So as we have seen there's pretty much panic in the markets right now. We see this as settling down very soon, but one sector that's likely to continue to feel some pain is high-flying technology. One such high flyer that I think is a buy, despite falling 20% since we started buying, is Nvidia (NVDA). We see many reasons for owning the stock long term, and before the market correction turned into panic, we felt the decline in the stock was a buyable moment. Well, as we saw, a few highly-volatile sessions took this world-building company's stock down another 20% the last few days. Truly painful. The market today just sold the stock off a little more on what was perceived as bad news if you look at the selling, but we see it as good news. Today we learned that Nvidia might walk away from the ARM Holdings deal. We think this is a positive catalyst longer term.
So what happened? Well, Bloomberg just reported that Nvidia is "quietly" laying the groundwork to withdraw from its acquisition of the United Kingdom's Arm Holdings.
The acquisition is a whopping $40 billion. While the deal would be long-term accretive for NVDA, and its offerings would complement present products, we believe the money is best kept in house. It's funny. One of the biggest perceived risks is that the Arm acquisition would not obtain the go-ahead from regulators. The deal has been held up for what feels like forever as regulators scrutinize the implications of concentrating so much power under Nvidia's umbrella.
So why would calling this off be a good thing? Well, with a deal of such a massive size, it's not uncommon for the deal to be approved with a ton of new restrictions on the company. Further adding possible risk to the post-deal company could be that regulators could force the company to divest businesses to promote competition and limit monopolistic-type powers. This possibility could severely cut the company if required to do so. We suspect that the regulatory headache could be driving this and that regulators might have been considering terms that were simply deal-breakers for Nvidia. In short, to get the deal through, Nvidia may have had to make some severe concessions. Concessions so deep that perhaps the company is simply better off without Arm. Just last month we saw that the U.S. Federal Trade Commission, or FTC, sued to block Nvidia's acquisition of Arm as it saw the combination being anticompetitive. It thought too much power was being concentrated because of how Arm technology is in nearly every smartphone and increasingly other computing applications. As such, regulators' view Nvidia's ownership of Arm as being a risk for no competition to enter the market, which could lead to higher prices or curb innovation for future technologies.
We do not know for sure, but this stands to reason. So the deal would cost $40 billion, and if it went through unscathed, it could increase the valuation of Nvidia by an incremental $25 per share. Well, the stock has shed about five times this amount in recent months, so, it's starting to look like a (sizable) drop in the bucket. While it was agreed by most (including us) that the deal with Arm going through would have been a net positive for Nvidia, this assumed it went through without any such concessions that may be on the table.
So why is it better off? Well, it may help to know why Arm was good for the company first. When you consider the ARM acquisition efforts, investors need to understand the current business model and the company's key strategic markets. Without question, revenue-wise, the most important segments/operations are its client GPUs. These are the processors which are used for things like high-end gaming and of course the ever-popular cryptocurrency mining. Then, there's the GPUs for servers which are used for machine learning/artificial intelligence, as well as other development needs. Frankly, the company has done better here in recent years, but the competition has been very stiff, and Nvidia has been in the middle of the pack. By owning Arm's CPU competencies it could block other server-side businesses from competing. Total lock if you ask us (and regulators, most likely). For more on why rather than drag this out another 12 months only to see it get denied, if the company pulls the plug, it can regroup. After so much market capitalization has been erased in the last few weeks, it feels kind of "right" to kitchen sink the action and get this out there. If the company pulls out it owes SoftBank some $1.25 billion (well actually it already advanced it). However, the company will now have a ton of cash with which to put to work, should it choose to.
While the pressing competition issues we mentioned that acquiring Arm could help quell, Nvidia now will have that available cash to pursue other acquisitions. It could return more money to shareholders through accelerated buybacks or dividends. But it may be best off to reinvest right in itself. And even without Arm, the company is dealing in one commodity that it can now leverage even further: Data.
We have to reiterate that many do still not appreciate the dominance that this name has in data. We have said it before and will say it again, data really is a commodity, in our opinion. Machine learning, decisive marketing, targeted advertisement, this is just the surface of what data can help with. Nvidia as we know has at its fingertips access to a vast amount of data through its traditional computing hardware business, but also in its gaming platforms such as GeForce Now, CUDA platform, as well of course as the Omniverse.
If the company does back out of this deal, which at this point is looking likely, we have faith in management. CEO Jensen Huang's leadership is the best in the business. Management has moved this from being a boring graphics card company to being a leader in several fields. This company can use its cash now to attract the absolute best talent and minds from the most prestigious universities all over the world. They have the right message to attract the talent, and the money to pay for it. This company is using data as its commodity. It will learn from the data it collects in its many areas, including the Omniverse.
Remember folks, the Omniverse engine is the technology infrastructure that produces and uses the commodity of data to innovate. The data collected will feed back to the artificial intelligence work the company is engaged in and has been seeing massive growth. Eventually, the Omniverse engine can be a place where companies go to create and design new and exciting virtual worlds, and while we have told our followers this before, it bears repeating, you simply can't quantify the total addressable market. It has not been built yet. We would love to see the company step up its investments in these areas while exploring smaller complementary acquisitions in the meantime.
