Following Nvidia’s (NVDA) announcement of the Mellanox (MLNX) acquisition earlier this month, the company CEO, Jensen Huang mentioned that they would not pursue any additional acquisitions according to Reuters at a conference.
Of course, it’s hardly surprising given the epic price tag of $6.9 billion to acquire Mellanox, which stretches Nvidia’s balance sheet. Nvidia had $7.4 billion in short-term assets and cash equivalents on the balance sheet based on its Q4’19 earnings. If anything, Nvidia cannot afford to make another all-cash transaction anytime soon, which would require the company to rebuild cash on its balance sheet, but to rebuild another $7 billion in short-term cash could take several years.
While the Mellanox deal sounds practical on the surface it also paid a 7x sales multiple for a business that generated $1.08 billion in revenue in FY’18, and profits of $114 million in FY’18. Meaning, Nvidia paid 60.5x prior-year earnings to acquire the company, which doesn’t afford Nvidia a whole lot in the way of earnings accretion, though they mentioned that there would be immediate accretion in terms of sales and earnings following a Q4’19 (calendar year) transaction close.
The main reasoning for the acquisition was tied to datacenter market share, which is one of the few areas, which still exhibit meaningful revenue growth compared to client computing markets or basically end-consumer purchases of graphics cards. Heightened emphasis on datacenter silicon means paying a massive premium in this environment, but it also exposes Nvidia if in the event they need access to more cash, or if market conditions worsen, as they have in the prior quarter whereby sales declined by 24% over prior year and dil. EPS also declined by 53% year over year.
Perhaps, the acquisition of Mellanox helps with diversifying revenue, as Mellanox has been able to post steady revenue growth figures for the past five-years. Though, the recent acquisition premium could come at a time where much of the growth is already priced into the business.
Nvidia stock has continued to trend higher following the announcement, because it could help cushion the lumpiness of the graphics market cycle (which we have seen recently).
Risks tied to the acquisition didn’t seem to matter, because shareholders seemed to like the transaction. This is partially driven by the rapid growth spurt of Nvidia’s graphic business, which isn’t as sustainable as it was in prior years. There’s bound to be added competition from AMD’s impending graphics card launch, which will include ray-tracing, and Nvidia’s full-year financial outlook implied flat year on year business comps.
Nvidia only markets graphics cards, so the addition of network interconnects makes it somewhat less dependent on its graphics business, which is a first in its entire corporate history.
Mellanox has steadily grown its revenues by 18.25% per year since FY’15, and with the transition to ethernet switches (datacenter connectivity) needed for high bandwidth HPC (high-performance computing) Mellanox has been able to demonstrate heightened revenue diversification away from its InfiniBand business.
This transitions Nvidia into both graphics and network connectivity, effectively looking more and more like Intel. But, looking more and more like Intel isn’t necessarily a great thing, because Intel has gone through periods of stagnation even after paying a lot of money to acquire companies.
Intel wasn’t able to grow shareholder value despite its high-profile acquisition of Altera ($16.7 billion) and Mobile Eye ($15.3 billion). After throwing $30+ billion at large acquisitions, Intel has remained range bound between $40 to $50, and that’s even after producing steady financial results.
Likewise, Nvidia’s latest acquisition could have a similar effect (some excitement initially among shareholders), but when financial results get reported over the next couple years, it’s still going to be a graphics dependent business with some additional categories that marginally contributes to financial results.
Disclosure: Alex Cho has no positions in Nvidia or Mellanox.
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