Hot off the heels of announcing its next generation Tegra K1 mobile system-on-chip that, frankly, looks like the most compelling mobile processor announced today, Canaccord Genuity downgraded NVIDIA (NVDA 3.71%) to "hold". Now, anybody familiar with Wall Street lingo, "hold" is synonymous with "sell" (except one looks much friendlier, particularly as these sell-side firms tend to want to seek investment banking business with these companies), so the question that investors must ask is: Was that downgrade justified?
Why the downgrade?
Analyst Bobby Burleson downgraded the stock largely on the basis that there was "limited upside" to calendar 2014 estimates. Further, Burleson believes that since NVIDIA trades at a much richer price-to-earnings multiple than some of its other semiconductor peers (the names mentioned are Broadcom, Intel (INTC 1.77%), Qualcomm, and Marvell), there's limited room for actual multiple expansion at these levels (NVIDIA trades at nearly 22 times fiscal 2015 estimates).
While there is certainly some logic to this particular downgrade, it doesn't seem to capture the entire picture. First off, while NVIDIA trades at 22 times fiscal 2015 estimates, it is important to note that the company has roughly $3 billion in net cash on the books (although this will decline as NVIDIA buys back shares with the $1.3 billion of convertible senior notes that it issued).On an ex-cash basis, NVIDIA trades at only 14 times forward estimates – not dirt cheap, but certainly not a "rich" valuation by any means.
Why NVIDIA deserves a premium valuation
NVIDIA deserves a richer valuation than many of its peers. Take, for example, chip competitor Intel. With a $53 billion revenue base and the majority of it levered to a slow-growth-at-best PC market, it takes a lot more to move the needle there than it does for NVIDIA, whose trailing-twelve-month revenue comes out to roughly $4 billion. A wildly successful Tegra selling, say, 30 million additional units means a whopping $600 million-$1.2 billion (selling price between $20 and $40) – or a meaningful impact on NVIDIA's business. For Intel this wouldn't mean much, thus a larger name is often deserving of a lower multiple as there's less room to grow.
Probably more importantly than its growth prospects is its importance as a strategic asset. It's no secret that graphics is vitally important in almost all areas of computing from handheld phones to high-end visualization, and NVIDIA is the world leader here. With NVIDIA's Tegra K1 essentially embarrassing all other mobile graphics architectures today, is it really so hard to see NVIDIA as a valuable acquisition target for a company that wants the world's best GPU IP to itself?
Don't panic – 2014 is NVIDIA's year to shine
Downgrading on "valuation" is probably the weakest downgrade possible. If NVIDIA were losing meaningful GPU share in PC gaming and/or HPC or if it were looking at another year of dud Tegra sales, then downgrading based on those drivers could be plausible. However, unfortunately for the bears, AMD's tall-tales of grabbing ungodly amounts of GPU share may prove to be more fiction than fact, and Tegra K1 looks to be absolutely stunning. Intel's Xeon Phi also isn't due for a refresh until 2015, leaving the HPC space pretty wide open for at least another year.
In short, 2014 is NVIDIA's year to shine. Don't get shaken out by downgrades on "valuation" for this cash-rich stock with an incredible future. If the story starts to go sour, then it may be time to reevaluate, but it sure looks like 2013 was the "trough" and that for 2014 a lot more can go right than wrong.
