Name That Trade – $NVDA: Chips and Dips

by Dan March 31, 2015 1:32 pm • Commentary

Last night on CNBC’s Fast Money we played a March Madness themed game of “would you rather” in the semiconductor space between Intel (INTC) and Nvidia (NVDA), watch here:

My choice was NVDA, primarily the result of my current dislike for INTC which I outlined yesterday in a trade post (New Trade – $INTC: Levering Up, Looking Down). After the company’s Q1 guide down I remain bearish, and do not like the prospects of an acquisition of Altera (ALTR) as reported Friday by the WSJ:

Its my sense that Friday’s bounce could be an opportunity on the short side for those who believe that when the company reports their Q1 results on April 14th they will guide Q2 below consensus, and that a deal for ALTR will not exactly be a near term positive as it will be mildly accretive this year to earnings and would either deplete a bit of their $21 billion cash position, or cause the company to add to their existing $14 billion in debt.  Levering up to buy a company that has only 7% expected earnings growth and 3% sales growth seems odd to me. Obviously the company wants to diversify a bit, but I am not sure how ALTR’s expected $2 billion in sales will move the needle on INTC’s expected $55 billion in sales.

I suspect INTC trades back to $30 in the coming weeks regardless of whether or not they buy ALTR.  

On the NVDA front, it is one of the few semiconductor stocks to post a beat and raise when they reported their fiscal Q4 results in mid February.  NVDA reported revenue growth of 13% year over year in their graphics chip business that could be on the cusp of a secular shift away from consoles back to PCs.  The stock is relatively cheap, trading at 14.6x expected fiscal 2016 earnings.  I guess the kicker here is that the company has 40% of their $11.6 billion market cap in cash, or about 30% net of cash. And while they pay a dividend that yields 1.6%, and buyback shares, the stock could be ripe for an activist to push for greater cash return, an acquisition to re-accelerate growth, and itself could maybe be a cheap acquisition target at a time where consolidation could become a big theme in the semiconductor space.

Last week on the big down day in the market the stock filled in its entire gap from Q4 earnings, and the stock is now down 11% from the 52 week and 4 year highs made on March 20th:

[caption id="attachment_52383" align="aligncenter" width="600"]NVDA ytd chart from Bloomberg NVDA ytd chart from Bloomberg[/caption]

Sentiment is kind of mixed in the stock with 9% short interest, and Wall Street ratings that are meh at best with 13 Buys, 17 Holds and 4 Sells.   And one high profile analyst from Goldman Sachs, James Covello, recently slapped a Sell rating and a $20 on the shares citing the potential of loss of licesning revenue from Intel, per Tiernan Ray from Barron’s:

Issue number one for Covello is that Intel has an agreement dating back to 2011 to pay Nvidia $1.5 billion over six years.

Intel and Nvidia the deal, the result of a patent infringement dispute, back on January 10th of 2011.

“If the licensing agreement is not renewed, we expect the impact to hit the income statement in 2017 (1QFY18), though the last impact to cash flow will be in January 2016 (4QFY16),” he writes.

He sees very low probability Nvidia can renew the deal with Intel. “Based on the current agreement, Intel has access to the agreed-upon patents in perpetuity, implying that Intel would need to renew the licensing agreement if it wanted access to patents that Nvidia filed after March 31, 2017. ”

Covello thinks investors have become “complacent” about that prospect.

Covello’s $20 target is well below the average analyst target of about $23.50, and also corresponds with a what appears to be a huge technical support level, which looks like a very attractive long entry:

[caption id="attachment_52384" align="aligncenter" width="600"]NVDA 1yr chart from Bloomberg NVDA 1yr chart from Bloomberg[/caption]

I’m not pulling the trigger here but if I had to I like the April/May 22 call calendar. If the stock works its way down towards $20 I will be very interested in pulling the trigger and in that instance will look towards a May or June Call spread or call fly.