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. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  2. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  3. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  4. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  5. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  6. Stock Analysis

    Top 3 Stocks for the Coming Holiday Season

    If you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
  7. Investing News

    Could a Rate Hike Send Stocks Higher?

    A rate hike would certainly alter the investment scene, but would it be for the better or worse?
  8. Investing News

    Corporate Bonds or Stocks: Which is Better Now?

    With market volatility high, you may think it is time to run for corporate bonds instead of stocks. Before you do take a deeper look into which is better.
  9. Mutual Funds & ETFs

    Using Short ETFs to Battle a Down Market

    Instead of selling your stocks to get gains, consider a short selling strategy, specifically one that uses short ETFs that help manage the risk.
  10. Investing Basics

    How to Diversify with International Stocks

    Diversifying with international stocks can benefit most portfolios, but beware of country risk.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. 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 >>
  6. 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 >>

You May Also Like

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!