This week NVIDIA (NASDAQ:NVDA) broke a long-standing practice of making only small acquisitions. The company announced Monday that it planned to acquire Israeli semiconductor specialist Mellanox Technologies (NASDAQ:MLNX) for about $6.9 billion in cash. NVIDIA will pay $125 per share for the company, a 14% premium over Friday's closing price. 

Mellanox designs, manufactures, and sells data center products, including chips, networking gear, and interconnects. These items help speed up the exchange of data between servers, storage systems, and across data networks, and are key components in cloud computing. This is the latest push by NVIDIA further into the data center.

IT technicians walking in a data center between rows of rack servers.

Image source: Getty Images.

Why it matters

Longtime NVIDIA followers will immediately recognize the potential for synergy. The data center segment has been NVIDIA's biggest growth engine in recent years, growing sevenfold in just 36 months, to nearly a third of the company's sales. This was the result of a recent paradigm shift in technology.

First, the advent of cloud computing has ushered in a big move of data from company servers to the cloud. NVIDIA's graphics processing units (GPUs) have become standard equipment in many of the largest cloud computing operations and data centers, making NVIDIA one of the biggest beneficiaries of the trend.

Additionally, researchers working in the field of artificial intelligence (AI) found that the ability of GPUs to quickly perform multiple, complex mathematical calculations -- a process known as parallel computing -- became one of the key components in the widespread advancement in the AI technique of deep learning.

With the addition of Mellanox, NVIDIA will become further entrenched in the growing data center and AI movements. The company will likely work to seamlessly integrate the workflow between its GPUs and Mellanox's data center products, creating something that is greater than the sum of its parts. This will build on the "long-standing partnership" between the two companies.  

Dollars and sense

To get an understanding for why this deal makes sense for NVIDIA, we need look no further than Mellanox's recent financial results. In late January, Mellanox released its fourth-quarter earnings report, producing revenue of $290.1 million, up 22% year over year. Net income grew to $42.8 million compared to a loss of $2.6 million in the prior-year quarter. This resulted in earnings per share of $0.78, up from a loss of $0.05 in the prior-year period.

For the full year, revenue was $1.09 billion, up 26% compared to 2017, producing net income of $134.3 million. Earnings per share grew to $2.46 for 2018 compared to a $0.39 loss in 2017. This was the first time revenue topped $1 billion. 

For the upcoming first quarter, Mellanox had forecast revenue of $300 million, up 20% year over year at the midpoint of its guidance.

Though some might view the deal was somewhat expensive, NVIDIA said it would be immediately accretive to non-GAAP gross margin, non-GAAP earnings per share, and free cash flow. The deal won't require any debt, as NVIDIA will fund the purchase entirely with the cash on its balance sheet. The transaction has already been approved by the board of directors of both companies and is expected to close by year-end.

Investor takeaway

NVIDIA has faced challenges in recent months, hit by a one-two punch that resulted from a cryptocurrency mining crash (miners used NVIDIA GPUs to power their servers) and an economic slowdown in China.

Rival Intel was rumored to be bidding for Mellanox as well, which could also have been a contributing factor in NVIDIA's decision to seal the deal. Acquiring Mellanox could help boost NVIDIA's data center business just as the company is looking to move past its recent difficulties.