly some risk in Nvidia's future. The tech sector is changing so rapidly that any company is vulnerable - just look at Apple. However, this is a company with a massive safety net in the form of billions in cash, is returning value to shareholders, and has the opportunity to experience colossal growth. With Tesla providing medium-term revenue growth until Tegra and GRID have matured and gained fair market share, the company has a string of products that will allow them to grow, not just quickly, but smoothly and consistently as well. With all the skepticism, share prices may not rise now, and they may not rise next month, but they will eventually rise. And when they do, it will be something no investor will want to miss. For further information related to NVDA, please feel free to contact us at

Disclosure: I am long AAPL, GOOG, MSFT, 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.

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