Industry overview and competitive positioning
Semiconductors are the building blocks (used to make integrated circuits/computer chips,
flash memory) of most all consumer electronics, including PCs, mobile phones, MP3 players,
etc. So as the increase of this demand of consuming electrical devices, this industry which is
of competition and innovation will keep an optimistic rise in the future.
Competitor’s Market capitalization:
NVDA 10.93B
AMD 2.19B
INTC 167.05B
TXN 53.77B
Industry 367.59M
Porters five force model.
1. Threat of New Entrants. In the early days of the semiconductors industry, design
engineers with good ideas would often leave one company to start up another. As
the industry matures, however, developing a new CPU requires 500 million dollars
and even setting up a chip fabrication factory requires billions of dollars in
investment. The cost of entry makes it painful or even impossible for all but the
biggest players to keep up with state-of-the-art operations. It comes as no surprise,
then, that established players have had a big advantage because old technology are
quickly replaced by new ideas through fast paced innovation likely during the setting
process. Regardless, there are signs that things could be changing yet again.
Semiconductor companies are forming alliances to spread out the costs of
manufacturing. Meanwhile, the appearance and success of "fabless" chip makers
suggests that factory ownership may not last as a barrier to entry.
2. Power of Suppliers. There are enough silicon and quartz – raw material of
fabricating the semiconductor, which lead to a large quantities of suppliers. For the
large semiconductor companies, suppliers have little power - many semiconductor
companies have hundreds of suppliers. This diffusion of risk over many companies
allows the chip giant to keep the bargaining power of any one supplier to a
minimum. However, with production getting hugely expensive, many smaller chip
makers are becoming increasingly dependent on a handful of large foundries. As the
suppliers of cutting-edge equipment and production skills, merchant foundries enjoy
considerable industry bargaining power. The largest U.S.-based foundry belongs to
none other than IBM – which is also a top chip maker in its own right.
3. Power of Buyers. Even the buyer power depends on importance of product to
quality of buyer product and intensive competition, as we mentioned above now the
product always are of reliability and the market is dominated by some huge
companies, most of the industry's key segments are dominated by a small number
of large players. This means that buyers have little bargaining power.
4. Availability of Substitutes. The threat of substitutes in the semiconductors industry
really depends on the segment. While intellectual property protection might stop
the threat of new substitute chips for a period of time, within a short period of time
companies start to produce similar products at lower prices. Copy-cat suppliers are a
problem: a company that spends millions, if not billions, of dollars on the creation of
a faster, more reliable chip will strive to recoup the R&D costs. Although the copycat suppliers can’t make products matching the reliability and performance, but the
growing trend should be taken into account.
5. Competitive Rivalry. The industry is marked by intense rivalries between individual
companies. There is always pressure on chip makers to come up with something
better, faster and cheaper than what redefined the state-of-the-art only a few
months before. That pressure extends to chip makers, foundries, design labs and
distributors – everyone connected to the business of bringing chips from R&D into
high-tech equipment. Another competition is from changes in consumer tastes
probably due to growing popularity of tablets and declining demands for PCs,
meaning that companies like Intel and NVIDIA who focus on PCs chips lose their
market share, leading appearance of companies manufacturing other chips.
Factor
Score
Description
Threat of new
entrants
low
Bargaining power of
suppliers
Low
Bargaining power of
buyers
Low
Threat of substitute
of products
Low
Rivalry between
established firms
High
Unlike the early stage of semiconductor industry, it is difficult
for new starting company to enter this industry because of
fund and innovation, but there is a little possibility to enter.
Diffusion of risk over hundreds suppliers is beneficial to keep
the bargaining power. Then as the refinery of chip, this power
will decrease.
Now this industry is dominated by some huge companies, and
on top of that, their product are of reliability and
performance, the bargaining power of buyers is low.
Even some copy-cat can produce similar product to some
degree, the performance and reliability can not match those
from huge companies due to lack of R&D expense.
Though there is only some huge companies and of fast
innovation in this industry, the competition is so fierce.
NVIDIA (NVDA) is a well-known player in the computing industry with its graphics
processing units that are used across a variety of applications. Thus, it makes
sense to put the company through a SWOT analysis and weigh the pros against
the cons.
Strengths

Product mix: It is the biggest weapon in NVIDIA’s arsenal. The manufacturer of graphics
processing units (GPUs) for PCs shifted its attention to the mobile computing boom
seamlessly and this has certainly increased its addressable market.

Innovation: Another trademark of the NVIDIA brand. The company never sits back after
designing a chip and comes up with a more efficient design pretty soon after. This
quality has helped NVIDIA provide better solutions to customers, retaining existing
ones and adding more in the process.
Weaknesses

Absence of a top selling device: The Tegra mobile chips which NVIDIA manufactures
have not found their way into a bestseller like the iPhone. And as far as tablets are
concerned, they power mostly Android-based devices which are yet to gather steam.
Opportunities

GPU has some fuel left: PCs might be on the decline but they still find takers in
emerging markets such as China (the largest PC market) and India. There is tremendous
room for growth in these markets as people are still crazy about adding a more
powerful graphics card in their machine. Again, the company provides solutions for
enterprise computing such as in supercomputers across industries. This is again an area
where NVIDIA leads the charge.

More from mobile: Barring a setback in the previous quarter, the Tegra chips have been
doing pretty well. There are a lot of possibilities in the smartphone and tablet space
and if NVIDIA gets it right here, it could turn out to be a winner.
Threats

GPU slowdown: The GPU business, which makes up half of the company’s revenue,
experienced some hiccups in the previous quarter. The Thailand floods impacted this
business and its effects could be felt in the coming quarters. Again, low demand of PCs
because of the advent of mobile devices will probably hurt NVIDIA’s core business.

Competition: A number of companies such as Texas Instruments, Qualcomm and
Samsung ply their trade in the mobile chip market. Qualcomm leads the space and its
Snapdragon processor is the chip of choice for Windows Phone devices. Moreover,
business from existing customer Samsung is expected to be low as it is now more of a
competitor.

Tegra powers a few smartphones and tablets but is nowhere close to Qualcomm. One
of the biggest disappointments for NVIDIA, however, has been the lukewarm response
to Windows Surface RT Tablets. Qualcomm also replaced NVIDIA in the second iteration
of the Nexus tablet.

NVIDIA was also beaten up badly by Qualcomm since Tegra it didn’t possess a LTE
modem, but now that it has one, it could be an advantage for the company. But
Qualcomm has already extended its lead in this market and could leave NVIDIA behind
in the long run as well.
Conclusion

The way I see it, NVIDIA has a lot of potential to unlock going ahead. NVIDIA will find it
difficult to push its Tegra line in the wake of stiff competition from Qualcomm. The
company is trying its best to deliver the best, but is handicapped by the lack of a bestselling device in its repertoire. NVIDIA has a number of other positives to look forward
to, but only time will tell if they are worthwhile.
Investment summary
Revenue drivers
As we all know, the demand of semiconductor will increase at a stable pace, which
means that the industry will grows at a certain percentage. Considering rare entrants
into this industry, the industry will keep this growth. Comparing to the other two huge
companies, INTC and TXN, NVIDIA has a huge advancement in its enterprise value, the
same to its revenue. Considering its bad performance of Tegra’s sale, we assume
NVIDIA will increase at an average percentage based on previous six years’ data.
Margin drivers
Since current 20years, the margin are always at the average 13% from database, I
calculate the margin and get the average data of NVIDIA is 11.34%. Although it is a little
under the industry level, considering its shortage that it do not have top sellers like
INTC, I assume its margin 11.34%.
Financial Analysis
Revenue Growth
Nvidia’s Sales Performance had been growing in the past few years, due to its efforts in
product differentiation, cooperating with other large companies such as Microsoft and Google.
Its most famous product, the GPU for gaming devices, has been giving the company a strong
support since the outlooks for PC Games are quite optimistic.
As one of the major players in its industry, we anticipate Nvidia’s stock price to grow at
10.76%. Based on past year data and given the company’s performance, we project the
company’s revenue annual growth rate in the next five years, that is, from 2014-2018 to be:
6.62%, 7.50%, 2.30%, 8.5%, and 3.00%. At this moment we believe the renevue growth will be
relatively stable, around 3%. Such anticipations derive from the fact that NVIDIA has been
growing constantly after the financial crisis, and the market it has targeted on has a
significantly promising future. Therefore the company has great potential and will continue to
grow in the next few years
Margins
From 2009 to 2013, the Average Gross Margin was 46.77%, while the Average EBITDA
Margin was approximately 10.13%. We believe that this growth rate will continue, therefore
we decide to use the same growth rate to project the following 5 years.
Working Capital
Working Capital increased from 3066.3 to 3527.6 from 2012 to 2013, when calculating
working capital we excluded cash, cash equivalents, and short term investments from current
assets, and excluded the current portion of long term debt from current liabilities. As a HighTech Company, Nvidia needs to maintain a relatively large amount of working capital,
therefore we believe the working capital will continue to grow. We took the average rate of
59.6% to forecast the future working capital growth.
Free Cash Flow
We used the formula NOPAT + D&A –CAPEX – Change in Working Capital to calculate the
Free Cash Flows for Nvidia. As Nvidia had been repositioning and developing new products in
the past few years, it maintains a high amount of working capital, making the free cash flow
to be negative. We anticipate that as the new market stabilizes, the free cash flow will turn to
positive from 2014. The Free Cash Flow will be particularly high, due to significant reduce in
capital expenditure and working capital. We used the EBITDA times EBITDA multiple to
calculate the terminal value to be 8584.72. With the Equity value of $ 12265.46 divided by
outstanding shares of 568, we calculated the price per share to be $21.59.
Ratio Analysis
Short Term Liquidity
Nvidia has a much higher quick ratio in the past few years than AMD, Intel and Texas
Instruments, nearly all of its major competitors, meaning the company has a very good short
term obligation and it is more likely to happen in the future as well. As for Inventory Turnover,
Nvidia also remains as the highest among the four companies aforementioned. With this high
inventory turnover rate, Nvidia is able to sell products more quickly and receive cash more
rapidly than its competitors, this could also be seen as a sign that the customers of Nvidia have
a higher purchasing power and are confident in the company’s products. Moreover, with a
cash conversion cycle of 52.2, just a little over Intel’s 50.6 but much lower than AMD and Texas
Instruments. From this we can see that Nvidia is able to convert inputs into cash in a relatively
short amount of time, among the highest in the industry. Considering the fact that Nvidia has
a higher quick ratio and inventory turnover, in general it can be concluded that the company
has very good short term liquidity.
Profitability
Nvidia’s Return on Equities is 10.3%, which is the same as AMD, but lower than Intel and
Texas Instruments. This means that Nvidia is doing OK in operating margins, considering it is
relatively a new comer in the industry.
Operating Performance
The debt ratio indicates the operating risk and the borrowing power of a company, in our
case we can see the ratio as total liability/total asset. At 38.9%, only a little than Intel’s 38.1%,
but much lower than Texas Instrument’s 41.5% and AMD’s 87.6%, Nvidia has a very low
operating risk.
Valuation
The value based on three models-the discount cash flow model, comparable analysis
model and residual income model. The price range got in the DCF model is $10.35 - $24.87
with several key assumptions: discount factor 5.13%, long term growth rate 3% and estimated
revenue growth in the future years. The comparable analysis model ends with a price range
$12.62-$22.61. And the residual income model gives the price range $14.49-$18.54 under the
assumptions: long term growth rate 0% and discount factor 5.13%. The detail information of
these models are attached in the Appendix.
Investment Risks
Products are associated to risks in R&D and manufacturing
As a high tech company, Nvidia relies highly on its superior technology over its competitors,
and the development of a new product can be very costly. If such product does not meet with
the demand of the market, or if its competitors have come up with better products at a similar
cost, the result can be catastrophic. Nvidia also relies parts of its production through
outsourcing, if the production or distribution cycle has been interrupted, it will also cause
trouble to the company’s performance.