This NVIDIA Downgrade Is No Reason To Sell

Hot off the heels of announcing its next generation Tegra K1 mobile system-on-chip that, frankly, looks like the most compelling mobile processor announced today, Canaccord Genuity downgraded NVIDIA (NASDAQ: NVDA  ) to "hold". Now, anybody familiar with Wall Street lingo, "hold" is synonymous with "sell" (except one looks much friendlier, particularly as these sell-side firms tend to want to seek investment banking business with these companies), so the question that investors must ask is: Was that downgrade justified?

Why the downgrade?
Analyst Bobby Burleson downgraded the stock largely on the basis that there was "limited upside" to calendar 2014 estimates. Further, Burleson believes that since NVIDIA trades at a much richer price-to-earnings multiple than some of its other semiconductor peers (the names mentioned are Broadcom, Intel (NASDAQ: INTC  ) , Qualcomm, and Marvell), there's limited room for actual multiple expansion at these levels (NVIDIA trades at nearly 22 times fiscal 2015 estimates).

While there is certainly some logic to this particular downgrade, it doesn't seem to capture the entire picture. First off, while NVIDIA trades at 22 times  fiscal 2015 estimates, it is important to note that the company has roughly $3 billion in net cash on the books (although this will decline as NVIDIA buys back shares with the $1.3 billion of convertible senior notes that it issued).On an ex-cash basis, NVIDIA trades at only 14 times forward estimates – not dirt cheap, but certainly not a "rich" valuation by any means.

Why NVIDIA deserves a premium valuation
NVIDIA deserves a richer valuation than many of its peers. Take, for example, chip competitor Intel. With a $53 billion revenue base and the majority of it levered to a slow-growth-at-best PC market, it takes a lot more to move the needle there than it does for NVIDIA, whose trailing-twelve-month revenue comes out to roughly $4 billion. A wildly successful Tegra selling, say, 30 million additional units means a whopping $600 million-$1.2 billion (selling price between $20 and $40) – or a meaningful impact on NVIDIA's business. For Intel this wouldn't mean much, thus a larger name is often deserving of a lower multiple as there's less room to grow.

Probably more importantly than its growth prospects is its importance as a strategic asset. It's no secret that graphics is vitally important in almost all areas of computing from handheld phones to high-end visualization, and NVIDIA is the world leader here. With NVIDIA's Tegra K1 essentially embarrassing all other mobile graphics architectures today, is it really so hard to see NVIDIA as a valuable acquisition target for a company that wants the world's best GPU IP to itself?

Don't panic – 2014 is NVIDIA's year to shine
Downgrading on "valuation" is probably the weakest downgrade possible. If NVIDIA were losing meaningful GPU share in PC gaming and/or HPC or if it were looking at another year of dud Tegra sales, then downgrading based on those drivers could be plausible. However, unfortunately for the bears, AMD's tall-tales of grabbing ungodly amounts of GPU share may prove to be more fiction than fact, and Tegra K1 looks to be absolutely stunning. Intel's Xeon Phi also isn't due for a refresh until 2015, leaving the HPC space pretty wide open for at least another year.

In short, 2014 is NVIDIA's year to shine. Don't get shaken out by downgrades on "valuation" for this cash-rich stock with an incredible future. If the story starts to go sour, then it may be time to reevaluate, but it sure looks like 2013 was the "trough" and that for 2014 a lot more can go right than wrong

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Comments from our Foolish Readers

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 January 12, 2014, at 2:27 PM, will1946 wrote:

    It was a cheap shot downgrade, even more so than the one after their latest earnings report. In my view, there is no coincidence here: both the downgrades occurred just after NVDA was breaking out of its boring 15 dollar range...just in order to knock it back again. There is something a bit sinister here.

  • Report this Comment On January 12, 2014, at 4:34 PM, KenLuskin wrote:

    AMD came to CES with a fully functioning MULLINS 64 bit chip that actually appears to be BETTER than the heavily hyped yet NON existent TK1, which won't be in products until 2015.

    AMD's MULLINS will be in products in Q2!

    ALL NEW AAA games are being optimized for AMD graphics!

    The MANTLE API for PCs is the equivalent of the proprietary APIs in the new consoles.

    ALL new AAA games will run 45% faster on AMD GPUs.

    That is why the MAJORITY of NEW LAPTOP DESIGN WINS went to AMD discrete GPUs!!!!

    OEMs understand... Its NOT that complicated..

    Even you could ... IF you started thinking, instead of reflexively defending the stock's you own.

    WHY are MSFT and ORACLE supporting HSA?

    WHY are ARM, QUALCOMM, SAMSUNG, TI founding members of HSA?

    Until you can understand...

    You will be stuck up a creek without a paddle!!!

  • Report this Comment On January 12, 2014, at 7:21 PM, enihcam wrote:

    LOL.

  • Report this Comment On January 13, 2014, at 11:50 AM, jwtrotter wrote:

    I think any objective investor can 'understand' as Luskin begs us to over and over when he posts in every other Fool article that has anything to do with AMD at all. We understand that no matter what AMD does they are still swimming in debt without a product that gives the margins they need to regain enough revenue to get out of the pit they dug for themselves. They may have a few victories technically but they are short-lived victories at best.

    For the investor looking to buy into a semi now, just realize the loudest (and most desperate and paranoid imo) posters should tell you what to avoid, not to buy. Just saying.

  • Report this Comment On January 13, 2014, at 9:47 PM, brokeagain73 wrote:

    @KenLuskin

    Ken - the only thing less accurate than your comments/understanding of the semiconductor market is your understanding of business metrics. I read a post by you regarding AMD margins that is filled with more conjecture and opinion than NY time editorial on gay marriage - not unlike this post. You're delusional if you think AMD is going to generate 15% plus operation margins.

    I was at AMD's TENT....yes they had a tent, not a booth inside by a tent...in the cheap seats. Mullins is going to be another eKabini failure. Limited compute power unless you crank up the wattage and clock. I've seen it and, it wasn't all that impressive nor would they give any detail on clock, power, or cost.

    "Even you could ... IF you started thinking, instead of reflexively defending the stock's you own."

    Ha - I suppose you don't own AMD and your comments are objective.

    "WHY are ARM, QUALCOMM, SAMSUNG, TI founding members of HSA?"

    Genius - First of all HSA isn't anything all that new - everybody who makes a current generation SoC already does it with their GPU and CPU.

    Second of all - joining the foundation means little as membership doesn't require you to produce a single product that supports, however if you're Qualcomm or Samsung you join because NVIDIA and Intel didn't - differentiate, it's that simple.

    To quote the Qualcomm engineer I spoke with when I broached HSA: "AMD is the ony one really pushing that right now...it's kind of a mess, so we'll have to wait and see!"

    Let me leave you with this: I suggest you take some of you're own advice and get yourself learned up on the tech and some basic business fundamentals before scolding and offering others, who seemingly do a better job of articulating opinions on the subject better than you, advice.

    About the only thing that makes AMD competitive is their price. They are willing to sacrifice margin and cash flow to no end just to gain footprin (this is from personal experience). Something NVIDIA and Intel won't do. This is why AMD's gross margins are about half that of NVIDIA's, and why their cash flow from operations can't even cover the interest from their debt (2.5 billion). Good luck with your position genius I am sure you put a lot of thought into it.

    BTW: what are you going to say when sony announces that their playstation now is built on NVIDIA Grid and can stream PS4 games to any device - which reminds me, MANTLE ISN'T used on the PS4 but NVIDIA's physx IS. IDIOT!!!!

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