Nvidia (NVDA 3.48%) stock declined 4.7% on Tuesday, following the tech giant's disclosure via a filing with the U.S. Securities and Exchange Commission (SEC) that the U.S. government has expanded its restrictions on sales of advanced semiconductors to China and certain other countries.
Here's what investors should know.
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Expansion of restrictions instituted in August 2022
This current move expands the restrictions instituted just over a year ago. On Aug. 31, 2022, the U.S. government ordered domestic companies to halt exports to China and select other countries of certain chips and systems for data centers that are capable of handling advanced artificial intelligence (AI) workloads. The government cited national and international security concerns for this move.
Nvidia stock plunged nearly 8% on the day following the initial ban last year.
The U.S. government's Interim Final Rule on the expanded restrictions on chip exports
As Nvidia wrote in its SEC filing:
The Interim Final Rule amends ECCN 3A090 and 4A090 [which included the initial restrictions] and imposes additional licensing requirements for exports to China and Country Groups D1, D4, and D5 (including but not limited to Saudi Arabia, the United Arab Emirates, and Vietnam, but excluding Israel) of the Company's integrated circuits exceeding certain performance thresholds (including but not limited to the A100, A800, H100, H800, L40, L40S, and RTX 4090).
Any system that incorporates one or more of the covered integrated circuits (including but not limited to NVIDIA DGX and HGX systems) is also covered by the new licensing requirement. The licensing requirement includes future NVIDIA integrated circuits, boards, or systems classified with ECCN 3A090 or 4A090, achieving certain total processing performance and/or performance density. The licensing requirement applies to the export of products classified ECCN 3A090 or 4A090 to a party headquartered in, or with an ultimate parent headquartered in, Country Group D5, including China.
For investors not familiar with Nvidia's product lines, this is a large expansion of the initial restrictions and affects a significant portion of the company's products within its data-center platform.
How important to Nvidia are its data-center product sales to China?
Nvidia's data-center platform is the largest of its four platforms, which also include gaming, professional visualization, and auto. In its most recently reported quarter (Q2 of fiscal 2024), the data-center platform accounted for 76% of the company's total revenue. Moreover, it's safe to assume that the data-center platform accounts for an even larger percentage of the company's total profits, but Nvidia does not break out profitability by platform.
In fiscal Q2, CFO Colette Kress said on the earnings call that "China's demand was within the historical range of 20% to 25% of our data center revenue, including compute and networking solutions." In other words, sales to China probably accounted for about 15% to 19% (0.76 x 20% to 0.76 x 25%) of the company's total quarterly sales.
Nvidia's near-term financial results should not be materially affected by the additional restrictions
The government's Interim Final Rule on this topic is effective thirty days after its publication, which is Nov. 16. And Nvidia's third quarter of fiscal 2024 ends on Oct. 29, so the current quarter will not be affected by the additional restrictions.
Moreover, it seems likely that at least the next few quarters will not be materially hurt by the expansion of the chip export restrictions. As Nvidia management discussed last quarter, the company has more demand than it can quickly fulfill for its data-center products that enable AI capabilities, particularly generative AI. In other words, it has a large backlog of orders, which should provide it with a nice cushion against feeling a negative impact from the expanded chip export restrictions for some time.
Indeed, in its SEC filing, CFO Kress said, "Given the strength of demand for our products worldwide, we do not anticipate that the additional restrictions will have a near-term meaningful impact on our financial results."
How about the longer-term impact?
The longer-term impact of the additional restrictions is not quantifiable, which is why Kress did not mention the long term in the SEC filing.
Assuming the U.S. government's Interim Final Rule on this topic remains permanently unchanged, then it seems to me that Nvidia's financials could be somewhat hurt over the medium term. That said, the company's robust long-term growth potential remains intact, in my view.
Nvidia has powerful demand across the world for its data-center products, which I believe will continue to be strong for quite some time, as well as other avenues for growth -- namely from self-driving cars.
