Current Trends Impacting Nvidia’s $19 Valuation

While most of its competitors including Intel (NASDAQ:INTC), AMD (NASDAQ:AMD) and Texas Instruments (NASDAQ:TXN) posted annual decline in 2012, Nvidia (NASDAQ:NVDA) saw a 7% rise in its earnings and witnessed a marginal increase in its gross margins during the same period. We believe that the increasing proportion of non-PC revenue in Nvidia’s overall sales has cushioned the impact of declining PC shipments to some extent.

Nevertheless, Nvidia’s stock price has declined by more than 15% in the last year and is currently trading close to $13. We believe this gives the company a valuation hard to ignore. In this article we list key trends that contributed to Nvidia’s top line growth in 2012, and will continue to drive its business in the future as well.

See our complete analysis for Nvidia

1. Slowdown In PC Shipments In 2012; Revival In Demand 2013 Onward

The slowing enterprise market, consumer softness in mature markets (U.S. and Western Europe), slowing demand from emerging markets, operating system transitions and cannibalization by tablets are some of the main factors leading to the current slump in PC shipments. However, while the PC shipments remained flat in 2012, IDC estimates they will continue increasing for years to come, albeit at a slower pace.

The improving macro conditions, increasing demand from emerging economies and the introduction of new convertible and hybrid PC designs will fuel demand in the future.

Source: IDC Press Release

2. Gaming Will Drive The Market For PC Graphics

Nvidia’s PC graphics can be broken down into two consumer segments:

– Original Equipment Manufacturers (OEMs) – OEMs that use Nvidia’s GPUs to differentiate their PCs from competitors.

– PC Gaming – Nvidia’s GPUs are also used by gaming enthusiasts to generate realistic and interactive graphics on PCs.

While the PC shipments have slowed down, the robust PC gaming market led to an increase in Nvidia’s GPU shipments in 2012. Jon Peddie Reasearch valued the PC gaming hardware market at $23.6 billion in 2012, and forecasts the global gaming market to cross $30 billion by 2015. ^[1]

Massively multiplayer games and growth in cloud gaming continued to drive a robust PC gaming market in 2012. As per market research firm Newzoo, the global massively mutiplayer games revenues grew 21% in 2012, reacing $13 billion. ((Nvidia Corporation’s CEO Discusses F4Q13 Results – Earnings Call Transcript, Seeking Alpha, February 13, 2013)) Cloud gaming is a category of online gaming which allows direct and on-demand streaming of games on a computer. Nvidia has around six partners and is in the process of evaluating new middleware partners, who provide cloud gaming to various TELCOs around the world.

Nvidia’s GeForce is the gamers choice of GPU by a margin of almost 2:1. ^[2] Additionally, at the 2013 Consumer Electronics Show, Nvidia launched its “Project Shield”, an Android based portable gaming console which can also be connected to a PC. Project Shield will attract great games to Tegra Zone, a free application available in the Android market, which can then be played on any Tegra powered device. Tegra Zone has already been downloaded 6 million times until now.

We believe that the above factors will continue driving growth in the PC gaming market, which in turn will lead to higher GPU shipments for Nvidia.

3. 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.

In 2012, Nvidia transitioned Kepler architecture across its GPU business. Kepler is the first architecture to include virtualization technology built right into the GPU. Nvidia believes that it is the most efficient GPU architecture to date, and expects the same to translate into more market share and higher margins.

Nvidia’s overall GPU market share increased from 53% in 2011 to 65% in 2012.

4. LTE Capability To Expand Opportunities In Mobile Computing

The launch of Tegra 3, the world’s first quad-core processor, is what gave Nvidia’s mobile computing plan a significant push, by scoring high profile design wins in 2012 – Google’s Nexus 7, the world’s first $199 quad-core 7-inch tablet, Microsoft’s Windows RT Surface table, World first RT device by Asus, etc. However, tablets remain the most important driver for Nvidia’s success in mobile computing and its progress in the smartphone market remains more or less stable.

Earlier this year, Nvidia introduced its next generation Tegra 4 processor and the Tegra 4i, which features built in 3G and 4G/LTE communication technologies, and we believe this will help it make a deeper foray into the mobile market. Tegra 4 is based on ARM’s most advanced CPU core and delivers a more realistic gaming experience, new camera capabilities through computational photography, faster web browsing and higher resolution displays. In addition, Nvidia claims that Tegra 4 consumes 45% less power than the Tegra 3 processor.

4G/LTE is the future of wireless connectivity for mobile devices, especially smartphones. Of the various technologies that are driving the market currently, LTE is seeing the strongest growth, as carriers around the world increasingly shift to the new standard for wireless communication.

We believe that a new improved processor and an integrated LTE chipset will increase Nvidia’s footprint in the mobile market. Nvidia’s Tegra revenues increased from $591 million in 2011 to $765 in 2012, and we expect the figure to reach $2 billion over our review period.

Our price estimate of $18.68 for Nvidia is at a significant premium to the current market price.

See our complete analysis for Nvidia’s stock

1. PC Gaming Hardware Market to Hit $23.6 Billion in 2012, Jon Peddie Research, May 3, 2012 [↩]
2. Nvidia Corporation’s CEO Discusses F4Q13 Results – Earnings Call Transcript, Seeking Alpha, February 13, 2013 [↩]