Moor Insights & Strategy “Investor Corner” is content specifically written for the professional investment community. This analysis was written by Steven Eliscu as part of Investor Corner, L-sq Advisors, November 11, 2013. See important disclosures and disclaimers below.
NVIDIA’s F3Q14 results on November 7th highlighted that the bear case of too much PC market exposure and a lack of major Tegra 4 applications processor design wins was overly negative; NVIDIA continues to lead in PC gaming and professional graphics with sales growth of its premium products while Tegra is showing a healthy near-term rebound bolstered by a module business in the automotive market. While the longer-term prospects for Tegra profitability remain questionable (especially as its next generation chip for FY2015, Logan, will require a vibrant market for Android-based gaming platforms), its core graphics business remains strong, and its emerging cloud graphics opportunity looks increasingly promising – just this past week, Amazon Web Services launched its cloud graphics service.
To quantify the upside potential of cloud graphics to NVIDIA’s financials, we explore the $5B addressable market that NVIDIA has identified, with virtual desktop infrastructure (VDI) being its biggest near-term opportunity (the company has over 200 ongoing trials in place).
We make the following baseline assumptions (likely similar to what NVIDIA has suggested) that could result in a $5B market: 275M PCs sold/year, 40% of which are commercial; one-third are for knowledge workers who could benefit from some level of accelerated graphics; 10 users (on average) can be served by each cloud graphics processor (GPU); the GPU (card + software) average selling price (ASP) is $1,500 (which could be higher depending on the level of recurring software license revenue).
To drive our NVIDIA EPS adder estimates from cloud GPUs, we assume gross margin is 70% (similar to its current professional graphics products), incremental opex is 10%, tax rate is 16% and diluted share count is 550M (as share count is likely to further decline with the new $1B buyback authorization).
Our analysis shows that even if a very low single-digit percentage of the commercial market moved to a GPU-enabled VDI model, the impact to NVIDIA’s EPS would be significant – perhaps growing it by 50% or more if the market just modestly develops over the next several years:
Table 1: NVIDIA EPS Adder Sensitivity to Cloud GPU penetration, ASP
|
% of Commercial PCs Using a Cloud GPU |
||||||||
|
$4.99 |
0.25% |
0.5% |
1.0% |
1.5% |
2.0% |
2.5% |
3.0% |
|
|
Cloud GPU ASP |
$1,000 |
$0.03 |
$0.05 |
$0.10 |
$0.15 |
$0.20 |
$0.25 |
$0.30 |
|
$1,250 |
$0.03 |
$0.06 |
$0.13 |
$0.19 |
$0.25 |
$0.32 |
$0.38 |
|
|
$1,500 |
$0.04 |
$0.08 |
$0.15 |
$0.23 |
$0.30 |
$0.38 |
$0.45 |
|
|
$1,750 |
$0.04 |
$0.09 |
$0.18 |
$0.26 |
$0.35 |
$0.44 |
$0.53 |
|
|
$2,000 |
$0.05 |
$0.10 |
$0.20 |
$0.30 |
$0.40 |
$0.50 |
$0.60 |
|
|
$2,250 |
$0.06 |
$0.11 |
$0.23 |
$0.34 |
$0.45 |
$0.57 |
$0.68 |
|
|
$2,500 |
$0.06 |
$0.13 |
$0.25 |
$0.38 |
$0.50 |
$0.63 |
$0.76 |
|
Source: L-sq Advisors
This analysis does not even take into account NVIDIA’s visual computing appliance (VCA) and cloud gaming opportunities, which the company has indicated will take longer to develop than VDI but could also be material.
As a stock, NVDA’s solid 27% year-to-date rise has likely been the result of the company’s new effort to return cash to owners and demonstrated resilience of the PC graphics market, offsetting the disappointment of the Tegra business. Nevertheless, Tegra continues to garner much of the attention as a stock catalyst and will likely continue to do so near-term, as the upcoming Consumer Electronics Show in January should be a showcase for NVIDIA’s next generation Tegra (Logan) chip and Logan-based Shield handheld game console platform.
However, on a longer-term basis, especially as investors project NVIDIA’s outlook from mid-FY2015, NVIDIA has a potentially much more meaningful opportunity in the cloud vs Tegra that is: 1) high margin from the get-go and 2) where unit sales in the tens of thousands (rather than tens of millions) would measurably move EPS higher.
DISCLOSURES
I do not own a stock position in any company whose stock is mentioned in this article. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. L-sq Advisors is a consulting firm that may have in the past, present or future solicited and/or generated consulting services from any company mentioned in this article.
BIOGRAPHY
Steven Eliscu is Principal at L-sq Advisors. He brings a unique combination of Equity Research experience – 9 years at UBS, a leading global platform, as a Semiconductor Analyst – along with more than 10 years of senior Marketing and Business Development roles in the technology industry, including 11 years of rising through the ranks at Integrated Device Technology. With this experience, he intimately understands the basis for valuation from the eyes of the financial markets through the lens of his framework for technology value creation. He has a firm grasp of key technology trends (with 3 patents to his name) and the competitive forces driving the tech industry, which have provided the proper context for his understanding of individual companies and ultimately how each should be valued. He developed the basis for his framework based on his experience as an Analyst, and subsequently refined it and brought it to market as the founding Principal of L-sq Advisors.
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