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Nvidia’s Using Nosebleed-Valued Stock to Pay for SoftBank’s Chip Unit

Despite all the recent news about Nvidia (NASDAQ:NVDA) and its proposed $40 billion acquisition of ARM, it still is overvalued. Most investors should probably avoid buying NVDA stock unless they are comfortable paying its nosebleed valuation levels.

An Nvidia (NVDA) semiconductor chip on a black background.
Source: Hairem /

By the way, I don’t really have a good track record on Nvidia, so maybe you shouldn’t listen to me. For example, I basically made the same argument about NVDA at the end of July.

In my article, “Avoid Nvidia Stock At Its Sky-High Valuation,” I argued that at 50 times earnings it was much higher than its historical valuation.

But then NVDA stock rocketed over 40% higher from $408.62 per share on July 28 to a peak of $573.86 on Sept. 2. Since that peak, the stock has fallen a bit. It’s off over $90 per share as of the Sept. 23 close, at $484.95, or down more than 15%. But today’s price is still almost 19% higher than when I last wrote that the stock was overvalued.

I believe that high price-to-earnings (P/E) stocks are not worth investing in over the long-run. Your returns are likely to be much worse than similar companies in the same industry with much lower P/E ratios.

Nevertheless, let’s look at Nvidia’s proposed acquisition of ARM, a SoftBank (OTCMKTS:SFTBY) semiconductor chip unit. Maybe that purchase justifies the high price that the market keeps on NVDA stock.

The Cost of the ARM Purchase

Nvidia is going to pay a mixture of cash and stock for ARM, based in Cambridge, England. The cash portion is $12 billion, of which $2 billion paid upfront at the signing of the deal on Sept. 13. The remainder of the roughly $40.1 billion deal is paid in stock, or a mixture of stock and cash.

For example, Nvidia says it will issue 44.3 million shares to Softbank for ARM. Pegging that to NVDA stock at $487.57 per share, makes it worth $21.6 billion.

Now the cost is $33.6 billion. Nvidia said it would also issue up to $ 5 billion in cash or up to 10.3 million in shares to SoftBank, based on earnout performance hurdles.

Nvidia will likely issue the shares rather than pay cash. So that means it will likely issue 54.6 million shares to SoftBank, worth $26.6 billion. That is almost 70% of the $38.6 billion payable to SoftBank.

In addition, it will issue $1.5 billion in restricted stock units (RSUs). These could turn into more shares. At today’s price that equals 3.1 million shares. Now the total is 57.7 million in shares.

This is not a lot of dilution. Nvidia has 617 million shares outstanding. So even if it issues 57.7 more shares that is only 9.35% of its total. In fact, it is only 8.55% of the total shares outstanding post-money.

This shows that what Nvidia has done is brilliant. It used its high-priced shares, in terms of valuation, to purchase a profitable company for just $12 billion in cash and only 8.55% dilution. It won’t even have to borrow for the cash portion.

What Will Happen With NVDA Stock

NVDA stock is up over 177% in the past 12 months. The iShares PHLX Semiconductor ETF (NASDAQ:SOXX) is only up 34% in the same period. Nvidia stock is that exchange-traded fund’s fifth-biggest holding, at 7.78% of the 31-stock portfolio.

Undoubtedly, if Nvidia had not had such a good year SoftBank might not have been willing to accept up to 70% of the sale price in shares.

Nvidia says the transaction will be “immediately accretive to NVIDIA’s non-GAAP gross margin and non-GAAP earnings per share.” It will increase earnings per share for the combined entities, despite the share dilution.

In the conference call on Sept. 14, Nvidia’s CEO, Jensen Huang, said that ARM makes “94% gross margins and adjusted pro forma EBITDA margin of approximately 35%.” The company made “1.8” billion in revenue in the 12 months.

Assuming he meant 1.8 billion in UK pounds, revenue is $2.32 billion, and EBITDA is $812 million. At a 20% tax rate and with 5% of sales depreciation and amortization, ARM’s net income would be $556.7 million.

Therefore, the $40.1 billion price tag values ARM at 72 times earnings.

Nvidia will likely pay just $12 billion cash for these earnings. That is just 21.5x earnings. The rest of the purchase price has just an 8.55% share dilution, which is nothing.

In other words, Softbank is getting a real bargain here. If it weren’t for overpriced NVDA stock though, Huang and his team would not have been able to do it.

On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Mark Hake runs the Total Yield Value Guide which you can review here.

Article printed from InvestorPlace Media,

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