A dreaded cyclical downturn for the chip industry is here. Specifically, consumers are slamming the brakes on the purchase of new PCs and smartphones, which has hit Nvidia's (NVDA -0.16%) empire built on the GPU (graphics processing unit) especially hard. During the last quarter, sales from video gaming and other graphics applications were halved compared to a year prior.
Enterprise computing is a different story entirely, though. At the moment, the sale of actual GPUs is still fueling plenty of growth at Nvidia, and a budding software business is beginning to emerge as well. Will 2023 be the year Nvidia makes the jump from semiconductor business to software?
Will Nvidia software revenue take off in 2023?
To be clear, Nvidia does not separate out revenue it earns from software services from revenue from selling actual semiconductor hardware. We can assume, though, that the bulk of sales still comes from the sale of GPUs and GPU-powered computing systems for data centers. After all, Nvidia has a long history of bundling free-to-use software with a chip purchase to make it easier for video game enthusiasts and developers to get their new GPUs running as quickly as possible.
However, Nvidia is already making more money off software sales than many investors realize. For example, many Nvidia chips are being used for incredibly complicated computing tasks that require advanced software programs to operate. Many of the companies putting Nvidia hardware to use are not themselves software technologists, so employing some of Nvidia's software engineering is already taking place. Some of this software access might be a one-off purchase, though, rather than a recurring Software-as-a-Service (SaaS) solution investors have come to love.
As proof of this, during the third-quarter fiscal 2023 earnings call, CFO Collette Kress explained that Nvidia will begin segmenting out its large "data center" unit. Not incidentally, "data centers" is by far the company's largest unit. It hauled in over $3.8 billion in sales (more than half of the $5.8 billion revenue total) during the quarter. Kress said:
As the number and scale of public cloud computing and internet service companies deploying NVIDIA AI grows, our traditional hyperscale definition will need to be expanded to convey the different end market use cases. We will align our data center customer commentary going forward accordingly. Other vertical industries, such as automotive and energy, also contributed to growth with key workloads relating to autonomous driving, high-performance computing, simulations, and analytics.
In other words, "data centers" have become far too generic a term for Nvidia's largest revenue segment. Included in that big $3.8 billion quarterly line item were sales of actual GPUs to data center operators, GPU "rentals" via a cloud service (known as Infrastructure-as-a-Service, or IaaS), engineering services, and software used to operate those GPUs. Starting with the next earnings report, expect a lot more detail from Nvidia on what its customers are actually doing with its silicon designs.
Building from small beginnings, but just how small?
Sales from Nvidia's data center unit are currently a bit opaque, but what about the other three primary end-markets of "gaming," "professional visualization," and "automotive"? There are no specifics on software sales here either, but Nvidia could already be making quite a lot of money from recurring software revenue.
Let's start with Nvidia's first subscription business, GeForce Now (think of it like Netflix (NASDAQ: NFLX), but for video games). This past summer, Kress said that GeForce Now's registered users exceeded 20 million globally. How much revenue is that generating? Here's a little guesswork: GeForce Now has a free tier (I'll assume half of the 20 million users subscribe to this), a "Priority" pass at $9.99 a month (let's say nine million subs on average, or $90 million in revenue), and an advanced pass at $19.99 a month (one million subs, or $20 million in revenue).
If this is even a remotely accurate assumption, that means Nvidia could be generating over $300 million in revenue on a quarterly basis. In Q3 fiscal 2023, total video game revenue was $1.57 billion, so video game streaming could still be a small -- but certainly not insignificant -- source of sales complementing the sale of video game GPUs.
Something similar is likely taking place with the "professional visualization" segment, which caters to video game and movie content creators, engineers, architects, and the like. Revenue was just $200 million in the last quarter, a big decline due to lower sales of PCs. However, Nvidia's Omniverse Cloud subscription (used for building 3D virtual worlds, for games and movies or to simulate real-world locations) is lumped into this unit.
Omniverse is free to use for individuals, but a basic enterprise package starts at $9,000 a year. Hundreds of companies are now using Omniverse, so it wouldn't take many teams subscribing to the service to make this a big chunk of the "professional visualization" segment.
The "automotive" segment is even trickier. Sales were $251 million last quarter, and we can assume that most of this revenue is from the sale of Nvidia's computing system used in modern cars (the Nvidia DRIVE Orin and Thor chips). However, Nvidia has a whole suite of software for companies developing self-driving vehicle technology, from actual computing chips to software used to accelerate development. However, many of these sales could be housed under the "data center" segment. Look for some more detail on that starting in fourth-quarter fiscal 2023.
At any rate, Nvidia has many irons in the fire when it comes to software, and 2023 could be a big year. But even now, it appears the company has been quietly building up its recurring software sales to complement its leading GPU designs. As more companies adopt Nvidia chips as they develop their own artificial intelligence systems and 3D applications, there is massive potential for Nvidia software to continue growing. This is a truly unique company operating within the massive semiconductor industry.
