Chip off the old bloc

In the three months to 30 April, Nvidia’s gaming revenue fell 38% on the year, to $2.24bn, and total revenue fell 13%, to $7.19bn.^{1SEC EDGARNVIDIA Announces Financial Results for First Quarter Fiscal 2024 (Form 8-K, Exhibit 99.1)24 May 2023,3Jon Peddie ResearchNvidia Q1 FY24 results25 May 2023} A normal firm with those numbers would have used the earnings call to apologise. Nvidia used it to say that revenue in the current quarter would be about $11bn, give or take 2%.^{1SEC EDGARNVIDIA Announces Financial Results for First Quarter Fiscal 2024 (Form 8-K, Exhibit 99.1)24 May 2023} That is roughly 53% more than it had just booked, and rather more than one expects from a business supposedly in a cyclical downturn.

The source of the confidence is not hard to find. Data-centre sales, the part of Nvidia that sells the chips behind modern artificial intelligence, hit a record $4.28bn, up 14% on the year and 18% on the quarter.^{1SEC EDGARNVIDIA Announces Financial Results for First Quarter Fiscal 2024 (Form 8-K, Exhibit 99.1)24 May 2023} They now make up about 60% of revenue, which makes the old gaming business the sideshow.^{3Jon Peddie ResearchNvidia Q1 FY24 results25 May 2023} Jensen Huang, Nvidia’s boss, said that “the computer industry is going through two simultaneous transitions, accelerated computing and generative AI”. He added that the firm was “significantly increasing our supply to meet surging demand”.^{1SEC EDGARNVIDIA Announces Financial Results for First Quarter Fiscal 2024 (Form 8-K, Exhibit 99.1)24 May 2023,2NVIDIA Investor RelationsNVIDIA Announces Financial Results for First Quarter Fiscal 202424 May 2023} We think that is the line to read twice. When customers fear a shortage they order more than they need, and a supplier’s order book then flatters its true demand.

The market read the number as a verdict. CNBC reported on Thursday that the guidance could “help catapult the stock into the group of public companies with a $1 trillion market cap”, a club whose members are Apple, Microsoft, Alphabet and Amazon.^{4CNBC, via the Sherbrooke RecordNvidia nears elite trillion-dollar market cap club of Apple, Microsoft, Alphabet and Amazon25 May 2023} A few years ago its best-known product mostly made explosions look better in video games. Joining Amazon in the trillion-dollar club would be an odd promotion.

The bull case is respectable. Nvidia’s chips and the software around them are what the industry currently buys to build AI systems, and demand of that sort is unusually insensitive to price: a laboratory racing a rival does not haggle. The bear case is as old as commerce. Nobody enjoys depending on a single supplier, and a supplier earning margins like these (Nvidia guided to a gross margin of 70.0% on a non-GAAP basis)^{1SEC EDGARNVIDIA Announces Financial Results for First Quarter Fiscal 2024 (Form 8-K, Exhibit 99.1)24 May 2023} is an invitation to every customer with an engineering department.

Nvidia knew as much. In September 2020 it agreed to pay $40bn for Arm, the British chip-design firm whose architecture sits at the heart of the industry.^{5NVIDIANVIDIA to Acquire Arm for $40 Billion, Creating World's Premier Computing Company for the Age of AI13 Sept 2020} Regulators in several jurisdictions objected, and in February 2022 the deal was abandoned, citing “significant regulatory challenges”.^{6NVIDIANVIDIA and SoftBank Group Announce Termination of NVIDIA's Acquisition of Arm Limited7 Feb 2022} The failed bid even left a mark on this quarter’s comparisons: operating costs a year earlier included a $1.35bn charge tied to the acquisition.^{3Jon Peddie ResearchNvidia Q1 FY24 results25 May 2023} We thought the regulators were right to be wary of one firm owning the plumbing of the industry. Mr Huang’s way to the top now has to run through the customers rather than around the competition, which is how markets are supposed to work.

Pro-market does not mean pro-valuation. Mr Huang has the best product in a market that has just discovered it needs one, and he is paid accordingly. Colette Kress, the chief financial officer, said Nvidia believes “the channel inventory correction is behind us”,^{3Jon Peddie ResearchNvidia Q1 FY24 results25 May 2023} which is the sort of sentence firms write shortly before finding out otherwise. Shortages end, and so do monopolies on the best chip.

Nvidia may well be worth $1trn. It would be the first firm to get there by selling picks and shovels in a gold rush that has so far produced mostly picks and shovels.