Up more than 80% year-to-date, Nvidia (NASDAQ:NVDA) is easily one of the most captivating stories in the technology sector. NVDA stock is beating the PHLX Semiconductor Index by a roughly five-to-one margin. And, it recently wrested the title of largest domestic chip maker from rival Intel (NASDAQ: INTC).
Predictably, Nvidia’s meteoric rise this year is fueling valuation concerns, which are relevant considering it trades at 53.48x earnings and 22.33x sales. At more than 53x earnings, NVDA stocks trades at nearly double the multiple of the PHLX Semiconductor Index.
However, valuations shouldn’t scare investors away from this juggernaut. Not at a time when growth continues dominating value, a trend that seemingly has no end in sight.
“For the rest of 2020, there will be fits and starts but growth styles are highly likely to continue their run, as broad economic and fundamental growth is still going to be challenged throughout the year as community re-openings have their own fits and starts,” notes Matthew Bartolini, head of SPDR Americas research. “And in an environment devoid of growth, investors are likely to seek it out and not be too concerned about paying a premium.”
Not Alarming, But a Reason to Be Cautious
Over the near term, valuation isn’t the primary concern with Nvidia. The company’s track record confirms it can grow enough to appease investors. It merits premium pricing relative to other more mature chip manufacturers.
Rather, the potential concern is a large-scale acquisition. Rumors are gaining intensity that Nvidia could make a play on Arm Holdings, which is owned by Japan’s SoftBank. The Japanese company doled out $32 billion to acquire the British chip designer in 2016. And there’s talk SoftBank could also opt for a traditional initial public offering (IPO) of Arm.
Scuttlebutt indicates an Arm IPO remains possible, but SoftBank is reportedly frustrated that deal wouldn’t command a $40 billion valuation. For Nvidia or any other bidder, and there are expected to be a few, Arm at the right price is a sensible acquisition. In fact, Arm already licenses processor designs to Nvidia.
Plus, Arm chips are found in 95% of the worlds smartphones and tablets. This makes it an ideal complement to Nvidia’s dominance in data centers, gaming and artificial intelligence, among other arenas.
NVDA Stock and the Cost of Acquisitions
The issue is, assuming Nvida makes a run at Arm, what the cost will be. Speculating here, assume that SoftBank will settle for break-even and sell the chip business to Nvidia for $32 billion. That would be more than quadruple what Nvidia paid last year for Mellanox – a $6.9 billion purchase that’s Nvidia’s largest to date.
Nvidia has almost $11 billion in cash, which is a fine trait, but obviously not enough to bring the Arm deal home. That gets Nvidia to a scenario where if it wants to go big game hunting it would probably need to issue debt and/or shares.
Moody’s rates the chip maker A3, which is a stellar credit rating, meaning debt would be cheap, particularly in today’s low interest-rate environment. Issuing new shares, however, would dilute current investors. This likely will lead to a short-term retrenchment in NVDA stock.
Bottom Line on NVDA Stock
Two things about Nvidia possibly being on the prowl for a big acquisition.
First, with Mellanox, the company is proving it can digest a sizable buy as analysts widely expect that deal will bolster Nvidia’s already robust data center business.
Second, Nvidia doesn’t necessarily need a deal to drive growth. In the first quarter (its next earnings date is Aug. 20), Nvidia said sales surged 39%. Sales were buoyed by 80% year-over-year growth in data center revenue and 27% year-over-year growth in gaming.
Time will tell what comes of the Arm rumors. But data centers and gaming offer plenty of catalysts over the back half of 2020. That means Nvidia can leave well enough and still deliver above-average growth for investors.
Todd Shriber has been an InvestorPlace contributor since 2014. As of this writing, he did not hold a position in any of the aforementioned securities.
