Nvidia (NASDAQ:NVDA), a leader in designing graphic processing units (GPU), introduced the world to computer graphics when it invented the GPU in 1999. From its roots in visual computing, the company over the years has expanded into parallel and mobile computing. Though the GPU business continues to account for majority of Nvidia’s revenues, the focused push into mobile computing last year is proof of the company’s ambition to become much more than a graphics chip maker.
Because of its vulnerability to the PC market, Nvidia’s stock has declined by over 20% since February 2012. However, we feel that the current slump in the stock value gives Nvidia a valuation hard to ignore. With a price estimate of $19.14, we believe that Nvidia has all the right ingredients to support a higher valuation. (Read: Nvidia Is Worth $19 Despite Its Vulnerability To The PC Market)
Here we provide a quick snapshot of how Nvidia makes money, the important segments that contribute to its business, and the key trends that could help drive the stock in the future.
What are the key markets and customers for Nvidia? What are the most important segments that contribute to its growth?
Nvidia’s business can be broken down into three key segments –
1. GPUs – Nvidia primarily designs and develops GPUs, which are high performance processors that generate realistic and interactive graphics on PCs. Usually a dedicated GPU and central processing unit (CPU) work in tandem to increase the overall speed and performance of a system. Nvidia sells its products directly to PC manufacturers, such as Dell, HP, Toshiba, Sony, etc. In addition, the company also sells some of its high-end GPUs directly to consumers through retailers such as Best Buy.
Out of the $4 billion in revenue earned by Nvidia in 2011, 75% was accounted for by the sale of its GPUs. The $3 billion GPU revenue can be further split into – $1.3 billion, $800 million and $900 million from the sale of discrete desktop graphics, discrete notebook graphics and professional graphics respectively.
AMD is the only major competitor for Nvidia in all three markets. Nvidia currently accounts for 62% and 52% of the discrete desktop graphics and discrete notebook graphics market respectively. Considering the close competition between Nvidia and AMD, we do not expect any significant share gains by either company in the future.
Nvidia earns close to 29% operating profit from these divisions, as per our estimate. We expect the margins to remain constant for the rest of our review period.
With over 80% market share, Nvidia has a bigger lead over AMD in the professional graphics market. However, with AMD’s increasing efforts to gain share in this segment, we forecast a marginal decline in Nvidia’s market share in the future.
At around 44%, the professional graphics division offer the highest operating margins for Nvidia. With increasing productivity gains, we estimate a slight upside in the margins over our review period.
2. Mobile Computing – With the introduction of its dual-core application processors, Tegra 2, Nvidia marked its entry into the fast growing mobile chip market in 2011. An application processor is a system-on-chip (SoC) which supports applications running in a mobile operating system. Tegra 2 processors did well to capture significant non-iPad tablet market share in 2011. However, 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. Key customers for Nvidia include handset vendors such as Samsung, LG, Nokia, Motorola, HTC, etc.
Nvidia made around $600 million in revenue (15% of total revenues) from the sale of its Tegra processors in 2011. It has been incurring operating losses from this division since 2008. At $125 million, the operating losses were the highest in 2011. However, we believe that an expanding revenue base and higher productivity gains over time could significantly increase margins in the future.
3. PC Microprocessors – Microprocessors are a PC’s CPU, an important component that drives computer power and performance. Nvidia is developing ARM-architecture based CPUs (code-named Project Denver) and is expected to mark its entry in the PC microprocessor segment in 2013. Primary buyers will be original equipment manufacturers (OEMs), original design manufacturers (ODMs) and individuals building custom PCs.
We estimate the revenue stream from Nvidia’s expected entry in the PC microprocessor domain to contribute around 6% to our current price estimate for the company.
Current trends that could favorably impact Nvidia’s stock value
We believe that Nvidia will continue to retain its leadership position in the GPU market for years to come, which is one of the primary factors driving our valuation for the company. In addition, here are some key trends which we believe are favorable for Nvidia’s stock price.
1. Discrete graphics remain a popular choice for high-end gaming
While many might argue that the significant improvement in Intel’s integrated graphic chipsets might threaten Nvidia’s dominance in discrete desktop and notebook graphics, we feel the increasing popularity of high performance GPUs for high end gaming will enable Nvidia to retain its foothold in the GPU market.
Though integrated graphics turn out to be cheaper and might provide an enhanced battery life, discrete graphics remain the preferred choice for gaming applications as the games become more advanced. Better image quality and higher performance are important criteria for gamers, and we expect Nvidia’s leadership in these qualities to help the company retain its foothold in the growing gaming market.
2. Rapid growth in tablets and smartphones
Mobile devices are the fastest growing segment in the computer industry. Research firm Gartner estimates global sales of media tablets to increase by 98% this year, from 60 million units in 2011 to 119 million units in 2012, and reach close to 370 million units by 2016.  Accounting for 31% of total mobile devices sales, smartphone shipments stood at 472 million units in 2011, a 58% increase from 2010.  The smartphone penetration in the overall mobile device market is expected to further increase in the future.
Nvidia’s Tegra business has witnessed a 50% y-o-y growth so far this year. However, tablets continue to remain the most important driver for Nvidia’s success in mobile computing as its progress in the smartphone market remain more or less stable. We feel that might change soon as the company is expected to showcase its new Tegra system-on-chip (Tegra Grey), which features built in 3G and 4G/LTE communication technologies, along with the next generation Tegra 4 processor, at the 2013 Consumer Electronic Show in January 2013.
Our price estimate of $19.54 for Nvidia marks our valuation at a significant premium over the current market price.Notes:
- Gartner Says Worldwide Media Tablets Sales to Reach 119 million Units in 2012, Gartner Press Release, April 10, 2012 [↩]
- Gartner Says Worldwide Smartphone Sales Soared in Fourth Quarter of 2011 With 47 Percent Growth, Gartner Press Release, February 15, 2012 [↩]