NVIDIA's Near-Term Forecast: Turbulence

There's an air of desperation around NVIDIA (Nasdaq: NVDA  ) . The company releases earnings after the market closes tomorrow, and the company has a pretty panicked herd of investors in need of a calming tummy rub.

Simply put, the company's endured a roller-coaster ride over the past month. It began when analysts at Needham downgraded NVIDIA all the way from a strong buy to a hold, sending investors scrambling for the exits.

Needham cited a host of problems with Fermi, NVIDIA's ambitious rearchitecting of its graphics-card line, including claims that yields for the cards were running around 20%-30%. (Semiconductor devices like NVIDIA's are made on giant wafers that get cut up into many chips. The percent of resulting chips that work properly is referred to as yield.)

Even with only two or three of every 10 chips working, NVIDIA's high-performance cards should be profitable, but their price will offer rival Advanced Micro Devices (NYSE: AMD  ) a distinct cost advantage on its core consumer graphics-cards offerings.

Make no mistake: Right now, Fermi is struggling. After long delays getting the first run of cards out, rumors of a poor ramp (substantiated by Needham) to mass volume, and lukewarm performance reviews, it's hard to get excited about the product. It's also difficult to argue against anyone claiming that NVIDIA's margins will face substantial pressure if low yields force the company to continue selling an older line of cards against more competitive graphics offerings from AMD.

Throw in the success of Intel's (Nasdaq: INTC  ) integrated graphics processors and other netbook multimedia-enhancement offerings such as Broadcom's (Nasdaq: BRCM  ) Crystal HD accelerator, and NVIDIA's graphics cards suddenly face a more competitive landscape than ever.

Even worse for NVIDIA, broad rumors of oversupply across the semiconductor industry and a queasy broader market have conspired to knock nearly 20% off the company's share price since mid-April. Ouch.

However, the chipmaker's news isn't all bad. At its recent financial analyst meeting, NVIDIA updated guidance on its Tesla lineup of cards, which are geared toward revolutionizing the supercomputing market. While Tesla revenue for 2010 should only total $26.6 million -- peanuts relative to the company's top line -- that's still a 280% jump from 2009. While it may not matter much now, Tesla makes long-term investors far happier about the company's direction.

In addition, investors sick of rumors of Tegra wins and hankering for tangible successes have to be pleased that Microsoft (Nasdaq: MSFT  ) selected the first-generation Tegra in its Kin smartphones, which went on sale earlier this month. However, due to the size of the order and timing, don't look for the win to affect NVIDIA's prior quarter. NVIDIA still claims to have a host of Tegra orders in its back pocket, but they should be backloaded for later in the year.

In even more happy news, Adobe (Nasdaq: ADBE  ) announced several features in its recently launched Creative Suite 5 that can only be used on NVIDIA graphics cards. NVIDA's worked hard to create a software ecosystem that adds value to its cards. Features like Adobe's Quadro-focused Mercury Playback Engine validate those efforts, and help defend NVIDIA's nearly 90% market share in high-end workstations, which provides the company with its best margins.

Notice a trend here? They're all long-term developments that are playing out well beyond last quarter. So if you're expecting earnings to soothe any fears tomorrow, don’t hold your breath. In the near-term, the company will be driven by sales of consumer-level graphics cards, and a rising semiconductor tide that's lifted all boats.

In the long term, I still like NVIDIA's ambitions and competitive position in the professional and supercomputing graphics card markets. Also, NVIDIA's core gaming "enthusiast" market is holding up much stronger than broader desktop PC sales projections would indicate.

I called NVIDIA the "Best Stock of 2010" late last year, and while I am very concerned about Fermi's rockiness out of the gate, the company's long-term growth potential remains. Despite the stock's bumpy ride, I'm hanging on.

Intel and Microsoft are Motley Fool Inside Valuerecommendations. Adobe and NVIDIA are Stock Advisor picks. The Fool has created a covered strangle position on Intel. The Fool owns shares of Intel and Microsoft. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Eric Bleeker owns shares of NVIDIA. The Motley Fool's disclosure policy is very confused by how magnets work. Don't listen to the lying scientists.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 14, 2010, at 10:21 PM, baldheadeddork wrote:

    Eric, are you still hanging on to NVDA today?

  • Report this Comment On May 15, 2010, at 3:50 PM, TMFEditorsDesk wrote:

    Hi baldheadeddork,

    I'm still hanging on today, and I'd love to buy more as soon as our disclosure policy allows me to. We didn't see nearly the margin weakness many anticipated, revenues were strong, their high end professional segment (my favorite part of the business) delivered. I like NVIDIA even more than I did last week, and I can buy it for 10%+ cheaper.

    Best,

    Eric Bleeker (TMFRhino)

  • Report this Comment On May 17, 2010, at 10:44 AM, baldheadeddork wrote:

    Thanks for the reply, Eric.

    My concerns about nVidia have been the yield and heat problems with Fermi (which have been known in tech circles since last fall) and the end of their chipset business. I think the company could weather either one separately, but looking at both over the next 1-2 years makes me bearish about their outlook.

    Thoughts?

  • Report this Comment On May 17, 2010, at 10:28 PM, TMFEditorsDesk wrote:

    Bald,

    Personally, I see Fermi as a short-term problem. If they can survive a pretty rocky architecture refresh like this while losing minimal market share, I'm impressed, and more to the point- think they had pretty lucky timing (IE- Lucky timing to release a partial clunker in a time of constrained inventory.) Keep in mind, the 20-30% yield numbers came from Needham, and the company seemed to indicate they've performed better than that. Margins increased at a time when Fermi ramped in the "hundreds of thousands", indicating yield are increasing as TSM continues ramping 40-nm production.

    Chipsets, definitely agree that's a bit more precarious. It's been a key profit contributor, and this little spat hurts. Personally, I kind of see Tegra as less of a "growth avenue" and more as a replacement ramp for chipsets. We should see a pretty substantial drop off in the next year or two as Nehelam ramps, so Tegra will have to grow to make up for that.

    In the end, I really like the potential of high performance computing and Tesla. As I said in the article, Tesla's only going to hit ~$27 million this year, but it seems like it can keep growing at impressive rates. Also, we've got some leading indicators on how well parallel programming is being picked up. You can watch its progress through increased focus in education, books, etc. More importantly, the company has defended its workstation status very well, and in the face of a rough workstation-purchasing market we've seen high performance graphics processors recovering well ahead of broader sales (again, in the workstation market). I see this trend continuing in the future, and due to their great margins, the HPC segment is very exciting.

    So, that was a mouthful :), but I think ramping in HPC and Tegra helps smooth out chipset weakness which should probably start becoming a major headache later this year, and Fermi's less a 1-2 year problem. For the diversion of engineering talent NVIDIA's taken away from its core offerings, their competitive stance held up pretty well. Now that they're bringing engineers back to their core graphics cards, I think releases across that time frame should be stronger than what we saw with the first couple Fermi models.

    Risks aplenty, but I feel like we're well compensated at these prices.

    Best,

    Eric Bleeker (TMFRhino)

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