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NVIDIA CORPORATION  (NVDA)

Last Updated: Jul 4, 2008


Business Summary

NVIDIA is a leading supplier of computer graphics processors. The company targets the high end of the market, where primary applications are computer gaming, video manipulation, and graphics editing.

Growth Strategy

NVIDIA benefits from a market with good organic growth potential. Video gaming has expanded as children who grew up gamers have remained gamers into adulthood. Computer video editing has expanded in both directions - creating entire animated movies and realistic special effects at the high end, and simple home video editing at the low end. This has led to a demand for high performance graphics even in bargain PCs. Additionally, modern operating systems have been developed to take advantage of the capabilities of these graphics. Mobile devices and supercomputing also are growing industries in need of GPU chips. NVIDIA aims to stay at the top of this market by remaining an innovation leader through R&D.

Competitive Position

Computer graphics is a very competitive business. 3 large players dominate the scene. NVIDIA and AMD (formerly ATI) form a near-duopoly in the high end processor segment, with the two companies historically leap frogging each other in successive generations. Intel embeds graphics processors with it's CPUs, catering to the low end of the market. Intel and NVIDIA will soon be competitors, however, as NVIDIA has already begun making low end embedded GPU's, and Intel has announced plans to enter the high end. NVIDIA's current competitive advantages in design are tenuous, short-lived, and non-durable.

Risks

The two primary risks are competition and the cyclical nature of semiconductors. NVIDIA and ATI have traded the technology lead several times in the past, sometimes in the span of just months. Intel looms as a major threat, with massive financial and intellectual resources to compete successfully in the high-end graphics market. Incorrectly timing the chip cycle can also result in a lot of pain over the short term.

Management

Management is experienced and well vested. The CEO is the founder, Jen-Hsun Huang, who owns a 6% stake in the company. He has successfully led Nvidia through competitive pressures, a technology crash, and numerous GPU process generations. The company is highly dilutive with stock options and grants.

Financial Health

NVIDIA has great financial health, with nearly 1.9 billion in cash vs. no debt. Over the past 12 months the company has produced over a billion dollars in free cash flow (29% of revenues), and 180% return on tangible capital. With improved products from AMD and potential competition vs. Intel, it's unlikely these lofty figures can remain intact. NVIDIA's 5-year average ROTC is 78%, free cash flow margin is a more indicative 8%.

MagicDiligence Opinion

NVIDIA is a fine technology company, financially very strong, well managed, and a history of leadership in the graphics processing industry. However, it's position as a Magic Formula stock is due to factors we don't feel are sustainable, particularly the stellar return on tangible capital figure. Add to this the fact that the stock is not remarkably cheap - at just a 5.21% earnings yield (most MFI stocks are 9% or higher). An R&D misstep for a product cycle would inevitably lead to a revenue, earnings, and stock price plunge. That said, the company is solid enough to survive a misstep or two, and there are much less attractive MFI stocks in the screen. NVIDIA is a upper level "tweener", but not a Top Buy.

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