Last quarter, NVIDIA (NASDAQ:NVDA) managed to grow its gaming revenue by 17% on a year-over-year basis, to $687 million.
NVIDIA's president and CEO, Jen-Hsun Huang, explained on the company's earnings call in May why he thinks NVIDIA is succeeding in the gaming market, and why virtual reality (VR) will help continue that growth through the company's graphics processing units (GPUs):
A GPU is a general purpose processor. It's a general purpose processor that's dedicated to a particular field of computing, such as computer graphics, physics simulation, et cetera. But the thing that's really important is all of the algorithms that sit on top of it, and we have a really, really fantastic team of computational mathematicians that captures our algorithms and our know-how into GameWorks, into the physics engine, and recently the really amazing work that we're doing in VR that we've embodied into VRWorks.
Of course, companies like to talk up their opportunities on earnings calls, but there a few reasons NVIDIA is in a prime position to benefit from virtual reality's upcoming growth.
NVIDIA's upcoming VR opportunity
According to an investor note published by Canaccord's Matthew Ramsay last month (republished on Barron's), NVIDIA's VR opportunity is almost here.
He noted that 80% of the installed base of NVIDIA's GeForce graphics cards still don't have a VR-ready GPU inside, meaning the vast majority of NVIDIA's graphics card users will eventually need to upgrade in order to use any type of virtual reality system. Ramsay thinks that could bring sustained strong growth in the low-teens for the company's gaming segment.
VR-ready computers need high-end graphics cards (like NVIDIA's new GeForce GTX 1080), and Ramsay thinks these new cards could push up the average selling price (ASP) of the company's GeForce cards and bring in more revenue.
NVIDIA has said itself that only 1% of computers on the market this year are VR-capable. And the company knows PC users may need a little prodding before they upgrade to virtual reality components.
That's likely part of the reason the company introduced its first-ever game last week, called VR Funhouse. The free game works on HTC's Vive VR headset and allows users to experience carnival-style games in virtual reality. Aside from giving it away, the company is also open-sourcing the game to developers so they can make similar VR experiences on their own.
NVIDIA released the game to highlight the the company's Pascal-based GPU, which sports its in-house technologies like PhysX, Hairworks, Nvidia Flow, Nvidia Flex, and others. Each of these technologies work together to create the "most technically advanced VR experience yet," according to NVIDIA.
The company is betting that getting more developers playing with and creating VR will lead to increased hardware sales for the company, which could be end up being very lucrative. The market for VR hardware market is expected to hit $3.2 billion this year and top $15.9 billion by 2020, according to Statista.
This opportunity may take a while
Gaming is already NVIDIA's biggest revenue driver. It brought in 53% of total revenue in Q1 2017. Clearly, the company wants to find new ways to keep gaming revenue strong, and virtual reality looks like its it.
But investors should remember that it's going to take VR a while to really catch on. Facebook's Oculus, which makes the Rift VR headset, doesn't expect the technology to truly take off for another five or 10 years.
The slow rise of VR isn't necessarily a bad thing for NVIDIA, though. The company's gaming revenue is already doing well, and NVIDIA is using its GPUs in new areas like machine learning and driverless car technology as well. Investors should view NVIDIA's focus on VR as wise investment in the company's gaming segment -- even if it takes a few years to see the benefits.