NVIDIA Corporation operates as a visual computing company worldwide. It operates in two segments, Graphics and Compute & Networking. The Graphics segment offers GeForce GPUs for gaming and PCs, the GeForce NOW game streaming service and related infrastructure, and solutions for gaming platforms; Quadro/NVIDIA RTX GPUs for enterprise design; GRID software for cloud-based visual and virtual computing; and automotive platforms for infotainment systems. The Compute & Networking segment offers Data Center platforms and systems for AI, HPC, and accelerated computing; Mellanox networking and interconnect solutions; automotive AI Cockpit, autonomous driving development agreements, and autonomous vehicle solutions; and Jetson for robotics and other embedded platforms. The company’s products are used in gaming, professional visualization, data center, and automotive markets. NVIDIA Corporation sells its products to original equipment manufacturers, original device manufacturers, system builders, add-in board manufacturers, retailers/distributors, Internet and cloud service providers, automotive manufacturers and tier-1 automotive suppliers, mapping companies, start-ups, and other ecosystem participants. NVIDIA has partnership with Google Cloud to create AI-on-5G Lab. NVIDIA Corporation was founded in 1993 and is headquartered in Santa Clara, California. The company is publicly listed on NASDAQ under the ticker “NVDA”.
NVIDIA was undoubtedly a great opportunity for everyone that entered a position over the last couple of year, but that doesn’t mean that buying now will lead to comparable returns. NVIDIA’s shares came down a lot over the last months, far more than the indexes it’s member of, and with interest rate headwinds looming, more potential downside exists.
Starting with the valuation, we consider this company overvalued. Indeed, NVIDIA grew by incredible amounts year-over-year the last few years, but we shouldn’t expect to continue seeing 40%, 50% or 60% growth quarters anymore. This is partially the result of the law of large numbers, which dictates that relative growth has to slow down eventually: it’s impossible for a company to grow at a massive rate forever.
On top of that, there are some related markets that influence a lot the performance of the company’s revenue growth that aren’t especially strong any longer: cryptocurrencies. When cryptocurrencies ran up over the last two years on the back of loose monetary policy and massive fiscal stimuli, mining cryptocurrencies became really attractive, which led to increased demand for some of NVIDIA’s products. With cryptocurrencies slumping in 2022, however, on the back of a more restrictive monetary policy, crypto-mining has become far less attractive. Miners will most likely withhold spending large amounts of money on new mining equipment, which is why GPUs demand from the crypto community should decline significantly this year, and maybe even beyond. Last time it happened, we saw the effects that this had on NVIDIA’s revenues: when cryptocurrencies declined to multi-year lows in late 2018 and early 2019, they took a hit both on a quarter-to-quarter basis and on a trailing twelve months basis. Therefore, NVIDIA is partly dependent on how cryptocurrencies behave. Obviously, the company is not the same as of 2019, but the correlation between these two markets shouldn’t be ignored by investors.
Then, we have the Arm acquisition, which looks unlikely to be completed. While management has pursued this acquisition because they saw a strategic rationale for it, the failure of the deal isn’t a negative news, actually. The acquisition, originally, would cost $40 billion. Usually, with deals of such a massive size, it’s not uncommon to be approved only with a number of new restrictions on the acquiring company. This simple fact adds possible risks to the company, since such restrictions may require NVIDIA to divest its business in order to promote competition and limit monopolistic powers. Since NVIDIA has always obtained deals it wanted, we suspect that the regulators might have been considering terms that were deal-breakers for the company: maybe in order to get the deal approved, NVIDIA may have had to make some concessions so deep that the company is simply better off without Arm. On the other hand, the only reason for NVIDIA to buy Arm was to create an almost monopoly in the processing units market, so it shouldn’t surprise that regulators stepped in to block it. If the company pulls out of the deal, it would owe SoftBank $1.25 billions. At the same time, the company would have all the cash required for the acquisition available to pursue other acquisitions, reinvest in itself or returning money to shareholders through accelerated buybacks or dividends. Even without Arm, the company still has a terrific management who allowed NVIDIA to move from being a simple graphics card company to a leader in many markets.
It’s important to keep in mind, though, that the company is heavily reliant on China’s demand, as we will see better in the business section. Considering that most projections about the GDP growth of the country as well as its consumer spending are downtrending, we could see a significant decline in Nvidia’s revenues. Furthermore, considering the worldwide rampant inflation, we shouldn’t be surprised into seeing a contraction in margins too.
In conclusion, we have to say that in the long run, the semiconductor industry benefits from strong growth tailwinds. NVIDIA is well-positioned to capitalize on them in numerous markets, including gaming, autonomous driving, AI and others. There is also the hype for the metaverse, but being at the moment anything but hype for something that still doesn’t exist, we shouldn’t care too much about it. However, with the law of large numbers working against NVIDIA, with crypto mining likely not a tailwind in the coming quarters and with metaverse tailwinds possibly overblown, we don’t think NVIDIA’s growth outlook at the moment is outrageously strong. Or, better, we don’t think the outlook is strong, at the current valuations.
Although the company started as a manufacturer of graphics processors in the gaming industry, since then it has developed in a few other markets. According to its financial reports, Nvidia operates in four major markets:
- Gaming: where the company has succeeded in enhancing the user’s gaming experience with graphics that are each year more sophisticated and advanced. Among the services that Nvidia propose in this market, we can find GeForce Experience, a computer application aimed at optimizing PC setting for different tasks and simultaneously recording and sharing game sessions. Moreover, their product for this segment includes GeForce RTX and GeForce GTX, two of the most well-known GPUs for PC gaming. This segment accounted for 47% of total revenue in 2021.
- Professional Virtualization: Nvidia’s GPU are becoming more and more popular for VR devices, not just for the gaming industry but also for the virtual car showrooms, medical and surgical training, and architectural walkthroughs. This segment accounted for 6% of total revenue in 2021.
- Data Centre: where the business’ computing platform, at the base of which there are NVIDIA’s GPUs, is improving a lot in the acceleration of the most compute-intensive jobs, such as AI, data analytics and scientific computing. Moreover, Nvidia provides this market with virtual GPUs (vGPU), graphics processor always available and easily shared across multiple virtual machines. This segment accounted for 40% of total revenue in 2021.
- Automotive: in this market, Nvidia has focused on the implementation of AI within cars and on the developing of the Nvidia Drive platform, which aids users with real-time knowledge of the car’s surroundings, improving a lot the safety for the driver, possible passengers and third parties. This segment accounted for 3% of total revenue in 2021.
It’s also important to see where the company’s revenue is coming from: indeed, in 2021, 27% of revenue was from Taiwan, 23% from China (including Hong Kong), 19% from the United States, 19% from the rest of Asia Pacific, 7% from Europe, and 5% from other countries. Information is based on the customers’ invoicing addresses, even if the revenue is attributed to end customers in a different location. For example, if the billing is done in Europe while the products are to be shipped to China, it would count as revenue generated from Europe. Said so, from the chart we can clearly see that Taiwan and China play a major role in the company’s revenue, making up alone more than 50% of the total revenues. The reason behind the Taiwanese dominance is to be found in the fact that TSMC, the semiconductor manufacturer that produces the chips designed by Nvidia, is located in the island. Rather, the reason behind the Chinese importance in the sources of revenue for the company is a little more complex, since most of the income from this region is related to cryptocurrencies activity. Indeed, most of the crypto mining activities are done in China because of the low cost of energy, despite several government regulations aiming to ban them, and most miners rely on the computational power and the graphics-accelerated capabilities of Nvidia GPUs. The boom in cryptocurrencies that we saw between 2020 and 2021 is also one of the reasons behind both the increase in Nvidia’s revenues and the global semiconductors shortage that we are still experiencing.
The market for NVIDIA’s proucts is intensely competitive and is characterized by rapid technological change and evolving industry standards. The principal competitive factors in this market are performance, breadth of product offerings, access to customers and partners and distribution channels, software support, conformity to industry standard APIs, manufacturing capabilities, processor pricing, and total system costs.
The ability for NVIDIA to stay competitive depends on how well they are able to anticipate the features and functions that customers and partners will demand, and whether they are able to deliver consistent volumes of their products at acceptable levels of quality and at competitive prices.
A significant source of competition comes from companies that provide or intend to provide GPUs, including Intel’s recent announcement that they will introduce high performance GPUs, embedded SOCs, and other accelerated, AI computing processor products, and providers of semiconductor-based high-performance interconnect products based on InfiniBand, Ethernet, Fibre Channel and proprietary technologies. Also, some competitors may have greater marketing, financial, distribution and manufacturing resources than NVIDIA have, and may be more able to adapt to customer or technological changes.
Depending on the sector taken under consideration, the current NVIDIA’s competitors are the following:
- Suppliers and licensors designing discrete and integrated GPUs and other accelerated computing solutions, including chipsets that incorporate 3D graphics, or HPC, such as Advanced Micro Devices, Intel Corporation and Xilinx Inc.;
- Large internet services companies with internal teams designing chips that incorporates HPC or accelerated computing functionality as part of their internal solutions or platforms, such as Alphabet Inc. and Amazon Inc.;
- Suppliers of SoC products that are embedded into automobiles, autonomous machines, and gaming devices, such as Ambarella Inc., Advanced Micro Devices, Broadcom Inc., Intel Corporation, Qualcomm Incorporated, Renesas Electronics Corporation, Samsung, and Xilinx or companies with internal teams designing SoC products for internal use, such as Tesla Motors;
- Suppliers of interconnect, switch and cable solutions such as Applies Optoelectronics Inc., Arista Networks, Broadcom, Cisco Systems Inc., Hewlett Packard Enterprise Company, Intel, Juniper Networks Inc, Lumentum Holdings, Marvell Technology Group and Xilinx, as well as internal teams of system vendors and large internet services companies such as Alphabet and Amazon.
We evaluated the company using our discounted cash flow model. The model relies on the past 15 years worth of financial statements data in order to estimate the future growth of the company. Each company is valuated in a slightly different way, and in this specific case we estimated the future free cash flows for the next 10 years by estimating line by line each of the three main financial statements.
We made some assumptions in order to valuate the company:
- The terminal growth rate is 4.00%;
- The total shares outstanding are 2,480.00 millions;
- The effective tax rate during the forecast period will be, on average, 8.29%;
- The United States 10-year treasury bond yield will reach 3.15% by the end of 2022;
- The risk premium is 6.00%;
- An average annual growth rate of 18.20% over the forecast period.
We used those assumptions to model the weighted average cost of capital, which resulted equal to 11.03%, and to estimate the future revenue growth and free cash flows. We estimated a fair value of $126.68, meaning that according to our valuation there is a possible downside in the stock price of 25.66%. A lot of factors could influence the valuation, including external conditions such as the state of the economy and the reputation: for this reason, we will update it in the future to better reflect the available informations.