Should You Buy NVIDIA in 2013?

NVIDIA (NVDA 0.74%) may have made some exciting mobile advances, but shares remain pressured by headwinds facing the PC industry. According to Gartner, worldwide PC shipments declined 8.3% from last year. Since 61% of NVIDIA's business is directly tied to the PC market, it's not surprising for shares to have lost 15% this year. The company has been working to reduce its exposure to the consumer-facing PC market by focusing on growing areas such as mobile computing and supercomputing. If these efforts bear fruit, investors should be in for a more rewarding 2013.

The pulse of business

Source: SEC filings. All dollar figures in millions. GPU = graphics processing unit business, PSB = professional solutions business, CPB = consumer products business

Its GPU business, directly tied to the PC industry has remained extremely resilient despite the overall global decline in shipments. The key driver behind this was a strong product refresh based on a more advanced 28-nanometer chip design.

The PSB business, which focuses on professional applications such as modeling and data-intensive supercomputing, experienced a touch of softness, due to a decline in its Quadro products, but was offset by an increase in Tesla sales.

The CPB segment, which includes its Tegra 3 mobile computing processor, was the main driver of growth in this segment. Tegra 3 is featured in Google's (GOOG +1.75%) $199 Nexus 7 tablet, which is selling at a pace of 1 million units per month, according to its manufacturer, Asus. It's also featured in Microsoft's (MSFT 0.13%) high-profile and more expensive Surface RT. If Steve Ballmer's words are any indication, sales are not expected to be nearly as robust for the $599 tablet-keyboard combo as Google's Nexus 7. Going forward, NVIDIA expects its Tegra business will grow by 50% in the next year, indicating more tablets and smartphones will being featuring the processor.

The value side
NVIDIA shares are trading at 15 times trailing-12-month earnings, and analysts expect earnings to grow by an average of 10.5% over the next five years. Historically, NVIDIA has grown its earnings an average of 4.3% over the past five years. Its enterprise value is 45% lower than its $7.6 billion market cap because the company is sitting on $5.50 per share in cash. If we back cash out of the equation, shares are currently trading at 8.25 times trailing-12-month earnings, offering a 27% discount to its five-year expected growth rate.

Data crunch
Data has exploded to the point that the last two years alone created 90% of the world's data. This has created a tremendous opportunity for NVIDIA's Tesla line of GPUs, which are designed to handle mountains of data for supercomputing applications. NVIDIA's GPU are currently employed in two of the top 10 supercomputers in the world, a number I fully expect to increase over time. As data continues to grow, demand for GPU-accelerated computing power will also continue to rise. This megatrend dynamic could very easily translate into benefiting NVIDIA's professional GPU business over the long term.

Tegra 4
On paper, NVIDIA's upcoming Tegra 4 processor is expected to be a technological beast. Leaks suggest it will be a quad-core processor that packs six times more graphical oomph than the current Tegra 3, all while shrinking the footprint from 40-nanometers to 28-nanometers. The processing cores are also expected to be upgraded to ARM Holdings' latest and greatest Cortex-A15, which will allow NVIDIA to better compete with Qualcomm's (QCOM +1.62%) custom- designed Snapdragon S4 processor, as well as Samsung's Exynos 5.

Competitively, the Tegra's missing ingredient has been its lack of integrated 4G LTE modem, which has hurt its smartphones position. During the most recent conference call, NVIDIA CEO Jen-Hsun Huang shared that the company is readying the launch of a chip that integrates both of these elements, and is expected to be "raced" to market in the coming quarter. This product takes direct aim at Qualcomm 's integrated chip solution and will likely invite some serious, perhaps margin pressuring competition. Being that the vast majority of Tegra growth has come from tablets , any win in the smartphone market would be a victory for NVIDIA.

Taking action
NVIDIA is the tale of two stories. One storyline shows a PC market in decline, and it's likely keeping a lid on share gains. Despite these challenges, NVIDIA's updated product mix has allowed it to grow this business. I think this is a strong indication of NVIDIA's ability to operate in difficult environments.

The other storyline tells us about the ever-growing needs of mobile and supercomputing. Unless the overall PC market turns itself around, these business segments will become the most important drivers of future growth. For mobile computing, integrating a modem into the Tegra chip will provide NVIDIA an opportunity to gain more share in the smartphone space. In supercomputing, the more data that needs to analyzed, the more positive its business prospects become.

The antagonist in this story is Intel (INTC 3.71%), which is planning on delivering serious competition to the ARM mobile computing platform in the coming years. By 2014 , its Atom chip will be fabricated on 14-nanometer nodes, technologically superior than what any ARM fabricator will have available. The power efficiency gap will no longer exist between ARM and Intel, tilting the scale back in favor of Intel's architecture.

In the end, investors should frame their thinking in the context of NVIDIA's growth drivers and if they will be enough to offset the headwinds in the PC market. Be sure to also consider the threat of Intel's mobile ambitions.

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