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Nvidia's Backing Its 'Big Game' Talks

Richard Saintvilus

NEW YORK ( TheStreet) -- Each time Nvidia is discussed it's always in the context of the company's ability to change its chip strategy.

The Street doubts Nvidia can successfully transition itself from a PC-dependent graphics chip company to one that can compete on the big stage with Qualcomm and Broadcom in the realm of mobile devices.

However, management has shown it has a "chip on its shoulder" in more ways than one. The company has made clear it doesn't appreciate the bets that have been placed against it. In fact, during the company's fiscal fourth-quarter earnings report in February, during which Nvidia posted increases of 16% and 36% in revenue and profits, respectively, CEO Jen-Hsun Huang said, "My expectation is that we'll gain market share this year or we'll continue to gain market share this year."

Companies don't often go out of their way to raise expectations and put undue pressure on themselves without knowing they can back it up. Nevertheless, in such a highly competitive chip market -- where rivals want nothing more than to put each other out of business -- Nvidia investors were eager to learn what the next quarter would bring. The company didn't disappoint.

Amid all of the PC-related doom, which continues to weigh on rivals including Intel , Nvidia delivered as solid a performance as could have been expected, beating estimates on revenue and earnings per share. For that matter, on a year-over-year basis, there wasn't much to complain about. Not only did revenue advance 3% year over year to $955 million, but Nvidia's GAAP EPS of 13 cents was 30% higher year over year.

As noted, despite the 13% decline in global PC demand that was reported by IDC, the fact that Nvidia's graphics processing unit, or GPU, posted an 8% increase in revenue was impressive. Not only has the company been "talking a big game" but consumers seem to be buying into Nvidia's industry-leading graphic chips, which are predominantly used in gaming.

Management also backed up its prediction in profitability. Non-GAAP gross margins advanced more than 4% year over year to 54.6%. On a GAAP basis, the percentage move was the same, though slightly lower in absolute by 30 basis points. The better-than-expected performance was partly attributable to lower Tegra sales, which means that management is eating up the costs associated with developing Nvidia's mobile strategy.

This cost absorption has affected Nvidia's near-term margins and is one of the reasons why the Street continues to have doubts about this company. For instance, although the overall sales numbers look solid, the fact that Tegra revenue declined 22% year over year sticks out like a red thumb. The good news is this strategy has worked as well as can be expected. Not only is Nvidia's Tegra line of chips gaining traction, but the costs to grow market share have not adversely impacted the company's operating margin.

Management understands what's at stake regarding mobile market share. Plus, Nvidia, which is still dependent on PC sales for roughly two-thirds of its revenue, has been working hard to broaden its portfolio. To that end, the Tegra line of mobile processors, which is a system-on-chip (SoC) that integrates many of the features of the ARM architecture into one package, has taken a major focus.

As it stands, outside of the Nvidia investment community, Tegra is not as wildly known as Qualcomm's Snapdradon or Broadcom's line of BCM LTE chips, but Tegra is gaining meaningful ground. Here again, during the conference call, Nvidia's management pulled no punches, saying the company's Tegra 4i "delivers three times higher performance than Qualcomm's S400 solution."

What's more, Nvidia continues to secure business some prominent companies including Microsoft and Google where the Tegra is a key component inside both Surface and Nexus 7 tablets. Device manufacturers are beginning to realize Tegra's features such as low power consumption coupled with high performance makes this series one of the best chips on the market today.

Bottom Line

If Nvidia can maintain revenue growth rate of 5% while also growing its Tegra market share, this company can become a legitimate competitor to Qualcomm and Broadcom in the next couple of years.

Accordingly, expecting the stock to trade in the $18 to $20 range over the next 12 to 16 months is not unrealistic. Despite Nvidia's 20% year-to-date gains, I think the stock is worth a gamble here for the long term. The risk-reward trade-off still favors holding.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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