NVIDIA (NVDA)

NVIDIA is clearly in no financial trouble. Management, too, is outstanding. Jen-Hsun Huang is the company's founder and CEO, holds a respectable 6% of shares, and has led NVIDIA through multiple graphics chip generations and a crippling technology boom and bust cycle. NVIDIA has emerged triumphant where a long list of competitors (3dfx, Matrox, S3, Creative) are either long gone or long ago exited this tough business. NVIDIA is a good company in a growing industry.

In assessing the cash flow statement of Nvidia (NVDA), here are my top three items:

• Operating Cash flow has been growing faster than net income being driven by the continuous focus on improving Accounts Receivable DSO (Daily Sales Outstanding)
• This increase in Operating Cash Flow has helped keep any debt off the balance sheet in connection with paying for any acquisitions that have been completed.
• Healthy Free Cash Flow with a yield of ~7.4% for 2008, coming in at +350 basis points higher than the 10-year Treasury note.

Over the last 5 years, there was a small amount of debt back in 2004 which has been eliminated since then. This results in the debt to equity % metric to be 0%, anything under 100% is favorable from a value standpoint. As a note of caution while I foot through the 10k, there appears to be some operating leases that the firm highlights as contractual obligations. Out of the total $941 million contractual obligations in the 2008 annual report, $188.6 million represent operating leases, a form of debt.

Dominant market share—Has only one major competitor in the high-end graphics market and consistently controls a market that is now growing and expanding internationally. The one criteria which is extremely applicable to NVIDIA - is durable competitive advantage. Competitive advantages in a field as fast moving as graphics processing are tenuous and very short lived. Technology cycles here can last less than a year. Historically, NVIDIA and AMD/ATI have traded the technology lead, often in the same year. Gamers and high end computer users are fickle and will jump to whoever wins the latest benchmarks. AMD's Radeon 3800 series chips have been scoring price/value benchmark wins against NVIDIA. Loss of technology leadership means loss of competitive advantage for NVIDIA, and leads to drastically lower margins through lower revenues and increased R&D spending to catch up.

Not only this, but there is nothing stopping OEMs from changing graphics cards in short order. Software relies on graphics library APIs such as OpenGL or DirectX, both of which are supported by all graphics card vendors. There is no hardware lock in here.

As a partner of [company name deleted - as it was recently formed], I attended the Analysts’ Day at nVidia on June 16, 2009. Highlights:

1. nVidia is convinced that the future belongs to a new architecture in which both a CPU and a GPU share the tasks that they are more appropriately designed to perform. Jen-Hsun Huang likened the use of a CPU to perform all functions to the use of a Bugatti Veyron’s 1001 HP engine for city commutes [generates a lot of heat]. The CPU/GPU model is one that he reiterated some forty times. The CPU/GPU co-processing model has been embraced by both Microsoft [for Win-7 - DirectX] and Apple [for OSX-Snow Leopard - OpenCL]. They (NVDA) had a bunch of impressive demos. Comment: Demos are demos. Even if you are “driving”, they are designed to feel good.

2. Extolled the virtues of Atom+ION. The benchmark numbers were impressive. To make a long story short, Atom (by itself) cannot run HD 1080p video at forty plus fps. Atom+ION can! Video transfer and video conversion [from HD to iPod] were 5x faster with Atom+ION [when compared to an Atom - which was unassisted]. In other words, this re-iterates the CPU+GPU model for all future computing (per nVidia).

3. Tegra is designed to deliver the highest performance at the lowest power. The nVidia philosophy is to start at zero power and go upwards from there. Tegra shuts off anything that is not working, and “divides the work” among multiple CPU’s. These CPUs are strategically chosen after a review of the types of jobs that can/will be run on the computer. Tegra has eight CPU’s [all of them have an ARM core]. The eight are:

a. 2xARM [CPU] b. GPU c. 2D Engine d. HD Video Encode e. HD Video Decode f. Audio – Poeral Player g. Image Sensor

4. NVDA already has 42 Tegra Design Wins. Of the 42, 18 are SmartPhones+MID [sans modem] subsidized by wireless carriers. The 42 design wins are at 27 unique manufacturers.

5. 27 wireless carriers have been engaged worldwide.

6. Opportunity is 25M smart-phones in 2010. OEM/ODM paired with carriers. First launches end of this year. Comment: That is a very optimistic number.

7. Tesla and Tegra will drive future growth.

8. Migration to 40nm will further improve margins.

9. On the near-term, inventories have been whittled down from 150 days to 64 days. Comment: Good for new product launch, and profit margins.

10. NVDA claims that Tesla is a desktop supercomputer [so was the Power Mac when it debuted], and this opens up a huge market that wasn’t previously served by nVidia.

Comments: This could possibly blind-side Intel. nVidia has about a two year edge when it comes to “middle-ware”

11. To improve gross margins, NVDA wants to: a. Drive sales UP. b. Increase ASP by transitioning product mix to higher ASP products. c. Decrease COGS by eliminating waste, and by transitioning to 40nm [complete transition will take about eighteen months]. d. Moderate OPEX.

Final words: 1. Nothing we did not expect. 2. NVDA seems to have a good read of the future of computing, but almost all of the future is partly based on the assumption that Intel will not counter nVidia’s version of parallel computing with one of their own. In fact, Intel has significant experience deploying supercomputing centers. 3. Most of this will play out in the end of 2009 or early 2010.

© Bapcha’s Stocks, 2009. http://www.bapcha.com

In these economic times 30 percent margins and beating the street by $150 million is good. Revenues were $664 million well above consensus of $514 million. Margins will improve in the coming quarters and will drive shares higher. Upgrades and downgrades make the brokers money not investors. If the stock nears $8.00 I will be selling puts to keep the premium. This company does not have any finacial issues and currently holds no debt.

"In the newest MacBooks, Nvidia not only seized graphics turf from Intel, but it also took the chipset socket. Intel was relegated to supplying only the processor. That's analogous to Nvidia snagging a piece of prime Manhattan real estate right from under Intel's nose. While Intel holds on to Times Square, Nvidia walks off with Rockefeller Center."

With the rise of netbooks, can NVIDIA take more ground away from rival Intel?

http://news.cnet.com/8301-13924_3-10127699-64.html?part=rss&subj=news&tag=2547-1001_3-0-5

The strong balance sheet of Nvidia would definitely allow it to survive through the current recession. While recession can bring hardship for the company in the coming year, or the next two years, it will also bring negative impact to the competitors. Here I'm referring to AMD, which was already struggling (lossing billions of money) even before the crisis surfaced. Whether the unprofitable AMD can survive through this financial storm is in doubt.

AMD/ATI mayt have scored a win with their current version of GPU, however, that is just one product cycle. According to CEO of Nvidia, they will definitely regain market share from AMD in the coming year. On top of GPU market share to be regained, Nvidia is moving full steam ahead with its CUDA and Tegra. So far, I have no idea how much increase in revenue Tegra can bring to Nvidia's balance sheet, but this company will be very profitable in the long term prospective.

In addition, other business sections, like profession workstation, is growing no less than 20% per quarter, although their revenue are not as significant as the consumer GPU section, yet.

In the below balance sheet exhibits, you will notice that on an annual and quarterly basis, the cash position has increase over the prior period in almost every time period. This is a very positive sign as the company starts to stockpile cash, coming in around $3.25 cash per share outstanding, a nice margin of safety as the stock trades in $23 per share range. This cash balance helps to improve current ratio and quick ratio metrics, both above 2.5x. As I continue to monitor this stock, the firm should be careful with how much cash they decide to sit on. Sometimes a large cash balance is seen by shareholders as an inefficient use of capital. Currently NVDA does not pay a dividend, so one has to assume the growing cash balance will be used in one form or another (i.e. M&A activity, dividends, etc)

Similar to the cash balance, the treasury stock has increased in every period when compared to the previous one. With no debt to pay off, NVDA is basically reducing the outstanding equity. This is a favorable sign on multiple fronts. First, the firm believes that the stock is undervalued in the marketplace and utilizing its cash to buy shares back. Secondly, by reducing the # of common shares outstanding, the earnings per share metric will be naturally improved by reducing the denominator.