By Michael Marcus
Let’s be blunt: 2018 was not a happy year for Nvidia (NVDA). The chip maker was heavily invested in the crypto mining sector, and it felt the pain of crypto’s 85% contraction. Nvidia survived because its products show a healthy diversity: its CPU and graphics chips are popular among widely dispersed customer bases, from gamers to autonomous vehicle engineers. While Nvidia dropped 40% in 2H18, it has shown gains of 25% since the New Year.
Nvidia Buys Mellanox
In the past week, Nvidia has made headlines for outbidding competitor Intel in the outright purchase of Israeli networking company Mellanox (MLNX). Nvidia spent $6.9 billion in cash on the acquisition, 93% of the $7.4 billion it had available. The purchase deal comes out to $125 per share of MLNX, meaning Nvidia paid about 15% more than the pre-sale share price in acquiring the company.
The benefits of that spend were not immediately apparent. Nvidia makes semiconductor computer chips, with a particularly strong reputation for graphics processing units. Its CPU and GPU chips are popular with gamers, and the company is making strong moves into data center, AI, and autonomous car technologies. Mellanox builds the hardware and software necessary for building faster networks – they specialize in connecting one server to another, and making that connection go as fast as possible.
Why Mellanox, and Why Now?
The overlap between these two companies most likely resides in Nvidia’s move toward data center tech. As data centers move more from collection to analysis, they are leaning more on AI technology and networked systems. Nvidia is already well-positioned with high-end AI chips and high-speed parallel processing capabilities derived from gaming graphics cards; the Mellanox acquisition will give the chip maker access to top shelf networking systems as well, just as the data center segment is moving toward a more integrated architecture.
So much for the obvious. There are some other points to raise as well, to explain why such different beasts as Nvidia and Mellanox would join forces.
Remember that Nvidia outbid Intel on this move. Was Nvidia’s winning bid an act of self-defense, to prevent a rival from gaining a stronger position? Intel was the #1 chip producer for decades, but in recent years has lost market share and slipped to #2; Nvidia is farther down the list at #10. So, this could have been a business move to weaken a stronger, but vulnerable, rival.
Less obvious, is that Mellanox is an Israeli company, and the acquisition will give Nvidia a foot in the door– to the Israeli HR market. AI savvy is a limited resource, and skilled AI designers are in high demand and tight supply. Israel’s reputation as a high-tech powerhouse is well-earned, and a US company may feel that $6.9 billion is an affordable price to pay for access to that talent pool.
Investor reaction to Nvidia’s move was fast, and positive. NVDA shares closed at $150.64 on March 8, the last session before the announcement. By end of trading on March 11, NVDA was up to $161.14, a gain of 7%, and the stock has added another 4% since then. NVDA ended trading on March 13 at $168.62 per share.
Wall Street’s analysts, however, have been mixed in their reactions. Since March 11, Nvidia has received 10 new reviews – these have included 6 buy ratings, 3 holds, and 1 sell.
Setting out the bearish case is Rajvindra Gill, of Needham. Gill puts a ‘sell’ on NVDA, pointing out that “The deal accounts for over 90% of NVDA’s $7.4BN of cash and short-term investments,” and noting that a transaction of this magnitude is unusual. He also expressed doubts about “the strategic synergies of the deal as the two companies sell vastly different products into the data center.” (To watch Gill’s track record, click here)
On the bullish side, we find Vivek Arya from Merrill Lynch. He describes the Mellanox acquisition as “immediately accretive to Nvidia’s pro forma EPS in calendar 2020 by 8 percent.” Of the complexities in combining the different directions of the companies, Arya says, “[That Nvidia] expects to see zero cost synergies implies its near-term focus will be on attacking future growth opportunities instead of harvesting current opportunities.” He clearly believes in those future growth opportunities, as his $193 price target implies a 14% upside to NVDA.
Oppenheimer’s Rick Schafer also sees Nvidia as a buying opportunity. The five-star analyst looks at the Mellanox acquisition and “estimates the deal is 5% accretive to the standalone Nvidia EPS estimates for calendar 2020 and 7-8% accretive including $150M in estimated cost savings.” Schafer gives NVDA a $190 price target, suggesting a 13% upside potential.
Overall, Nvidia maintains a Moderate Buy rating from the analyst consensus, based on a total of 18 buy ratings, 6 holds, and 1 sell. The stock has an average price target of $188, suggesting an 11% from the current share price of $168. (See NVDA’s price targets and analyst ratings on TipRanks)
Nvidia spent most of its available cash to my Mellanox, and most observers agree that the immediate upside will be muted. The real benefits to Nvidia will come one or two years down the road, as data center technology – where Nvidia already has a strong footprint – begins to rely more and more on networked systems. Investors have been bullish on the move, pushing NVDA shares up in recent sessions, suggesting that they see this as a powerful strategic move by Nvidia.