Despite increasing competition from the likes of AMD (NYSE:AMD) and Intel (NASDAQ:INTC), Nvidia (NASDAQ:NVDA) continues to be the leading player in the PC graphics processors market. The GPU segment of the company contributes close to 76% to the overall revenue, and we estimate the same to constitute over 63% of our valuation of $21.85 for Nvidia. We believe that despite the intense competition from AMD in the GPU segment, Nvidia will continue to retain its foothold in the core PC graphics chip business, which augurs well for the company’s valuation.
Additionally, since its entry in the mobile computing market last year, Nvidia has had a significant number of design wins with its quad-core Tegra processors, and we expect the trend to continue in the future as well. Though we estimate Tegra related revenues to contribute just under 8% to Nvidia’s valuation, we feel that the division could become a significant revenue driver by the end of our forecast period. (Read: Tegra Could Become Nvidia’s Most Valuable Business)
Nvidia’s stock has lost close to 10% of its value in the past six months, and we feel that the current market price gives the company a valuation hard to ignore. Here, we discuss certain factors driving our $22 valuation for the company.
1) Nvidia to Retain its Foothold in the Core PC Graphics Chips Business
Gaining the trust of professionals with its Quadro, Fermi and Tesla brands, Nvidia dominates the professional graphics market with a 84% share. Though, AMD is looking to catch up with Nvidia in this segment, we estimate the latter to account for over 80% of the market for the rest of our forecast period.
However, when it comes to discrete notebooks and desktops graphics, the competition is a lot more intense. The introduction of new graphic products in the market by Intel (NASDAQ:INTC) and AMD (NYSE:AMD) has threatened Nvidia’s dominance. The Sandy Bridge and Llano APU processors by Intel and AMD respectively have put the integrated graphics chips and entry level graphics cards in jeopardy. Though they threaten the discrete GPU business of Nvidia, this division does not seem to have been affected as drastically as the integrated chipsets segment.
Historically, AMD has been able to increase its share in the GPU market and continues to remain the main rival for Nvidia in this segment. We believe that the neck to neck competition between the two will make market share gains for either player unsustainable over the long-run.
Potential Risk – Downward Pressure On Prices
Although, we have assumed stable pricing for the professional as well as discrete desktop and notebook GPU’s over time, there is a possibility that the price may not rise as much as expected in the current year and might even slightly decline next year onwards. With PC shipments being fueled by growing demand from emerging markets, AMD is likely to resort to some price competition in order to gain a stronger foothold. Thus, to retain its market share, Nvidia might resort to price cuts in the future. For a 10% decline in our estimated average GPU price, we could see a 5% downside to our price estimate.
2) Growing Opportunities in Mobile Computing
Last year, Nvidia began a focused push into mobile computing with ambitions of being more than a graphics chip maker. It positioned its standalone dual-core app processor, Tegra 2, well to capture significant non-iPad tablet market share in 2011. With the growing success of its quad-core Tegra 3 processor, Nvidia plans to make a deeper foray by targeting low-end tablets and cashing in on the huge untapped opportunity that the nascent tablet market offers. The company is eying the lucrative tablet market as a way of challenging Qualcomm’s (NASDAQ:QCOM) growing smartphone dominance.
Mobile devices are the fastest growing segment of the computer industry. According to research firm Gartner, tablet sales to end-users will register a 98% increase, totaling close to 120 million units by end of this year and, with the growing popularity of tablets, sales could cross 350 million units by 2016. 
The launch of Tegra 3 accelerated Nvidia’s growth in the mobile computing segment. Hitting record sales in Q2 2013, Tegra 3 processors featured in a number of exciting devices this year – Google’s Nexus 7, the world’s first $199 quad-core 7-inch tablet, Microsoft’s Windows RT Surface tablet, Fujitsu’s ARROWS X, the world’s first quad-core LTE smartphone, and the World first RT device by Asus.
Additionally, by leveraging its recent acquisition of Icera, Nvidia is working toward LTE integration. We believe the integration of the LTE modem could substantially grow Nvidia’s market opportunity in the future. Keeping in mind the company’s continued efforts to expand in this space, we expect Tegra related revenues to cross the $2 billion mark by the end of our forecast period.
Potential Risk - Threat from Qualcomm and Texas Instruments
Qualcomm has been working closely with Microsoft and preparing its Snapdragon processors for the Windows 8 tablet to be launched later this year. It also recently showcased its chipset with a quad-core Krait CPU, which might negate Nvidia’s competitive advantage in the coming quarters. Additionally, the recently announced Kindle Fire 2 continues to feature an OMAP processor as Amazon claims that Texas Instruments’ (NASDAQ:TXN) OMAP chip has better bandwidth and computing power than Nvidia’s top mobile component. 
The mobile market remains crowded with larger players like TI and Qualcomm. In the likely scenario of our forecast being too optimistic, there could be some slight downside to our price estimate.
3) Nvidia’s Expected Entry in the PC Microprocessor Market
The estimated revenue stream from Nvidia’s expected entry in the PC microprocessor segment, contribute close to 5% to our current price estimate for the company. Nvidia is developing ARM-architecture based CPUs (code-named Project Denver), which could challenge the x86 CPU architecture that currently dominates the desktop, notebook and server CPU markets. Nvidia’s ARM-based CPUs are expected to come to market in 2013 and if successful, could be an industry disrupting move by the company.
We see Nvidia’s share in the PC microprocessor market reaching 1.6%, by the end of our forecast period.
Potential Risk – One of the primary risks is the failure of project Denver. If the project does not take off in 2013 or fails to reach the expected market share of 1.6% by the end of our forecast period, we could see some downside to our price estimate.Notes:
- Gartner Says Worldwide Media Tablet Sales to Reach 119 Million Units in 2012, Gartner Newsroom, April 10, 2012 [↩]
- Nvidia’s miss in Kindle Fire surprises some investors, Reuters, September 7, 2012 [↩]