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NVIDIA - Arm deal finally sealed

Nicholas Hyett, Equity Analyst | 14 September 2020 | A A A
NVIDIA - Arm deal finally sealed

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NVIDIA Corp USD0.001

Sell: 170.85 | Buy: 170.86 | Change -7.07 (-3.97%)
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NVIDIA has announced it will be acquiring computer-chip designer Arm from Softbank for $40bn. This will be paid in $21.5bn of shares and $12bn of cash, with Softbank able to earn an additional $5bn if certain performance conditions are met and $1.5bn in shares due to be paid to Arm employees.

NVIDIA expects the deal to be immediately accretive for underlying gross margin and underlying earnings per share.

The deal is subject to regulatory approval in various countries and expected to complete in around 18 months.

NVIDIA shares were broadly unmoved in afterhours trading prior to the announcement.

View the latest NVIDIA share price and how to deal

Our view

NVIDIA started out making graphics cards for gamers. Gaming still accounts for a little under half of sales, leaving NVIDIA well placed to capitalise on the growing gaming industry. However, the power of NVIDIA's chips means that as time's gone on they're increasingly in demand outside the world of consoles and joysticks.

The 'Professional Visualisation' division supports digital design and engineering work in architecture, oil & gas and medical imaging. The group's DRIVE platform gives it a stake in the potentially exciting self-driving car market, with a product that can "perceive and understand in real-time what's happening around the vehicle...and plan a safe path forward". The end markets for both divisions have been hit hard by coronavirus, but should recover over the longer term.

However it's the Data Centres business which has been the real engine room. As well as powering some of the world's most powerful supercomputers NVIDIA produces cutting edge hardware for training artificial intelligence (AI) software.

It's these AI expertise, enhanced by the $6.9bn acquisition of Mellanox last year, which are being used as the strategic rationale for the blockbuster Arm deal.

Arm designs chips and licences out its technology, staying well clear of any manufacturing or direct sales processes. This is a very cost effective way of operating, with capital requirements pretty minimal, and means over 180bn Arm technology chips have been shipped since the group was founded. It also means there are millions, if not billions, of devices in use today including Arm chips.

As well as the fundamentally attractive core business model, it's this global reach that has attracted NVIDIA to Arm. If it can perfect its AI technology and integrate it into devices from smartphones to supercomputers that would place it at the heart of the next technology revolution.

The deal is expensive though, even if a lot of the cost is being paid in shares. The cash component should be pretty manageable, but if it doesn't work out, issuing new shares will be dilutive to existing investors.

Looking back at the core NVIDIA business, we generally see coronavirus as a positive for the group - despite disruption in some of the smaller divisions. Increased interest in gaming and cloud computing are both good news for long term demand. But if growing end markets is one attraction, the group's neat business model is another.

Like Arm NVIDIA outsources all of its manufacturing. Without the costs, capital and risk associated with owning manufacturing facilities NVIDIA's delivered impressive gross margins and cash flow.

High gross margins help fund the research & development budget, which stood at $2.8bn last year. Recent innovations have included real time ray tracing, which could revolutionise gaming graphics with ultra-realistic imagery.

With net cash on the balance sheet (at least until the Arm deal completes) and hefty operating cash flows, it's difficult to see NVIDIA as anything other than a very high quality business. Unusually for a US tech company, the group's willing to return surplus cash to shareholders, mostly through share buybacks, although these are on hold at the moment, and there a very modest dividend on offer.

Overall it's hard not to be impressed by a business at the cutting edge of some pioneering industries. But keep in mind all those strengths come at a price - the shares change hands on a PE ratio well above the ten year average.

NVIDIA key facts

  • Price/Earnings ratio: 47.7
  • 5 year average Price/Earnings ratio: 25.9
  • Prospective yield: 0.1%

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Results (20 August 2020)

NVIDIA reported a 50% year-on-year increase in second quarter revenues reaching $3.9bn. That reflects the acquisition of Mellanox at the start of the quarter, without which revenue would have risen 28.9%. Operating profits rose 14% year-on-year to $651m - held back by acquisition related expenses.

The group announced a quarterly dividend of $0.16.

Data Centre revenues rose 167% year-on-year, to $1.8bn, driven by the acquisition of Mellanox. Without Mellanox the division would have reported revenue growth of 87.2%, driven by increased sales of Ampere GPU architecture products - the group's AI and Supercomputing product.

The Gaming division saw sales rise 26% year-on-year to $1.7bn, with both standalone gaming cards and console sales driving growth. That reflects the launch of new GeForce laptops and new games using the NVIDIA TRX ray tracing technology.

Sales in Professional Visualisation and Automotive fell 30% and 47% to $203m and $11m respectively. That reflects the impact of the coronavirus outbreak on the group's end markets.

The small Original Equipment Manufacturer (OEM) & Other division saw revenues rise 32% to $146m, driven by increased sales of entry-level laptop GPUs.

Changes in product mix led to a 5.9 percentage point improvement in underlying gross margins, to 66%. Underlying operating expenses rose 44.6% to $1.4bn, driven by higher stock-based compensation and increased employee numbers following the acquisition of Mellanox. The group also reported a $229m of acquisition related costs.

Free cash flow of $1.3bn was up 63.9% on the $823m achieved last year. That reflects the increase in non-cash expenses (stock based compensation and depreciation/amortisation).

Net cash fell 54.9% in the year, to $4.0bn, following the acquisition of Mellanox.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.

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