Having marked its entry in the rapidly growing mobile computing market last year, graphics chip maker Nvidia (NASDAQ:NVDA) has been focused on aggressively expanding its presence in the smartphone and tablet market. Nvidia positioned its standalone dual-core app processor, Tegra 2, well to capture significant non-iPad tablet market share in 2011. With the success of its Tegra 3 processors, the world’s first quad-core processor, Nvidia was able to make a deeper foray into the tablet market in 2012 with significant design wins, including Google’s Nexus 7, Microsoft’s Windows RT Surface tablet, World first RT device by Asus, etc.
Nvidia is now set to launch its next generation Tegra 4 processor, code-named Wayne, and a new Tegra system-on-chip (Tegra Grey) which features built in 3G and 4G/LTE communication technologies, at the 2013 Consumer Electronic Show in January. While we expect the company to score additional tablet design wins with the upgraded Tegra 4 processors, we feel the launch of Tegra Grey will equip Nvidia to challenge Qualcomm’s (NASDAQ:QCOM) growing dominance in the smartphone market.
Nvidia continues to derive a majority of its revenue from the PC market and thus a slowdown in PC shipments has restricted its growth rate. However, a growing focus and success in the mobile computing space has cushioned the negative impact of lower PC shipments to a certain extent. While the company is yet to make profit from the Tegra division, we feel that growth potential in the mobile computing space would augur well for Nvidia’s long term growth and valuation. (Read Related Article: Is Growth In Nvidia’s Tegra Sales Enough To Offset PC Weakness?)
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LTE Capability Could Help Increase Penetration In The Smartphone Market
While the Tegra processors business has marked a 50% y-o-y growth so far this year, tablets are up by almost 100% and remain the most important driver for Nvidia’s progress in the mobile computing space. However, when it comes to smartphones, the company’s progress remains more or less stable with only a few design wins such as the HTC One X and LG Optimus 4X, to its credit.
With most of the high-end flagship smartphones supporting LTE, Qualcomm (NASDAQ:QCOM) continues to lead the smartphone market as it largely dominates the production of LTE chips. While Qualcomm’s standalone application processor is similar to Nvidia’s Tegra processors, its chips come with integrated wireless capabilities such as LTE. The LTE leadership has allowed Qualcomm to command the majority of the smartphone market. For example, Samsung’s Galaxy S III and HTC’s One X series had to be launched in the U.S. with a Snapdragon core since rival chipsets did not play well with Qualcomm’s LTE basebands.
During Q2 2012, Nvidia completed its acquisition of Icera, an innovator of baseband processors for 3G and 4G cellular phones and tablets. Icera’s high-speed wireless modem products have been approved by more than 50 carriers across the globe. With Icera on board, Nvidia has been focused on developing its 4G LTE application processor.
4G/LTE is the future of wireless connectivity for mobile devices, especially smartphones, and we believe that Nvidia’s upcoming Tegra LTE chipset integrated into Tegra processors (Tegra Grey) will help the company increase its penetration in the smartphone market.
Intense Competition In Mobile Computing Suppress Margins
Given the immense growth opportunities, mobile computing remains a highly crowded market with every chip maker vying to mark its entry in the same. In addition to Qualcomm, Nvidia faces competition from leading handset manufacturers – Apple (NASDAQ:AAPL) and Samsung – which design their own chips in-house and could end up selling them to other device manufacturers in the future.
Apart from other competitors such as Marvell and MediaTek, who recently unveiled its first quad-core chipset. Intel’s (NASDAQ:INTC) increasing efforts to branch out in the application processor market in light of the global PC slowdown is proof enough that competition is only going to increase in the future. As a result of the intense competition, the mobile computing segment offers lower margins compared to Nvidia’s GPU division.
Operating margins from Nvidia’s Tegra business have remained negative since 2008. The company is relatively new to this business, and has still not established a wide enough sales base to be profitable. However, as Nvidia ramps up production volumes of its Tegra chips, we expect it to increase its profit margins for mobile phone graphics. Higher volumes and focus on a single product line will yield improved utilization levels, which in turn would increase profit margins.
Our price estimate of $19.54 for Nvidia marks our valuation at a close to 50% premium over the current market price.