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Enterprise Hardware Segment To Drive Sales As AI Takes Over

Bailey Pemberton

Equity Analyst

Published

July 25 2023

Updated

July 25 2023

14

Narratives are currently in beta

Key Takeaways

  • Nvidia is poised to capture a larger share of the growing Data Centre market thanks to class leading hardware supporting the most demanding applications
  • Nvidia's hardware is the best on market for AI applications and greater AI implementation will mean greater the demand for Nvidia hardware.
  • Nvidia's DRIVE autonomous vehicle platform opens the door for Nvidia to flourish in a $300 Billion market.
  • Nvidia's lead in the consumer GPU segment will be unassailable , with competitors needing to catch up in both hardware and software implementation.

Catalysts

Company Catalysts

AI and machine learning dominance keeps customers lining up for Nvidia’s hardware and API services.

Nvidia's GPUs are widely used in AI and machine learning applications, such as autonomous vehicles, robotics, and natural language processing. The company's CUDA platform has become the industry standard for AI and machine learning, attracting numerous researchers and developers. Nvidia has created itself some sort of a positive feedback loop where their architecture supports the development of new AI applications, and new AI applications develop specifically for Nvidia architecture as it’s the most advanced. As AI and machine learning continue to grow, demand for Nvidia's GPUs is expected to remain strong.

Nvidia has solidified itself as an authority in ‘Generative AI’, a subsection of artificial intelligence which can produce images, text and other media through written prompts. Generative AI first took-off with mainstream users with the spike in popularity of ChatGPT a large language model (LLMs) that can generate text information in response to users' prompts. Nvidia recently showcased the work its done around AI in the latest earnings presentation which investors took to like a moth to a flame, causing a ~30% price jump in the days afterwards and helped Nvidia reach the US$1 Trillion market cap milestone.

Nvidia: Breaking Records In Machine Learning Performance

Nvidia and Adobe have partnered to bring Adobe Firefly to market, an add-on to Adobe’s Photoshop that allows users to selectively add, remove or replace elements within an image using text prompts. Firefly relies on Nvidia’s Picasso cloud service to help render generated images. This Picasso cloud service is also being employed by the likes of Shuttershock and Getty Images to serve up license-free imagery generated by AI. These image generations from third-party companies are serviced through calls to Nvidia’s Picasso API and so there’s a revenue stream here whereby Nvidia can charge per API call, which could be a serious money-maker as the popularity of generative AI imagery continues to snowball.

Nvidia’s stranglehold on the gaming market in terms of market share and performance will continue to drive consumer hardware sales.

Nvidia is a leading player in the gaming industry, thanks to its GeForce GPUs. If you take a look at Steam’s Hardware & Software Survey for March 2023, you can begin to get a picture of how dominant Nvidia is in the GPU space, particularly among gamers and enthusiasts. Nvidia cards hold the top 19 positions by ownership share for all Steam users and - perhaps more impressively - Nvidia occupies 34 of the top 40 GPUs based on these hardware ownership stats.

With the gaming market expected to grow in the coming years after already overtaking both Hollywood and the music industry COMBINED, Nvidia's dominance in the consumer GPU market will likely continue to bring solid sales growth. Next-gen video game engines like Epic Game’s Unreal Engine 5 are now being supported by Nvidia with their RTX software suite. Video game developers are now able to implement Nvidia technologies using the Nvidia NvRTX branches integrated into Unreal Engine, this helps cut down on development time while also improving the graphics. Aside from the obvious kickbacks Nvidia will receive from licensing their RTX suite, there's one other massive benefit that this catayst will bring and that is gamers who are wanting to have the best experience in graphical fidelity and performance with these upcoming games will be needing Nvidia GPUs to do it.

Nvidia Data Centers: The backbone of the Internet’s future.

Data centers are the lifeblood of the digital age and Nvidia is at the forefront of this rapidly expanding industry. Nvidia's data center division, boosted by the surge in AI and high-performance computing (HPC), has seen impressive growth in the past few years. The company's high-end data center GPUs like the H100, are the cornerstone for many supercomputers and cloud-based services around the globe.

The trend towards AI-accelerated applications, coupled with the need for faster processing power, has made Nvidia's GPUs essential to the backbone of the data center industry. With more data being generated and processed than ever before, organizations across the globe are looking towards Nvidia’s high-performance computing solutions to help manage, analyze, and store these vast amounts of data effectively and efficiently.

Nvidia's DGX systems are also becoming the go-to solution for AI training and inference in the cloud. These are designed as fully-integrated hardware and software stacks, delivering previously unheard of compute power. Nvidia's DGX GH200 and H100 are like supercomputers in a box, that are designed to handle even the most robust AI workloads. This hardware handles the processing power behind generative AI models and LLMs greater that anyone else which is a huge selling point and explains why the data center segment is Nvidia’s best performer in the last 12 months and will likely be well into the future.

Nvidia Omniverse could change how companies approach manufacturing.

Nvidia's Omniverse platform is a powerful real-time simulation and collaboration platform for 3D design workflows. With the growing demand for 3D content creation, virtual production, and remote collaboration, there’s a fairly large void that Nvidia is attempting to fill here.

Nvidia Omniverse bridges the gap between reality and the digital applications that drive company workflows, helping augment 3D workflows across a variety of platforms.

Mercedes-Benz announced that it is using the NVIDIA Omniverse platform to design and plan manufacturing and assembly facilities. Planners can access the digital twin of the factory, reviewing and optimizing the plant as needed at a relatively low financial cost and low planning overhead cost.

Industry Catalysts

Growing demand for AI and machine learning.

It seems we’ve reached an inflection point for generative AI where companies no longer see it as something that is “Too expensive to adopt” and rather something as “Too expensive not to adopt”. As AI and machine learning applications become increasingly prevalent across industries, the need for more advanced hardware infrastructure grows at both a user and enterprise level. This rapid growth could be a catalyst for a company to capture a lot of market share and lucrative supply contracts by developing technologies that are more innovative than their competitors.

The rapid expansion of gaming market provides a boost for gaming hardware manufacturers across the board.

The gaming industry is expected to grow as more people engage with video games, virtual reality, and eSports. Forecasts pin the global gaming market size at US$545.98 Billion in 2028. According to studies conducted in 2019, 91% of males in generation-Z play video games regularly, compared to 84% of millennials which is a remarkably high figure. Also, the worldwide youth unemployment rate is gradually declining, which has increased purchasing power and sped up consumption.

Increased adoption of cloud computing and edge computing.

More and more businesses are looking to move away from on-premises data centers in favor of cloud computing. While on-premises computing still has its place, cloud computing - where data is hosted off-site by a third party- offers many benefits to a business that is growing rapidly. Cloud computing allows for businesses to pay for their infrastructure on a “as-needed” basis. In times of rapid growth or great demand, these businesses can quickly scale up their capabilities to meet the demand. Likewise in periods of reduced activity, they can scale back their infrastructure needs to lower cost, which is something that can’t be done quickly with on-premises computing. As businesses continue to adopt cloud computing and edge computing solutions, the demand for data center GPUs is expected to increase.

Assumptions

Data Center growth driving by computational requirements of AI applications

The growing demand for AI and accelerated computing leads to unprecedented demand for Nvidia’s data center architecture. Advancing AI applications means greater computational requirements which Nvidia is able to service in a one-stop-shop way, owing to their 3 chip strategy. Nvidia maintains a leadership position that is head and shoulders above competitors. Diminishing returns begin to take effect (the 51% CAGR is representative of them coming off <$3B in revenue 5 years back) but growth remains strong.

According to IDC, the worldwide spending of enterprises and service providers on hardware, software, and services for edge computing solutions - just one small part of Data Center applications - was projected to reach $274 billion in 2025. Furthermore, Prescient & Strategic Intelligence says that the entire Data Center market could be worth $605 Billion per year in revenue by 2030.

McKinsey: Data Centre Demand Growth in the US

On the balance of this, I estimate that the entire Data Center market could be worth $530 Billion a year, which I expect Nvidia to capture around 8% of this market up from the ~5% they currently capture. I am forecasting that deeper penetration amongst enterprise customers could result in Nvidia almost tripling Data Center revenue to $42.4B by FY2028. This is representative of a 22.98% CAGR.

Expansion of the Gaming market is a wave Nvidia will ride

I believe Gaming revenue grows slightly but at a lower rate than before. The general expansion of the gaming market to a $545B powerhouse will naturally see benefit flow through to Nvidia. I predict Nvidia will still have a healthy lead in the consumer GPU market but not as powerful as it is now. Nvidia’s 30 series was a massive hit but we’ve seen the latest 40 series hit less than stellar sales figures with the older GPUs still being incredibly popular. AMD and perhaps Intel will begin stalking down Nvidia’s market share lead as their own AI-driven GPU software helps close the performance gap. An optimistic estimate of gaming revenues would see gaming grow at 8% pa. Less than the growth over the previous 5 years, but still a healthy boost. I forecast revenues of $13.35B in FY2028.

Pro Viz adoption will be relatively subdued

In this case, I’ll assume Pro Viz adoption to be negligible. Nvidia’s bet on their Omniverse (the Nvidia ‘metaverse’) is a necessary one to make considering it was all the rage in 2020-2022 and ignoring it from the company’s strategy would’ve been seen as an archaic move, but I don’t particularly see large potential for growth. The segment has grown at an 11% CAGR over the last 5 years but I’ll use a steady 4% growth to use in all valuation scenarios to encapsulate minor customer expansion. I forecast FY2028 revenues of $1.87B

The opportunity in the automotive industry is immense and Nvidia will make significant headway

In Nvidia’s investor presentation, they detail their combined businesses participate in a market with over $1T in opportunity with the automotive opportunity being the equal largest at $300B. Considering Nvidia’s automotive segment is the smallest by revenue, but is the equal largest by opportunity, the company itself thinks that this could be a valuable growth pathway.

Grand View Research: Autonomous Vehicle Market Growth in North America

Nvidia’s historical automotive revenues have been driven by infotainment but this is set to change as Nvidia begins to dedicate resources towards NVIDIA DRIVE, their autonomous vehicle and AI cockpit platform. Nvidia anticipates an $11B design win pipeline through to FY28 based on DRIVE Orin, which started ramp in FY23. In my optimistic forecast, I’ll estimate that Nvidia realises 60% of that design win pipeline, resulting in $7B in revenue, a 50% CAGR over the years to FY2028.

Gross margin will continue to be thinner as ramp-up costs loom

Gross profit margin has declined in the most recent fiscal year as a result of increased investment into growing the accelerated computing side of the business. Gross margin fell from 67% in FY22 to 57% in FY2023. I think this is a fair assumption of long-term gross margins over the 5 years to FY2028. I think the next few years could see leaner margins as ramp up costs build but this will be offset by later operational improvements and reductions in costs (both supply chain driven and reduced R&D expenditure) in the later half of the 5 years. I’ll use a Net Profit Margin of 16.5% (the current NPM) to determine forecasted earnings.

Data Centre market share growth supports higher price to sales multiple

Given the earnings and revenue growth established in this scenario, I feel that the company could be trading at a 29x P/S ratio. This is a slight premium to the ~26.5x P/S ratio that they currently trade on but I feel the a 19.23% pa. revenue growth rate could justify it, particularly with my assumption that Nvidia now captures up to 8% of the Data Center market share. The forecasted growth rate actually is less than the past annualized growth rate of 25.3% but a slight decline in growth is expected as diminishing returns from the uptick in Data Center sales kicks in. The higher price multiple will be supported my Nvidia’s strengthening within the market, rather than pure growth rates.

Risks

Increased competition increases the risk of losing market share.

Nvidia faces competition from companies like AMD, Intel, and other hardware manufacturers. Intel has recently debuted their first discrete GPU product in the Arc A700 GPU series which could be a formidable competitor in the near future. Increased competition could lead to pricing pressures and reduced market share for Nvidia.

Pricing strategy could halt sales growth among consumers as people get priced out of ownership.

If you take a look back at the Steam Hardware survey for March 2023 and analyse the GPUs with the largest % gains in ownership on a month to month basis, you’ll notice that Nvidia latest 4000 series GPUs don’t appear anywhere in the top 10 for ownership growth. In fact, you’ll have to scroll down to 15th place to find Nvidia’s first 4000 series GPU in the list. This is quite alarming for a new product launch and could indicate that Nvidia missed the mark on pricing and are risking sales growth. People seem to be foregoing innovation in favour of cost savings.

Regulatory hurdles could prevent acquisitions and stifle growth.

Nvidia's previously proposed acquisition of Arm Limited was under scrutiny from various regulatory bodies. The plans for acquisition were promptly cancelled in February of 2022 due to the regulatory challenges, with Arm Limited now set to IPO at some stage in 2023. Future acquisitions could be at risk from similar regulatory scrutiny, which could see acquisition-driven growth as something out of reach for Nvidia.

Supply chain disruptions could impact future hardware sales.

The global semiconductor industry has experienced supply chain disruptions due to various factors, including trade restrictions and the COVID-19 pandemic. Further disruptions that are a direct fallout from the issues mentioned or new disruptions as a result of macro-economic changes could impact Nvidia's ability to meet demand for its products and thus possibly lose ground to competitors that have inventory on hand.

How well do narratives help inform your perspective?

Disclaimer

Simply Wall St analyst Bailey has no position in any company mentioned. Simply Wall St has no position in the company(s) mentioned. This narrative is general in nature and explores scenarios and estimates created by the author. These scenarios are not indicative of the company’s future performance and are exploratory in the ideas they cover. The fair value estimate’s are estimations only, and does not constitute a recommendation to buy or sell any stock, and they do not take account of your objectives, or your financial situation. Note that the author’s analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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