BPS Capstone Project

Drew Cordell

BPS 4305

BPS Capstone Project

Project Executive Summary

NVIDIA is a corporation which specializes in graphics processing units (GPUs), machine-learning, and self-driving cars. Its closest competitor, AMD, despite having a market cap 1/10th the size of NVIDIA’s, remains in close competition with NVIDIA within the GPU industry. This report analyzes NVIDIA on corporate and business levels, evaluates the competitive advantages, infrastructure, financial composition, and strategy of the firm. Based on my findings, NVIDIA should continue with its current strategy to dominate the GPU industry while exploring new business units (related to existing business units) with an increased R&D budget which can synergize with other segments of NVIDIA to create the most value and maximize long term revenue and growth of the corporation.

Financial Analysis

NVIDIA (NVDA) is a technology company known for inventing the graphics processing unit (GPU) in 1999. GPUs are used for powering computer graphics, and can be used for a variety of other practical applications in programming. Since the creation of the GPU, NVIDIA has focused on researching and improving the power of their GPUs and have moved toward the AI, supercomputing, and graphics-driven processes. As of January 2017, NVIDIA employees over 10,000 people, most of whom are engineers in one form or another given the extremely technical nature of the industry.

PC graphics cards are primarily used by PC gamers to run impressive, beautiful-looking games. NVIDIA has realized the power of GPU technology to power machine-learning and visual recognition--two primary components of artificial intelligence. NVIDIA is in direct competition with Advanced Micro Devices (AMD) which produces microprocessors in addition to graphics cards. AMD has recently been closing the gap in terms of graphics card power, cost, and popularity in the PC community. While AMD is in direct competition with NVIDIA, Intel Corporation is also one of NVIDIA’s major competitors, though the two companies have been known to work together on certain projects, especially in the creation of microprocessors that are capable of running video and graphics in PCs without dedicated graphics cards.

NVIDIA is healthy and is rapidly growing and increasing in value. From 2016 to 2017, NVIDIA experienced explosive growth of net income, going (in thousands) from $614,000 to $1,666,000. This is a 171.34% increase, and represents an intense increase in value. Furthermore, NVIDIA has financed this growth of assets needed to increase profit by a massive shift to long term debt while still healthily increasing equity held in the firm. NVIDIA went from (in thousands) $10,000 in long term debt to a $1,989,000, a staggering 19790% increase in long-term debt. NVIDIA now holds most of this increased liability in the form of cash and cash equivalents as the firm now holds 196.3% more than it did in 2016. NVIDIA has a history of strength in its liquidity ratios, and none of the three main ratios (current, quick, and cash) are below a 2.0, this is very good. Furthermore, NVIDIA has good ratios for total debt, debt-to-equity, and the equity multiplier. All of these ratios are low enough and do not put up any red flags in terms of risk of insolvency. From NVIDIA’s financials, the firm seems very able to pay back debts, and has the net income and cash flows to support them as well. NVIDIA is also able to quickly turn over its inventory with an average inventory turnover of only 30 days while AMD’s ratio is over double at 64 days.

While AMD has become a lot stronger in 2017, my company comparison uses the year of 2016 since AMD and NVIDIA use different business year dates for the purpose of releasing yearly financial data. AMD did not have a good year in 2016, and has yet to close the gap with NVIDIA who continues to perform exceptionally well. AMD lost money in 2016 while NVIDIA generated a healthy profit. Unlike NVIDIA, all of AMD’s liquidity ratios are below a 2.00, and the firm seems most healthy when it comes to cash with a cash ratio of only 0.94. Typically, cash is the fastest way to repay debts, and while AMD’s quick ratio is 1.32, the firm is not quite as liquid as NVIDIA. AMD also was not as solvent as it probably should have been in 2016. The company was going through a restructure of capital, and had a debt-to-equity ratio of 6.98 and an equity multiplier of 7.98 which are not healthy numbers.

2017 is a lot more interesting for both firms, so it is important to include in this report to give a fair representation of both companies as they exist today and explain the changing landscape they operate in. Both AMD and NVIDIA have been hugely successful in 2017 so far. It is shaping up to be a year that defies the standard seasonal nature of the industry, and both titans of graphics processing have experienced increased sales throughout the year. While AMD and NVIDIA both focus on selling directly to consumers that are building their own PCs, both companies also have business-driven revenue sources, and customers that are large corporations themselves.

The GPU industry has grown steadily as more gamer customers (people who enjoy playing high-end video games) switch over from playing games on consoles, to building or buying their own high-end PCs with dedicated graphics cards made by AMD and NVIDIA. Because both companies are directly competing with one another, they must release new product lines each and every year to remain competitive and offer the innovation that is required to improve the limits of what is possible with graphics processing and playing video games.

According to Jon Peddie Research, a financial analyst firm specializing in the GPU industry, both AMD and NVIDIA have experienced a year-to-year total increase in GPU shipments of 6.4% which consists of both laptops and desktop graphics cards. In addition to the increased popularity of playing video games on PCs, cryptocurrencies such as Ethereum and Bitcoin have driven graphics cards sales.

Cryptocurrencies are digital assets that can be transferred through a publically recorded ledger known as the blockchain. When people use their computational power to help verify transactions of a cryptocurrency network, they are rewarded through the generation of the cryptocurrency they’re aiding (the process is called mining.) Different cryptocurrencies use different underlying algorithms, and some of them cannot be mined using traditional SHA-256 hashes that are able to be processed with dedicated chipsets. For Ethereum, the only reliable way to mine the cryptocurrency is with a graphics card. The more power the GPUs used to mine have, the more opportunity there is to profit. As mining continues, the process becomes more difficult for everyone, and expected returns on owning physical equipment used to mine decrease. A lot of Ethereum miners have purchased large quantities of graphics cards from both AMD and NVIDIA, producing a nice burst in sales for both companies. Unfortunately, this sudden surge in sales did result in periods of shortages where both cryptocurrency miners and customers wanting graphics cards for their PCs had extreme difficulty finding fairly priced products to purchase.

Another analyst firm, Citron Research, published a report in June 2017 which compared the value gains in NVIDIA’s common stock to a slot machine. The report was titled “The Moment that Separates the Gamblers from the Investors NVDA to Trade back to $130”. Needless to say, the report didn’t favor NVIDIA and encouraged investors with stock in the company to take their profits, sell, and move to Google who continues to perform well. NVIDIA has been moving into AI, data storage, and self-driving autonomous cars. Citron cites that Google has extensive experience and the infrastructure in place to do all of these things better with the statement “would you rather own the internet, or make chips for video game consoles?” The negative article by Citron caught on, and both NVIDIA and AMD took hits in their common stock value as a result.

General Environmental Analysis

Demographic

As mentioned above in the financial analysis section that explained a little about the recent surge in the performance of both AMD and NVIDIA, PC gamers and cryptocurrency miners represent NVIDIA and AMD’s main consumer customers. Acquiring demographic data specific to PC gaming is difficult. Since many of the same games can be played on both PC and gaming consoles, gamer data is almost always grouped together. These demographics are taken from the 2016 Essential Facts about the Computer and Video Game Industry report.

The average gamer is 35 years old, and the average age of people who purchase video games is 38. 60% of gamers are men while the remaining 40% are women.

Looking into the cryptocurrency space, data from research conducted by the University of Illinois provides some insight on users who user Bitcoin and other cryptocurrencies and would be likely to use NVIDIA or AMD products to support it.

Over 70% of Bitcoin users are between age 22 and 40. Surprisingly, only 1.76% of Bitcoin’s user base are women. This is the most shocking trend about cryptocurrencies, and while the number of women in cryptocurrency is on the rise, there is still a staggering separation between gender when it comes to cryptocurrency.

Sociocultural

The number of women who play video games is increasing, and this represents the opportunity for NVIDIA and AMD to sell more products to women who are getting into PC gaming or cryptocurrency mining. Furthermore, graphics cards also have plenty of application for rendering graphics, 3d modeling, and graphic design, an industry that has more parity amongst men and women involved. The study on video game players shows that the average US household has 1.7 gamers, and also shows that many people prefer to play video games with their spouse.

Political/legal

Since AMD and NVIDIA are both so technical, the majority of their staff are engineers. Both companies are corporations, and both are taxed as such. Since there is little danger in GPU industry for consumers, there is very little regulation that negatively impacts these companies and what they are able to sell to consumers. Since everything they sell is legal and doesn’t contain illegal functions, AMD and NVIDIA do not have to worry about things a gun or pharmaceutical manufacturer would. Since manufacturing of GPUs happens overseas, NVIDIA and AMD would have to follow regulation on work visas when going to and from the US from countries like China.

Technological

AMD and NVIDIA are both technology companies. Their business is dependent on constantly innovating their proprietary technology and continually releasing new products that improve what is possible on PCs. NVIDIA is working on AI, image recognition, self-driving cars, and other potential groundbreaking applications of their tech. Both companies have huge R&D budgets and continually innovate.

Economic

In regards to PC gaming, both NVIDIA and AMD’s products are very dependent on their customer’s disposable income in the consumer segment. While both businesses are cyclical, they also offer solutions for businesses and partner with popular computer manufacturers to include their products on computers primarily used for business applications, thus mitigating some of the cyclical nature of the consumer segment of their businesses. Like many other firms, NVIDIA and AMD do well when the economy does well.

Global

NVIDIA and AMD are both dependent on global relationships and the partnerships and business infrastructure they build overseas. In addition, both companies sell their products internationally and are therefore exposed to currency exchange rates, increased competition and desire to infiltrate the growing Indian and Chinese markets, and trade agreements and laws which must be respected in order to conduct business in other countries.

Porter’s Five Forces

Threat of new entrants

The threat of new entrants in this industry is low.

●This is an industry that requires immense resources and economies of scale to accomplish positive financial results.

●Product differentiation is low in this industry. AMD and NVIDIA continue to release products with identical technical specifications (Same amount of video ram, processing power, etc.) The only differentiation is in the products themselves and the other brands of computer components that they integrate with which does differ between the brands.

●Capital requirements for a business like this are extreme to say the least. This is a very technical industry that requires a huge R&D budget and the ability to manufacture highly technological products in bulk.

●Switching costs for consumers switching between AMD and NVIDIA are moderate since these are high-end products which typically run from $400-700 for the most up to date versions of the graphics cards.

●For new entrants, securing strong distribution channels would be a challenge since strong relationships with manufacturers and shippers in China would need to be established just to get products to the US.

● No cost advantages could be easily established when compared to NVIDIA and AMD. Both companies have impressive infrastructure in place already, and manufacturing and developing similar products cheaper than them would be extremely challenging.

The Bargaining power of buyers

The bargaining power of buyers in this industry is low.

●Buyers are typically a single consumer, and those consumers purchase these products one at a time. The lifespan of a single graphics card can be upwards of 5 years.

●Like a lot of other businesses, both AMD and NVIDIA rely on retailers to sell their products in addition to offering them directly from the company. Both companies partner with multiple retail outlets and have set pricing rules which retailers must follow for a certain time in order to sell their products to buyers.

●Switching costs for buyers are moderate to low. In addition, graphics cards typically have high resale value and a large secondary market which makes it easier for buyers to switch. This is an advantage for buyers.

●Backward integration is near impossible for buyers unless they have the money to buy NVIDIA or AMD, both valued in billions of dollars.

●NVIDIA and AMD have charged similar prices for their products and buyers pay it. Buyers are not extremely price sensitive when it comes to purchasing these products and continue to do so regularly as they upgrade their PCs.

The bargaining power of suppliers

The bargaining power of suppliers in this industry is moderate to high.

●In terms of the chip manufacturers, there are only a few that meet the needs of NVIDIA and AMD, increasing the strength of these suppliers.

●Graphics cards require very specific chip sets which have been meticulously designed. There is no substituting these chips in the production of graphics cards.

●Suppliers of these chip sets typically do not manufacture anything else and stick to these chip sets.

●The supplier’s products are extremely important for NVIDIA and AMD, without them, the graphics cards they produce will not function.

●Since NVIDIA and AMD do their own R&D, they could technically switch manufacturers at a lower cost, but the issue of finding a manufacturer with the technical capacity to build such an intricate chip set remains.

●Forward integration would be very difficult for suppliers. NVIDIA and AMD generate most of their value through R&D and continued innovation. Chip set manufacturers often manufacture chips for other technology industries, but do not have the resources in play to do what AMD or NVIDIA does easily.

Threat of substitute products and services

The threat of substitute products and services is high.

●While PCs provide the most sophisticated gaming experience around, it is easy for gamers to substitute a high-end graphics card for a gaming console like the Xbox One or PS4 which might actually cost less than the graphics card itself.

●Other substitutes can be anything done for entertainment or used in the customer’s free time. Because of this, the number of substitutes for entertainment is practically limitless.

●In terms of gaming alone, PCs still represent the best performance for the price and can be easily upgraded over time to stay up to date. Consoles cannot be upgraded and therefore have higher upgrade costs since a new console must be purchased rather than just a new component for a PC.

Intensity of rivalry among competitors

The intensity of rivalry in the GPU industry is high.

●Both AMD and NVIDIA continue to release new products with more or less the same specifications. Both companies are in active competition to secure an exclusive partnership with Intel which could be a very great opportunity for growth.