Should Investors Get Excited About NVIDIA Corporation's Mobile Business?

Following a disappointing year in 2013, NVIDIA's mobile business seems to be on the rise again, thanks to a strong automotive segment and a focus on high-end devices. But even if revenues keep increasing down the line, will this translate into returns for investors?

Jun 3, 2014 at 12:00PM

NVIDIA (NASDAQ:NVDA) is a household name thanks to their GPUs, which have been a key component of the PC gaming experience for years. But the company is also coming up with innovative extensions to this core business, and it's found success in adapting GPUs to high-performance computing and virtualizing desktops in the cloud. However, the most intriguing initiative is the Tegra system on a chip, NVIDIA's move into the mobile chip business.

Going beyond the GPU
The idea behind Tegra is to combine the high performance of NVIDIA's desktop GPU with the low power consumption needed in the mobile world. For example, Tegra 4, which was released last year, offers 72 GPU cores and a 4-core application processor, coupled with an additional core that's in charge of saving power.

Over the past several years, Tegra has been included in some notable devices, such as the first two versions of Microsoft's Surface tablet. However, revenue from Tegra in 2013 was only $398 million, 8% of NVIDIA's total. Even more worryingly, Tegra revenue decreased 48% from the previous year, as slowing sales of Tegra 3 products weren't offset by increases in Tegra 4 sales.

At first sight, this might look like a failed entry into a market dominated by giants such as Qualcomm (NASDAQ:QCOM) and Intel (NASDAQ:INTC). What is NVIDIA's mobile strategy, and how is it working out for the company?

Tablets and phones
On the first-quarter conference call, CEO Jen-Hsun Huang said that phones and tablets are still one of the major drivers of growth for Tegra. In an interview with CNet several weeks later, Huang further explained that NVIDIA is not interested in competing on price for mainstream devices, and instead wants to help build the "Porsche of tablets or phones."

In the phone market, Tegra will mostly be competing against the high-end 800 tier of Qualcomm's Snapdragon chip line. While the Tegra 4 outperforms the current versions of Snapdragon, Qualcomm is releasing a more powerful chip, the Snapdragon 805, later this year. Considering that cellular is Qualcomm's core business, and one in which it has a dominant 66% share, NVIDIA has its work cut out.

As for tablets, NVIDIA does have one significant design win with Xiaomi's iPad Mini competitor, the Mi Pad. On the other hand, it appears that Microsoft's Surface 3 will be powered by Intel rather than NVIDIA. Intel recently reported that its mobile and communications group posted a $3 billion loss in 2013, showing the level of determination and competition that NVIDIA will be going up against in this market.

More than just phones
NVIDIA has stated that the mobile opportunity is bigger than just phones, and that, as a "performance-oriented company," it will go after markets that can benefit from its high-end chips. One opportunity is mobile gaming, and NVIDIA expects that this will be a valuable business down the line.

But currently, the most promising driver for mobile growth is automotive. Tegra chips drive infotainment systems in the Audi 3 and the Tesla Model S. Also, the Tegra K1, which NVIDIA calls the "first mobile supercomputer," is powering Audi's prototype of a self-driving car. In the first quarter, NVIDIA's automotive segment grew 60% year-over-year, and management stated that they have a $2 billion pipeline going forward .

What this means for investors
Tegra numbers have picked up recently, partially validating NVIDIA's mobile strategy. Earnings have increased sequentially for the last three quarters, and in the first quarter of this year, NVIDIA reported $139 million in revenue from Tegra, a 35% year-over-year increase. Management also seemed upbeat about Tegra's prospects, calling for continued growth in coming quarters, particularly in the second half of this year.

Still, even if NVIDIA's mobile plans turn out as hoped, there are two reasons why investors shouldn't get too excited. First, gross margins on Tegra are lower than the gross margins on GPUs , which ultimately means less incoming cash. Second, whatever profit that Tegra will generate won't necessarily make its way back to investors. NVIDIA has traditionally invested heavily in R&D -- 32.3% of revenue in 2013 -- and CEO Jen-Hsun Huang has stated he would also love to invest more on R&D in the future.

In conclusion
NVIDIA's mobile effort, Tegra, is a good opportunity for the company. In spite of heavy competition in the high-end device market, Tegra might see significant revenue growth down the line thanks to growth in the automotive segment. Nonetheless, it's not clear how much of this will translate into returns for investors, since Tegra has lower gross margins than NVIDIA's GPU business, and since the company likes to invest its profits into expensive R&D.

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Srdjan Bejakovic has no position in any stocks mentioned. The Motley Fool recommends Nvidia. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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