Nvidia (Nasdaq:NVDA) generates a healthy amount of free cash flow and has maintained a strong GPU business despite but the pressures in the PC market, but analysts and investors have increasingly soured on the company's mobile ambitions. Tegra has yet to catch on, and with competition ramping up from Intel (Nasdaq:INTC), Qualcomm (Nasdaq:QCOM), Marvell (Nasdaq:MVRL), and others, this whole adventure may end up as little more than an expensive mistake. The shares don't look expensive even on undemanding assumptions, but Tegra-related concerns are likely to keep a lot of investors out of the shares.
 
Decent Second Quarter Earnings
All things considered, Nvidia didn't have a bad fiscal second quarter. Revenue fell 6% from the year-ago period, but was more or less in line with expectations. Revenue from the GPU business rose 8% from last year and 9% sequentially, while the company saw a sharp trailing off of Tegra (down 71% and 49%, respectively). 
 
With more of the revenue mix in the higher-margin GPU business, Nvidia's gross margin came in strong relative to expectation, rising four points on a GAAP basis (or 150bp sequentially). Operating income was down 25% from last year, but still came in about 15% higher than expected despite an 18% increase in R&D spending.
 
SEE: A Look At Corporate Profit Margins

Tegra Upside Seems To Be Vanishing Quickly
Nvidia management has talked a good game on Tegra for quite a while, but they have yet to get a large portion of the sell-side to buy into the story. This quarter's guidance won't help. With updated guidance, it sounds like Tegra is going to be down about 30% year-over-year (versus prior guidance of flat revenue), with tablet and phone-related revenue down considerably more.
 
Worse still, it's getting harder to find the near-term upside to the program. Nvidia seems to be losing sockets to Qualcomm, and both Intel and Marvell are likely to get VoLTE solutions qualified by the end of the second half of 2013. While I suppose Tegra could see some traction or upside in areas like automotive (Audi and Tesla are already Nvidia users), it's hard to see any sort of near-term payoff coming from the large sums Nvidia continues to spend on R&D.
 
I also have to question the company's GPU IP licensing strategy. While Qualcomm has managed to create a side-by-side licensing and chip production model, it's harder to see the argument for companies like Apple (Nasdaq:AAPL) agreeing to license Nvidia's technology. On the other hand, if this is a prelude to the company abandoning its ambitions in producing SoCs, the Street would respond positively.
 
Opportunity Coming At A Cost
I can appreciate why Nvidia feels the pressure to grow its addressable markets – Wall Street is always a “what have you done for me lately?” sort of place. So even though I think assumptions that the PC market is doomed to vanish are very much premature, and Nvidia has an under-appreciated high-performance computing business, I understand the desire to take on new markets.
 
The trouble is the amount of money that management is committing to these new opportunities. What I see is a slowing high-end mobile device market and fierce competitors like Qualcomm, Intel, Marvell, and Broadcom (Nasdaq:BRCM) fighting for this slowing market. Maybe there's still an opportunity for Nvidia to stand out with a high-performance product, but my concern is that Nvidia is chasing a low-potential market and wasting the cash flow that strong GPU business creates.
 
The Bottom Line
Even with modest long-term growth forecasts (3% revenue growth, 5% free cash flow growth), Nvidia looks underpriced with a fair value in the high teens. Likewise, the company's return on equity suggests meaningful upside to the company's P/BV ratio. While these shares may be cheap, they're cheap for a reason given that the Street presently expects all of this spending on Tegra to basically be a waste of resources. That view may be short-sighted but absent more confidence in the outlook for Tegra, these shares may have a hard time attracting much support.
 
Disclosure – At the time of  writing, the author did not own shares of  any company mentioned in this article.

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  3. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  6. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  7. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  8. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  9. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  10. Professionals

    Tips for Helping Clients Though Market Corrections

    When the stock market sees a steep drop, clients are bound to get anxious. Here are some tips for talking them off the ledge.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  5. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  6. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!