Shares of ATI Technologies (NASDAQ:ATYT) jumped today after a short press release announced a development deal with Microsoft (NASDAQ:MSFT). Though the announcement did not explicitly say so, investors assume that ATI -- not current provider and marker leader Nvidia (NASDAQ:NVDA) -- will develop the graphics chip used in the next iteration of Microsoft's Xbox game console. ATI rose 7% on the news, while Nvidia shed 4% in morning trading.
ATI and Nvidia both make chips that deliver speedier and better 3-dimensional graphics to PC monitors --essential to realistic game software. Console leaders Sony (NYSE:SNE), Microsoft, and Nintendo choose the spiffiest graphics technology so that software developers can create games that attract players first to the hardware and then to more lucrative online gaming networks.
ATI already produces chips for Nintendo's GameCube, but Microsoft's choice of the company for the better-selling Xbox is a real boost, just as Sony's pick of Rambus' (NASDAQ:RMBS) speedy memory chip interface for the bestseller PS2 boosted that company's prospects.
But should either ATI or Nvidia attract chip-savvy investors? Nvidia's trailing-12-month (ttm) revenues of $1.7 billion have declined year over year for the last two quarters, though the company still churned out free cash flow and GAAP profits. And new products are coming. Nvidia did not look pricey at 16 times -- and an enterprise value at 12 times -- trailing free cash flow. But with today's news, and with Xbox related-revenues representing 19% of the latest quarter's sales, the cash machine may slow, the valuation may rise, and the shares may be no deal.
ATI sports $1.2 billion in ttm revenues and, on a year-over-year basis, these have climbed for the last four quarters. The company churned out sweet free cash flow during the last two quarters, and six out of the last eight, but the stock is likely priced too high at 114 times free cash flow and at an enterprise value 78 times free cash flow.
But even if confirmation that ATI will displace Nvidia in the next Xbox is forthcoming, neither sales declines for Nvidia nor sales gains for ATI appear particularly imminent. After all, Microsoft CEO Steve Ballmer recently said that the next Xbox (they should call it NextBox, don't you think?) won't appear until 2006.
Are both too highly valued for current prospects? Be your own analyst and find others on our Nvidia and ATI discussion boards -- the best on the Web. While you're at it, h elp The Motley Fool celebrate its 10th anniversary with 10 Ways to Make More Money Now!
