Beyond The Hype has been ahead of the curve (NASDAQ:NVDA). Our recent writings on the issue foreshadowed a value reduction for Company, with the stock trading at record highs. However, looks may be deceiving. Hypergrowth aspirations drive the present narrative of the Company. The Company’s hypergrowth narrative has completely duped investors and the sell-side analyst community. Given the Company’s fast sales growth in recent years, it is an easy trap to fall into. Outside of unsustainable short-term or one-time stimuli, the fact is that this so-called hypergrowth company’s growth is moderate.
Its “Gaming” and “Datacenter” sections are virtually non-existent. While management continues to speak in superlatives, particularly in the “Automotive” division, the narrative has been. It continues to be separated from reality, and there is little evidence that autonomous vehicles are on the horizon. The “Pro Viz” section appears to have had rapid growth recently. However, anecdotal information suggests that this is being driven, at least in part, by crypto mining. I would not be surprised if bitcoin accounts for $200M to $300M of this segment’s $600M quarterly run rate. It’s worth noting that Nvidia’s preannouncement shows a $200 million shortage in this category. This corresponds to the $200M to $300M forecast. In other words, outside of crypto mining, there may not be much, if any, growth in this market.
Second, its “Gaming” revenue declined by nearly $1.6 billion between the first and second quarters. As any moderately astute investor is aware, this was mostly caused by the bursting of the Bitcoin bubble. This bubble, unlike previous cycles, is not returning owing to the well-known “Ethereum Merge.” The Ethereum Merge is rapidly looking like a September event. In other words, Ethereum will switch to Proof-of-Stake in approximately a month, and crypto mining demand will fall. What is a realistic level of “Gaming” revenue with the implementation of Ethereum PoS? $1.5 billion each quarter? $2 billion every quarter? To calculate this, we must evaluate how crypto mining has influenced Nvidia’s income in recent years. This will be discussed more in this post.
Third, COVID, bitcoin, and free FED-driven affluence have fueled the Datacenter sector, with many useless businesses spending like drunken sailors, particularly on obscure AI initiatives. These short-term growth drivers will now fade. This will operate as a headwind for data center development, and near-term growth will likely be more moderate than investors have seen in recent years.
Finally, it should be noted that the Mellanox purchase has contributed significantly to Datacenter growth. While Nvidia does not break out sales from the Mellanox division, it appears that Mellanox accounts for around one-third of Datacenter revenues. It should be noted that this bought growth is unlikely to occur again until Nvidia makes another large acquisition.
The preceding explanation is that most of Nvidia’s recent growth has been driven by unsustainable “once-in-a-lifetime” occurrences like COVID and crypto and that a price based on this growth is unreasonable.
How can we estimate Nvidia’s new post-reset level of business? What is the Company’s sustainable long-term growth rate? These issues will be addressed in the sections that follow.
Crypto Headwinds Are Deeper Than The Market Realizes
Understanding the PC industry dynamics is an excellent start when projecting long-term Gaming GPU demand. While the AIB industry for desktop PCs has been dropping for the previous decade, gaming laptops have been countering the decrease. Whether the combined desktop and laptop GPU market is growing is uncertain. Much of Nvidia’s “Gaming” growth has been driven by rising GPU pricing. However, there is little data to support robust overall growth.
The top three Turing SKUs, RTX2080Ti/2080/2070, debuted for $999/$699/$499, respectively. The top three Ampere SKUs, RTX3090Ti/3090/3080Ti, were released for $1999/1499/1199, respectively. We do not believe there was ever a significant market for gaming at $1000+ price points, and the ASP increase was virtually completely driven by bitcoin.
After a significant increase during COVID, PC units are returning to pre-COVID levels. Back to pre-COVID periods, we can see from the image above shows that the “Gaming” high was less than $2B, and sales have been in the $1B to $2B since Q3 FY2017. If one is kind to management, $2.0 billion is not a bad quarterly Gaming revenue projection for future quarters.
H2 Prognosis And Relative Valuation
Based on the abovementioned issues, Nvidia is expected to suffer another $500 million decline in Q3 revenues compared to the recently released Q2 projection. Datacenter expansion will not be able to compensate in any meaningful way. In other words, third-quarter revenue is expected to be in the $6.0 to $6.5 billion area. Given the high margins of the crypto industry, the gross margin damage will be severe.
Nvidia is expected to have a relative valuation concern in addition to reduced growth, lower revenues, lower margins, and lower EPS. As shown in the graph below, AMD has now surpassed Nvidia in revenue and is rising faster. As a result, AMD is expected to outperform Nvidia in terms of sales and profitability in Q3. Given this fact, Nvidia’s considerably greater multiple will appear more ludicrous.
With profitability slashed owing to various issues, the Company may begin trading on a revenue multiple rather than a PE multiple, and things might get nasty.
The market also does not appear to have realized that the extremely high-margin crypto sector is not returning. This development will have a negative impact on Nvidia’s long-term gross margins and profitability, contrary to management’s expectations.
Nvidia’s value is ready for a reset owing to declining profitability and decreased growth rates. Additional factors indicate that revenue recovery will be slow, and profit recovery will be much worse. With EPS declining, if Nvidia’s value begins to approach that of competitor AMD on a sales multiple, the stock might collapse by at least 50%, if not more.
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