Nvidia: The Artificial Intelligence Engine for Earth (NASDAQ: NVDA)
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NVIDIA (NASDAQ: NVDA) is well on its way to becoming the AI powerhouse for Earth. With accelerated computing being the backbone of AI, Nvidia is poised to capture the exponentially growing AI market with its three key advantages:
- Omniverse: A real-world digital twin that obeys the laws of physics and allows real-world challenges to be simulated in a virtual environment before building the physical.
- CUDA: A programming language platform for developers to create their own AI applications.
- Data Center GPUs: Powerful chips that meet high-performance computing needs for AI and deep learning.
More than 25,000 companies already use Nvidia hardware and software to solve complex real-world problems such as drug discovery, autonomous driving, climate forecastbuilding car factories from the future, hospital fall detectiontranslating languages into videoconferences, prevent financial fraudbuild a virtual city for simulate 5G setup, and much more. My thesis assumes that in the future Nvidia will be able to charge for recurring software revenue Where development costs for third parties using their CUDA programming platform and over 150 software libraries. Nvidia aims to democratize AI.
This article examines Nvidia’s adoption of AI, upcoming catalysts, new company announcements, and why I think Nvidia is a must-have for long-term investors. With shares trading at $260 at the time of writing, I believe the stock has at least 15% upside potential.
Nvidia’s acceleration of AI adoption in numbers
Nvidia’s Data Center and Automotive businesses are primarily responsible for the growth of AI. Let’s take a look at some key numbers that show how Nvidia’s AI adoption is accelerating:
- Data Center Growth up 11% QoQ and 71% YoY, by the end of Q4FY22
- Automotive growth down 7% QoQ and 14% YoY, by the end of Q4FY22
- Data center and automotive segments account for 42% of Nvidia’s total revenue in FY22
- CUDA adoption: Developer count for CUDA is 3 million users (six times in the past five years)
- Omniverse adoption: downloaded 30 million times in the past 15 years, 7 million in the last year alone
- More than 25,000 companies use Nvidia AI
- Eight out of 10 supercomputers use Nvidia
Nvidia innovates at scale and brings new products to market quickly. The increase in adoption is clearly visible in revenue as well as other internal metrics.
Catalyst: Recurring software subscription revenue may not count for Nvidia
As I mentioned earlier, I believe Nvidia will soon be able to charge for recurring software subscription revenue Where development costs for their platforms. Nvidia starts with high performance chips, but for each area of science, industry and applications, they create a complete stack. They have over 150 SDKs (Software Development Kits), which serve industries from gaming and design to life and earth sciences, quantum computing, AI, cybersecurity, 5G and robotics.
Let me paint a picture of how I see Nvidia’s future:
Today, Apple (AAPL) and Google (GOOG) have achieved great success being the hardware and software platforms for apps and games that run on iOS and Android. Nvidia’s vision to democratize AI will allow them to collect software revenue from third parties who want to use Nvidia’s software and CUDA stacks to build their own AI-enabled applications on Nvidia’s GPUs. One day, every company will be a data business, and each server will be an accelerated computer.
We can already see hints from management on this. During the fourth quarter 2022 earnings call in February 2022, Nvidia’s chief financial officer, Colette Kress, explained how the company is still in the early stages of its software revenue ramp-up:
For the entire AI software industry, revenues are expected to more than double by 2025 from their current level:
Breakthrough Announcements During Nvidia’s Keynote GTC 2022 Event
Twenty years ago, this was all science fiction. 10 years ago it was a dream. Today we live it. – jensen huang
Nvidia made some groundbreaking announcements on March 23, 2022, at its GTC 2022 Keynote event. While there were many new initiatives mentioned by Nvidia, I wanted to name a few that piqued my interest:
- Autonomous driving Partnership with BYD and Lucid (LCID)
- Omniverse Kit and omniverse cloud collaboration platform to democratize creation and collaboration on Omniverse
- A powerful new H100 GPUs; for comparison, 20 H100 GPUs can support the equivalent of global internet traffic
EOS, an AI factory; for comparison, EOS has four times the processing power of the world’s largest supercomputer in Fugaku, Japan
Such speed of innovation and such scale of vision are impressive.
Nvidia is a buy at these levels with an asymmetric rise
Nvidia has five business segments: 1) Gaming, 2) Professional Visualization, 3) Data Center, 4) Automotive, and 5) OEM and Others. While Nvidia’s products may span multiple segments, it’s safe to assume that AI, omniverse, and software-based growth will come from data center and automotive businesses. I will present my assessments in three cases (bullish, base and bearish), with different assumptions. You can decide what you believe in the most. Personally, I think there is an asymmetric advantage in the bullish case with a potential recurring software revenue stream not factored in.
For Nvidia, I prefer to use a 10 year discounted cash flow model instead of a relative valuation. Indeed, Nvidia has steady and growing cash flow. I’m willing to make educated guesses about future growth rates depending on where the world is headed. My source for the discount rate is fin boxwhile my source for the Wall Street consensus estimates in the base case is simplywallstreet.
Bull Case*: Sustained growth in AI adoption through 2031 and Gaming; supply constraints ease
Here are my assumptions:
- Revenue growth of 30% to 10% between 2023 and 2031
- Free cash flow margin in 2031: 29%
- Growth to infinity: 5%
- Discount rate: 8%
Intrinsic value: $305
*One upside surprise that is possible but not included in my assessment is recurring software revenue.
Base Case: Wall Street Consensus Free Cash Flow Forecast
- Free cash flow in 2031: $29 billion
- Free cash flow margin in 2031: 29% (until 2027 I use Wall Street consensus estimates, beyond 2027 to 2031 is my own contribution)
- Growth to infinity: 1.92%
- Discount rate: 6.72%
Intrinsic value: $188
I did the base case valuation just to get an idea of what Wall Street is thinking.
Bearish case: declining growth, cyclical activity with stable cash flows
- Revenue growth of 20% to 6% between 2023 and 2031
- Free cash flow margin in 2031: 29%
- Growth to infinity: 4%
- Discount rate: 8%
Intrinsic value: $139
This bearish case is unlikely in my opinion, as it would mean that Nvidia stops innovating and becomes a chip company.
Risks for Nvidia
My Nvidia thesis is in jeopardy if the AI industry is not able to move forward at the expected speed. Of course, it remains to be seen how this translates to the top and bottom lines. The first signs are promising. Many real-world AI adoption use cases were showcased and their data center business saw hypergrowth.
For an asymmetric advantage, recurring software revenue and achieving L4/L5 autonomy with self-driving cars are essential. Without these, Nvidia might struggle to give outsized gains.
What to look for next
For a quantifiable cross-check of my thesis, look for two key things from Nvidia:
- Revenues from Nvidia’s Data Center and Automotive segments are expected to reach over 60% of Nvidia’s revenues by 2025 (currently at 42%).
- Will Nvidia be able to increase its software revenues by the end of 2023/beginning of 2024? The likelihood is high, as the CFO made positive comments during the Q4 2022 earnings call.
If Nvidia realizes recurring software revenue, valuations will need to be readjusted by Wall Street to project recurring revenue into the future. In this case, I expect an upside asymmetrically higher than my bullish case of $305.
My thesis will be violated if Nvidia is unable to generate software revenue by 2024. Then it will have to be valued solely on its ability to sell GPUs, even closer to my bullish case of $305.
In this article, I intentionally focused on the opportunities for Nvidia rather than its status quo. Nvidia continues to do well in its dGPU market and is the market and product leader. The Gaming and Professional Viewing segments have seen remarkable growth over the past year. But asymmetric advantage isn’t based on today’s business – it’s probably on tomorrow’s whole new AI-based world.