Why Nvidia Corporation (NVDA) Is a Big, Fat Question Mark Right Now

After some bumpy trading based on valuation concerns, shares of Nvidia Corporation (NASDAQ:NVDA) have rebounded, gaining 12% from lows earlier this month. Two-thirds of the gains in NVDA stock have come since the surprising acquisition of Mobileye NV (NYSE:MBLY) by Intel Corporation (NASDAQ:INTC). That deal was of tremendous importance to Nvidia, given its competition with Mobileye in automotive applications. And, for now anyway, investors appear to see the INTC-Mobileye tie-up as good news for Nvidia and for NVDA stock.

Source: Nvidia

I’m not quite so optimistic. There are reasons to see Intel’s entrance into automotive as a positive for NVDA stock and as a negative.

Nvidia now is competing with two giants in the automotive space, which could be a near-term problem. But the entrance of both Intel and Qualcomm, Inc. (NASDAQ:QCOM) into the automotive space seems to validate the long-term opportunity for Nvidia, and the long-term potential for NVDA stock.

Intel & Mobileye: The Good News for Nvidia

The most obvious piece of good news for Nvidia in the INTC-Mobileye merger is that it validates the market opportunity in automotive. NVDA stock has more than quadrupled in just 18 months in large part due to optimism about the potential for revenue and profits in autonomous driving and other applications. With giant Intel paying a whopping 31 times Mobileye’s estimated 2017 sales, those gains don’t look nearly as outlandish.

From a fundamental standpoint alone, the comparison between NVDA stock and MBLY would seem to imply sharp upside for NVDA. Nvidia’s revenue multiple is about one-fifth of that being paid for Mobileye by Intel. And its automotive revenue is higher than that of Mobileye. NVDA drove $487 million in automotive revenue in fiscal 2017 (ending January 2017), per its 10-K. Mobileye’s entire revenue for calendar 2016 was just $358 million.

Meanwhile, the entrance of both Intel and Qualcomm into automotive seems to prove how valuable the business really can be. Qualcomm has agreed to pay $46 billion for NXP Semiconductors NV (NASDAQ:NXPI). Intel is paying over $15 billion for Mobileye. Clearly, there’s some logic to the optimism toward the automotive space — at least if the semiconductor industry’s giants are to be believe.

Intel & Mobileye: The Concerns for Nvidia Stock

The most obvious problem is that NVDA now has to compete directly with those giants. The Qualcomm/NXP partnership no doubt has a smaller direct impact on Nvidia, but will still be a force in the space. As for Intel-Mobileye, Cowen & Co. analyst Timothy Arcuri put it best in calling it a “two horse race“. It would seem NVDA’s chances of winning that race were stronger against Mobileye — a company just a few years past being a startup — than Intel. Intel is well-funded and is looking to leverage its success in data centers, even calling autonomous cars “data centers on wheels.”

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The less obvious concern might be that investors still are overplaying Nvidia stock’s automotive exposure. Yes, Mobileye sold for ~31x forward sales. And yes, NVDA’s business is larger. But automotive still generated just 7% of 2017 revenue. A 31x forward multiple on Nvidia stock’s auto business would value that business at about $21 billion. However, NVDA stock is worth $62 billion. Since the election, gains in Nvidia have added $22 billion to the company’s market capitalization

To be sure, the rest of NVDA’s business isn’t chopped liver. The core gaming business drives 59% of revenue, and grew an impressive 44% last year. But comparing the valuations of Nvidia stock and MBLY isn’t apples to apples. And if Mobileye’s valuation truly is ridiculous, then NVDA stock might look overvalued itself — if less so.

How to Play NVDA Stock

All told, I still question whether Nvidia stock has run a bit too far, too fast. Indeed, the impact of the INTC-Mobileye deal seems to mirror the case for NVDA stock as a whole.

After all, there’s a lot of good news, and multiple reasons for optimism. Nvidia is dominant in gaming, and has a chance to do the same in self-driving vehicles. Should automotive success come, NVDA stock no doubt will rise.

But that success isn’t guaranteed, and investors are paying a dear price for that potential already. Intel and, to a lesser extent Qualcomm, will be fearsome competitors. Nvidia now is too large to be acquired itself, which means it will have to grow into its valuation. That’s certainly possible — and maybe even likely. But Intel and Mobileye will have something to say about that, and at the very least, NVDA stock seems likely to hit some bumps along the way.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.

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