NVIDIA Valuation
Author: Eric Villac. Art creation: Eric Villac
Company Overview:
NVIDIA is broadening its business model by venturing into new markets such as Enterprise Software, Systems, and Software. Established in 1999 as a trailblazer in PC graphics with GPUs for the gaming market, NVIDIA has since emerged as a leader in computer graphics. The company’s investment of over $37 billion in R&D has solidified its leading market position. As a result of this maturation, NVIDIA has developed key strengths in its operations, including: (i) valuable IP assets, (ii) AI-driven hardware and software for autonomous vehicles, (iii) a comprehensive accelerated computing platform for deep learning and machine learning, and (iv) cutting-edge GPUs.
DCF Valuation — The Narrative:
Market context (2022-)
NVIDIA employs a platform strategy that encompasses hardware, systems, algorithms, and services. Key growth avenues include: (i) the $100 billion gaming market (CPUs), driven by the rise of eSports, game streamers, gamers, creators, academic research, and students; (ii) data centers and AI; (iii) the Omniverse powered by RTX. Moreover, (iv) a $300 billion market opportunity exists in the automotive sector, with NVIDIA securing an $11 billion design win pipeline over a 6-year timeframe. Generally, computer graphics have become essential for numerous professionals, and additional solutions will cater to emerging business needs across various industries, such as Amazon robotics, data centers, and AI.
1. Discount rate: NVIDIA has revenues in many countries (mainly China, Taiwan, and the US), thus, it was used as a weighted average for Equity Risk Premium and the marginal tax rate. The same discount rate will be used for all the years in the projection. For the perpetuity, the only change will be that the company will converge the D/E ratio to the average of semiconductors peers of 66.97% (sample of 731).
2. Cash Flows: The projection started by using an adjusted fundamental growth rate approach[1], thus revenue growth was the byproduct of ROC (108%) and reinvestment rate (19%), considering the average past 7 years (FY16-FY22), therefore, the company will be in a high growth period for the next 7 years, growing revenue by CPI in the last year. The projection for COGS, expenses, and R&D used the average past 7 years (FY16-FY22) percentage of revenues (39%, 9%, and 22% respectively). It’s important to disclose that from 2023 and beyond the company will not be able to expense R&D, consequently, the company will have a higher EBIT margin, pay more taxes in the projection, and, given that R&D is going to be capitalized, it will be a Capex expenditure (10-K, p. 43[2])
3. Risks
The main risks to NVIDIA’s business are (1) industry and market trends; (2) related to supply, demand, and manufacture.
Given Moore’s law (that the number of transistors on a microchip would double every two years), success depends on the ability to identify industry changes and develop products that attend to the changing needs, which involves the maturation of R&D. Thus, investment in R&D may not produce a considerable result for years. Not winning the current design and adoption today may impact subsequent generations of products and diminish the probability of selling future products.
NVIDIA could lose its competitive position in the market. Technologies from competitors may be cheaper and provide better features, which can result in lower prices for NVIDIA products, thus, possibly lowering revenue. In addition, current customers could pose competition as they develop their own capabilities in In-house, substituting NVIDIA solutions. It also can be a risk of losing market share and not establishing the scale necessary to meet business objectives.
Regarding manufacturing, the Company do not manufacture semiconductors, being dependent on suppliers (such as in Asia, e.g., Taiwan Semiconductor Manufacturing Company). This reduces NVIDIA’s control throughout the supply chain. Furthermore, disruptions in the chain could pose mismatches between supply and demand.
In addition, geopolitical tensions in the Pacific Region could leverage uncertainty, overdue deliveries, and rise prices (impacting expenses and revenue in the end).
Assumptions for DCF valuation
Currency: US dollar (USD). Units in USD million. The valuation was done in nominal terms (considering inflation)
The period until the mature stage: 7 years of the period of high growth and the last year of stabilizing growth. For perpetuity, CPI was used (considering growth just inflation).
Revenue growth: sales growth used the fundamental growth approach. The average reinvestment rate and ROC for revenues were 21% and 108%, respectively (FY16-FY22). It has used the moving average considering 7 years window to forecast growth, resulting in average yearly growth of 18% through the series.
EBIT margin: NVIDIA reported from FY23 and beyond R&D expenses could no anymore be expense deducted, as a consequence, paying fewer taxes. Thus, the EBIT margin for the projection was adjusted going from the historical average of 29% to 53% in the projection series. In contrary war, EBIT margin in perpetuity will stay 20% above the past EBIT margin if R&D were capitalized.
Income taxes: the company has operations in many countries; thus, it was used the weighted average considers the geographies that the company sales (China, Taiwan, US, Global), resulting in a corporate taxes rate of 25.16% in perpetuity, and for the series it was used the analyst forecasted effective tax rate of 12.5%
Cash: The cash position in 1Q23 is USD 13,296 mm.
Cross holdings: The company doesn’t have cross holdings.
Debt and leases: company recognizes leases assets and liabilities for all lease arrangements.
Options plan: with a weighted average strike price of USD 3.54, 0.92 years of the expiration period, 57.5% of expected volatility, a 10-year US bond rate of 3.45%, 5,676,538 options outstanding, and a tax deduction equivalent to the marginal tax rate in US of 40%.
Unrecognized assets: the company has unrecognized tax benefits of $1.02 billion.
Probability of default and liquidation value: the probability of default[3] corresponds to the 10-year cumulative probability according to the rating (0.56%). The liquidation value was estimated as 100% of the intangible asset and PP&E.
Reinvestment Needs
Capex is projected as the average historic average of the percentage of revenue (22% for the series and 18% for the last 3 years). Working capital, including receivables (39 days), inventory (77 days), prepaid expenses (8 days), accounts payable (36 days), and accrued liabilities (52 days), was projected using the average days of the past 7 years, which translate to the Sales/Capital ratio close to the FY22 of 0.7x. In perpetuity, considering that the company will grow revenues by CPI, ROC will be the sector average of 18.52%.
DCF Valuation — The Numbers:
Relative Valuation — Comparable peers
Capital IQ was used to screen for comparable companies. The screens used were:
For specific sample (sample of 731 companies):
1) Company Type: Public Company
2) Industry Classification: Semiconductors
a) Relative valuation peer comparison– EV/ RevenueEV/EBITDA LTM — Comparable peers per segment
This relative valuation uses peer comparison. At the date of this report, NVIDIA’s price has skyrocketed in the past 6 months with a 100% increase in share price, being priced with a TEV/Revenue of 24x and TEV/EBITDA of 92x, far away from the average of the specific sample. Even if we consider Capital IQ quick comps (samples =10) with more proximate characteristics, the respective average multiples and maximum would be distant from current pricing, which if we go back to fundamentals could signal the high growth period and high growth rate of the Company.
The relative valuation is based on the average. Bridging EV to equity results in an overvaluation and a SELL recommendation.
Recommendation:
Intrinsic and relative valuations present the same conclusions. Furthermore, checking with analyst projections of revenues and EBIT, my DCF reached pretty close to its estimates. Thus, the recommendation is SELL.
[1] For revenues:
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[2] Link:< https://s201.q4cdn.com/141608511/files/doc_financials/2023/q4/4e9abe7b-fdc7-4cd2-8487-dc3a99f30e98.pdf>. Accessed march,30, 2023.
[3] Damodaran, Aswath, Valuing Declining and Distressed Companies (June 23, 2009). Available at SSRN: https://ssrn.com/abstract=1428022 or http://dx.doi.org/10.2139/ssrn.1428022 (p. 41–42)