Nvidia Corp. (NVDA) – Price $32.65; Break-up Value $42.31
Nvidia is the last stand-alone graphics chip maker after ATI was bought out by AMD last year. NVDA and ATI were (and will still be) fierce competitors, locked in battles not unlike those seen from AMD and Intel. Now that ATI has the extra financial backing and distribution abilities, it will be interesting to see how well Nvidia can compete on its own. So far Nvidia dominates in all the key spots, with market share over 80% in the high-performance areas of notebook and external chipsets.
There has been speculation that Intel would look to acquire Nvidia (you know, just to keep things even), but Intel instead is hoping to establish its own foothold with a graphics processor chipset due out later in 2007.
If future growth rates resemble the past at all, the stock’s valuation is very reasonable, with a PEG right around 1. But there are concerns split amongst flat desktop sales, a mobile segment that produces no operating income, and a very disappointing PS3 launch. The latter is especially dragging on the stock because the graphics chips used in the console systems sport drool-inducing 74% operating margins with the boost from royalty payments.
Nvidia operates in four operating segments, with the largest being the internal chipset business for desktop and notebook computers. Two smaller segments create products for mobile devices and external motherboards, and the last segment (Consumer Electronics) represents the console business mentioned above.
It would make sense for a move to happen that unlocks the premium value of the console business, slow PS3 or not. A joint venture would be a good route, as the segment is on the small side for stand-alone treatment but valuable enough to the Nvidia image to keep their hands partly on the wheel. As for the valuation for this segment, it’s hard to pin down precisely as we are still in the beginning of the current console cycle. At some point Sony needs to realize that they’ve priced themselves out of the mass-market and slash PS3 prices; the losses will be worth it to preserve their status in the industry before it’s too late to recover from.
If we assume a moderate console growth rate of 20%, the console chip segment should be worth 15x operating income, giving us a value of $1.2 billion (see effective tax note below).
The mobile segment has been a dog lately, and since the company seems to believe in its future, we’ll have to keep it under the NVDA umbrella and see what the company can do with it before assigning any meaningful value to it.
This leaves the two largest segments, internal computer chips and external chipset solutions. As we’ve said, Nvidia dominates in both when measured in terms of market share, and this distinction is more important than current growth rates in the desktop market, which has its requisite cyclical sales figures. The external business is large enough to stand alone as a spin-off, which could be a brilliant strategic move; as it aims to compete with the new Intel product and AMD, a stand-alone company could lead with brand visibility and access to capital. Margins aren’t as fat in this segment as in the core internal chips, but top-line growth is clocking in at 80% plus, which should allow for a slight premium to the market multiple, if less than industry-matching levels. We’re giving the segment a 2.5x sales valuation upon being spun off, adding another $2.2b in value.
In this scenario, Nvidia is left with full ownership of the flagship product, where revenue growth is more moderate in the mid-teens, but margins are showing impressive improvement and growth in notebooks more than makes up for the lackluster desktop market. The segment also sports very healthy operating margins, at just shy of 30%. The company’s effective tax rate is also very low (under 20%) due to high mix of international revenue, which allows us to ascribe a valuation of 20x operating income to end up with a company PEG of 1. Even though the mobile segment is still under the Nvidia roof, revenue is so small in proportion to the total that we shouldn’t expect any real multiple compression while the company figures out if this is a business they should really be in. All told, the value of the core segment is worth $11.7 b, and the total break-up value of Nvidia comes to over $42/share.
Ryan Barnes
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