NVIDIA Counting Chickens Before They Hatch
NVDA

February 17, 2011

As an analyst and investor, one of the main things I do is count chickens before they hatch. Today graphics chip specialist NVIDIA has a high price-to-earnings ratio (non-GAAP 62x trailing, 26x leading), indicating some investors are counting on a lot more chicken profits in the future than they have been seeing lately. Is this a smart assumption?

NVIDIA will have a profit boost for the next six years from its licensing deal with Intel. For the most recent quarter ending January 30, 2011 it booked $57 million for the litigation settlement portion of the deal (booked as a negative operating expense, not revenue). For each quarter it will book about $60 million in royalties.

Other than that, the last couple of years have been hard on NVIDIA. Q4 fiscal 2011 (the most recently reported quarter) revenues were $886.4 million, down 10% from $982.5 million in the year-earlier quarter. That does not sound like a high-growth company that deserves high PEs on its stock price. [for a fuller report on Q4, see NVIDIA Q4 fiscal 2011 analyst conference call summary]

What speculators are speculating on is a chip called Tegra. The first version was interesting but did not generate much revenue. The second version is available now in a few tablet and smart phone devices. It produced little revenue in Q4, but is supposed to contribute substantially to Q1. Therefore, instead of a normally seasonally down Q1, guidance is for a 6% to 8% sequential revenue ramp. That is impressive, if it happens.

In addition, the third version of Tegra, called Kal-El for now, is already sampling and is supposed to be in devices for sale for holiday 2011 shopping. Reviews of Tegra 2 are generally positive.

The NVIDIA vision is not just to dominate the smart phone and tablet markets. Future versions of Tegra are supposed to be powerful enough to go into notebooks, desktops, and ever servers.

Before you pay a premium for all them chickens, you might want to think about all the other chickens that will be on the market. NVIDIA's Tegra CPU unit is based on the ARM architecture, which anyone can license. The NVDA advantage is in graphics, but there are a number of companies that license graphics capabilities that were designed specifically to work with ARM. NVIDIA's were designed to work with the 8086 architecture of Intel and AMD.

Competitors each have some advantages. Apple, of course, is the perceived frontrunner. There is no guarantee that the iPhone is ultimately going to be defeated by Android-based phones or less likely competitors.

When it comes to ARM based chips for tablets and phones, each competitor brings some serious advantages to the court. Qualcomm has far more extensive experience in cell phones than NVIDIA does; so does TI. Intel and AMD want to get into the game. AMD gained a lot of market share against NVIDIA in discrete graphics cards for computers during 2009 and 2010; their fusion chips offer some extreme advantages, especially for tablet computing. Among a host of other contenders, Marvell (MRVL) should be noted, since they generate a lot of cash each quarter and have a lead in China, a much bigger market to fight over than the U.S. market. Then there are the Koreans, and Japanese, and numerous small innovators.

None of the other contenders have PE ratios as high as NVIDIA's. I have owned NVIDIA stock in the past, and if it had a low PE I might scoop up those chickens right now. I have always admired NVIDIA's technological skills, and the Tegra 3 is promissing. I don't see how it can be all that much better than competitors, however. Everyone has promissing designs, everyone is hustling to squeeze usability out of the same limitations of silicon.

I have done well recently with some hatchlings at Dot Hill, Dendreon, and TTM. On the other hand, I like to keep in mind Anesiva, where I correctly predicted its Zingo product would hatch (get FDA approval), only to watch it die a horrible death and then take the entire company into bankruptcy with it. The secret is to see them chickens before momentum investors drive up the stock prices. If you bought NVDA a year ago at $8.65 per share, congratulations. If you are thinking about buying it today at $25.48, you might want to consider that it could take NVIDIA a couple of years of outstanding growth to justify this price.

Keep Diversified!

William P. Meyers

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