Demand for high-end computing is booming in the wake of the pandemic, and showing no signs of letting up. And yet at the same time, the semiconductor industry -- the provider of all technology's basic building blocks -- is consolidating to address the economy's tech needs.
There are good reasons for this, and NVIDIA's (NVDA +2.98%) bid for chip architecture licensing leader ARM Holdings embodies the issue. At the same time, Nvidia is pouring vast resources into research and development, and coming up with an expanding suite of cloud-based software as a result. The rulebook is changing for semiconductor industry success, and Nvidia's combo of tech hardware licensing and software makes it the best bet for the 2020s.
A new battle looming with tech giants
Cloud computing is reshaping the economy. The pandemic and the remote work movement it spawned have shoved the world further down the cloud path, cementing the data center (from which cloud services are built and delivered to users) as a critical computing unit for the decades ahead.
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This has of course been a boon for semiconductor companies, but it's also presented a potential problem. Chip companies' biggest customers could eventually become its biggest competitors. You see, massive secular growth trends have turned multiple companies into tech titans with vast resources at their disposal. And several of them -- including Apple (AAPL +0.33%), Alphabet's (GOOGL 1.67%)(GOOG 1.63%) Google, and Amazon (AMZN 0.73%) -- have started developing their own semiconductors to best suit their needs. All three have licensed ARM's extensive portfolio of chip designs to help get the ball rolling.
To be fair, tech giants represent a tiny share of the silicon market at this point. Even with the help of ARM's advanced blueprints, it takes incredible scale to engineer circuitry in-house and then partner with a fab (like Taiwan Semiconductor Manufacturing (TSM 1.46%)) to start production. But that's the point. Companies like Apple, Google, and Amazon are large enough and have enough spare cash that it's beginning to make financial sense for them to journey down this path. The potential of this is concerning for the semiconductor industry.
That's why Nvidia's bid for ARM is such an incredible move. Granted, Nvidia has promised to keep ARM independent and won't deny anyone access to its designs if the merger is approved (there are still lots of question marks on whether regulators in the U.K. where ARM is based, as well as those in Europe and China, will sign off on the deal). Nevertheless, if Nvidia does get ARM, it says it will devote more research dollars to the firm and add its own extensive tech licensing know-how -- especially in the artificial intelligence department. Rather than diminish the competitive landscape, this could give purpose-built semiconductor firms a fighting chance to continue developing best-in-class components for a world that is increasingly reliant on digital systems.
And if Nvidia doesn't get to acquire ARM? There's nothing stopping it from accessing ARM's portfolio and adding its own flair to the design. In fact, even ahead of the merger decision, Nvidia has announced a slew of new products aimed at the data center market. And if it can't redirect some of its research budget to ARM, it can continue to develop on its own. In fact, Nvidia is one of the top spenders on research and development as a percentage of revenue out there, doling out nearly one-quarter of its $19.3 billion in sales on research and development over the last trailing 12 months.
With or without ARM, Nvidia is in prime position to dominate the tech hardware market in the decade ahead as data centers and AI grow in importance in the global economy.
Becoming a partner on the cloud software front
Of course, when it comes to designing semiconductors, the real end goal is to build a killer product or software service. Once chip companies do their job, that process has historically been out of their hands, and in the realm of engineers and software developers.
Historically, Nvidia has played by the same playbook -- but that's changed in recent years. The company has been planting all sorts of seed for its future cloud software and service library. It has its own video game streaming platform GeForce Now, Nvidia DRIVE has partnered with dozens of automakers and start-ups to advance autonomous vehicle software and system technology, and the creative collaboration tool Omniverse, which builds on Nvidia's digital communications capabilities, is in beta testing.
New cloud services like AI Enterprise and the Base Command Platform demonstrate the power of Nvidia's hardware, as well as Nvidia's scale to be able to build business tools it can directly go to market with. While public cloud computing firms like Amazon, Microsoft (MSFT +1.50%), and Google get all the attention, don't ignore Nvidia. It's going after the massive and still fast-expanding software world as secular trends like the cloud and AI are forcing the transformation of the tech world.
Between its top-notch tech hardware licensing business and newfound software prowess, it's clear Nvidia is no normal semiconductor company. It may not be the most timely purchase ever -- shares currently value the company at 95 times trailing 12-month free cash flow, partially reflecting the massive growth this year from elevated demand for its chips. The stock price could also get volatile later this year and next, especially as a more definitive answer on the ARM acquisition emerges. However, if you're looking for a top semiconductor investment for the next decade, look no further than Nvidia, as it's poised to rival the scale of the biggest of the tech giants.
