Nvidia as an Acquisition Target: Pros and Cons
12/14/2012 by: Ashraf Eassa
Nvidia is one of the best-managed semiconductor firms in the industry today, as the firm’s pristine balance sheet ($3.43B in cash, negligible debt) attests to. The company has demonstrated a repeated ability to create and/or enter new markets, even when the odds are stacked very highly against them. The firm emerged as the leader of the brutal graphics competition back in the late 90’s and early 2000’s, pioneered and heavily evangelized the use of GPUs as floating point co-processing monsters, and has been aggressively pushing in the mobile system-on-chip space with its "Tegra" lineup. While the mobile phone chip space is dominated by Qualcomm, Nvidia’s position as one of the premier Android tablet chip vendors is clear to the industry.
However, the semiconductor world is changing, and Nvidia now faces deeper competitive pressures than it has in the past. "Tegra" faces serious competition from the legions of ARM licensees as well as Intel, which itself is "sleeping giant" that will soon leverage its significant technological prowess and resources to attempt to establish leadership in this area. Nvidia's bread-and-butter: high performing, power-efficient GPUs for gaming and workstation use are probably safe and will keep financials healthy (albeit not a "hyper growth" segment), but the firm’s latest growth vector – the "Tesla" high performance compute processors – will now face very credible competition from Intel’s "Xeon Phi", which chip-giant can sell along with its traditional server CPUs. As Intel aggressively pushes here, Nvidia will lose market share (although the TAM expansion is likely to offset share losses).
The question on everybody’s mind, then, is whether Nvidia is a ripe acquisition target at these levels. There is certainly a case to be made for both sides of the argument, and that is what I will explore here.
Pros – Valuation, Product Leadership, Patents
The most obvious reason that Nvidia could be an attractive takeover target is that the firm is downright cheap. At a $7.82B market capitalization and $3.43B in net cash, a potential acquirer – even at a 30% premium to these levels at roughly $10B – would really only need to shell out $7B or so to acquire the company and its IP. The acquirer would get a top-notch GPU hardware and software development teams, over 4,500 graphics patents, $4.13B in trailing-twelve-month revenue (and growing), $419M of trailing-twelve-month free-cash-flow, an immediate leadership position in the workstation graphics market, and a solid footing in the mobile system-on-chip and baseband market. Ex-cash, the company trades at less than 1x price-to-sales and 8.66x earnings. At these levels, the firm represents a bargain to any potential acquirer.
For Nvidia, the benefit would potentially be the freedom to more aggressively push in all of its key areas and to leverage its expertise and patents into adjacent sectors of the market without worrying about pleasing the public markets. Although it seems clear that cash is not a concern and it is fortunate enough to be able to write the checks that it needs for R&D as well as supply agreements with the foundries. In fact, with the announcement of the first-ever quarterly cash dividend, it is clear that Nvidia is very well capitalized and now can afford to hand back ~36% of its profits to stakeholders.
Cons – Shareholder Value, Management Style, and Other
While the financial picture is generally rosy for Nvidia as an acquisition target from the perspective of the acquirer, there are certainly factors that would make Nvidia an unattractive target. First off, Nvidia’s bread-and-butter is high performance GPUs. This is a growth area in its own right, but it is not clear that such a business would see much growth under a larger firm or if another firm is even interested. Nvidia already holds the dominant position in this space with over 60% market share.
Nvidia's roadmap has shown weakness in execution - manufacturing issues are the key reason for long lead times, and both Fermi and Maxwell endured long delays
With Tegra, there is also the problem of commoditization of CPU and GPU cores by the likes of ARM Holdings and Imagination Technologies. While Nvidia’s system-on-chip IP is good and continues to improve with each generation, CPU cores from ARM Holdings and GPU cores from ARM and Imagination make it very simple for a semiconductor firm with its own fabrication plants, such as Samsung, to develop its own highly competent solutions. The value proposition of such an acquisition also falls off of a cliff when we consider that Nvidia’s mobile GPUs are not yet truly competitive with the best from Imagination and ARM (although the next generation should be a significant improvement if "Kepler" is utilized), which can be licensed cheaply.
So it boils down to this: a larger company probably doesn’t need Nvidia since it can license off-the-shelf IP and build a competing solution (or spend the cash to roll its own like Qualcomm does), but as an independent, fairly small company, Nvidia can see significant top- and bottom-line upside by taking market share and selling its products to the device vendors while maintaining the core "cash cow" of its GPU business.
Another thing that would stand in the way of a potential acquisition is Jen-Hsun Huang, CEO. Nvidia is his baby, and his ambitions for the company are quite grand. Unless offered an insanely lucrative deal, or the CEO spot of the acquiring company, I find it difficult to believe that Mr. Huang would agree to an acquisition outside of a retirement move.
Finally, I do not believe current shareholders would be particularly happy to accept an offer at anything below $22/share, or nearly ~100% premium to today’s levels. Why? Everybody who bought – institutions included – at about that level in 2011 are now horrifically underwater and would probably vote against such a deal unless it represented a significant premium to even those levels. At that kind of a premium, the value proposition begins to fade.
Nvidia has great technology, great management, and is growing quite nicely. However, I do not believe that an acquisition is likely in the near future, especially as the firm’s management is likely to want to continue to achieve organic growth with its "Tegra" and "Tesla" businesses. In addition, at these levels, the company is incredibly cheap, and it is not clear whether shareholders would accept a less-than-juicy offer. However, the great thing about the industry is that it is always full of surprises...
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