NVIDIA Corporation's Exposure to China Is Lower Than You Think

Source: NVIDIA

In August, Goldman Sachs put out a list, which was subsequently picked up by various news outlets, containing the 20 S&P 500 companies that had the highest revenue exposure to China. Near the top of this list is graphics chip company NVIDIA (NVDA 4.19%), which derives a whopping 54% of its revenue from the region, according to Goldman. If Chinese economic growth were to slow down, any company with heavy exposure there could suffer severe negative consequences.

Taken at face value, this dependence on China would be a good reason to be wary of investing in NVIDIA. It turns out, though, that Goldman was a bit fast and loose with the numbers.

Technically correct
Goldman is correct in saying that NVIDIA derives 54% of its revenue from China, but there's a key detail that the company left out. Here's NVIDIA's revenue for each geographical region in fiscal 2015, which ended in January:

Source: NVIDIA 10-K 

Indeed, revenue from Taiwan and China combined was 54% of the company's total revenue during fiscal 2015. But looking at this data, it should be immediately clear that these numbers don't tell the whole story. Taiwan, with a population of around 23 million, accounts for more revenue than any other geographic region.

How can this be? NVIDIA explains in its annual report: "Revenue by geographic region is allocated to individual countries based on the location to which the products are initially billed even if the revenue is attributable to end customers in a different location."

NVIDIA doesn't sell gaming graphics cards directly to consumers. The company designs the graphics chips, which are then manufactured by a third-party foundry and sold to NVIDIA's board partners. These partners then manufacture the actual graphics cards using these chips.

NVIDIA books revenue based on the location of these board partners, not on the location that the actual end product is sold. Here's a list of the six board partners authorized to sell NVIDIA graphics cards in the United States, along with the country in which they are based:

Regardless of where graphics cards from Asus, Gigabyte, MSI, or Zotac are ultimately sold, NVIDIA attributes this revenue to either Taiwan or China. This means that NVIDIA's true exposure to China, or how much of its revenue is actually attributable to Chinese consumers and businesses buying its graphics cards, can't be determined from the above data.

China's PC gaming market is pretty big. According to analyst firm Newzoo, Chinese consumers spent $12.5 billion on PC games in 2015, not including casual web games that don't require more than a basic PC. Globally, PC game spending was $27.5 billion, putting China at about 45% of the market.

There are major differences, though, between China and the U.S. when it comes to PC gaming. First, Internet cafes remain popular in China, allowing people to play games without needing to buy a PC.

Second, the most popular genre of PC games in China is multiplayer online battle arena, or MOBA, accounting for 50% of Internet cafe gaming in the country, according to Niko Partners. MOBAs generally don't require particularly powerful graphics cards, and in fact, NVIDIA recently launched the GTX 950, a low-end graphics card specifically aimed at MOBA players.

I think that we can draw two conclusions. First, because Internet cafes are popular, the percentage of PC gaming spending attributable to China is probably higher than the percentage of graphics card sales attributable to China. Second, because the most popular games in China only require low-end graphics cards, the mix of NVIDIA's products probably skews more heavily toward the low-end compared to the United States.

As a result, NVIDIA's true China exposure is likely far lower than the 54% Goldman reported, and also likely lower than China's 45% share of PC game spending. The Chinese PC gaming market is growing faster than the global PC gaming market, so NVIDIA's China exposure will likely rise going forward. But NVIDIA isn't nearly as vulnerable to a Chinese slowdown as Goldman's list implies.