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NVIDIA Plays Games With Investors

To quote the character Scar from Disney's The Lion King, “Being king isn't always what it's cracked up to be.”

Although there are obvious benefits to being on top, the other side of the coin is that there’s no shortage of enemies looking to bring you down.

So it is with NVIDIA Corp. (NVDA).

The company has emerged as the uncontested leader in the AI semiconductor space with the explosion in demand for its graphics processors.

Although these processors were historically developed for things like gaming, video editing and processing, or digital animation, the chips have become the unlikely hero in the AI revolution.

As it turns out, many of the features of these chips – like the ability to handle large amounts of data and process a massive number of calculations in parallel – have made them well-suited to the needs of AI development and usage.

The swell of enthusiasm for AI kicked off when OpenAI released ChatGPT this time last year.

Since that time, the enthusiasm has only grown stronger.

Sales at NVIDIA have tripled over the past year. The company continues to crush analysts' estimates as its processors sell out faster than Covid vaccines at an Anthony Fauci fan club meetup. 

Lead time for its H100 based servers is currently six months to a year.

With all this good news, it seems NVIDIA stock should be headed for the stratosphere.

One would think.

However, the stock has sold off a bit (roughly 6.5%) since the company announced its earnings last Tuesday.

Although the company blasted through analysts' estimates, the market was spooked by guidance given by the company that next year's sales could be lighter than expected on reduced demand from China.

Analysts and investors pounced on this opportunity to suggest there are other weaknesses in NVIDIA’s business model. 

Customers, such as Google, Amazon, OpenAI, and Meta are evaluating developing their own chips to reduce reliance on NVIDIA and gain an edge in AI development.

These threats have caused analysts and investors to challenge the belief that NVIDIA can continue selling processors at the current pace.

In our estimation, these analysts and investors are entirely wrong.

What NVIDIA’s Not Telling Investors 

There’s little doubt that NVIDIA will face challenges in China due to new US regulations restricting exports of the highest-performing chips.

However, the impact these restrictions will have on NVIDIA’s sales is far less clear.

For one thing, the company has historically been able to engineer chips specifically for the Chinese market that can get around US regulations.

Secondly, although sales of servers to China might be restricted, this will not fully prevent Chinese access to these servers.

At least in theory, Chinese companies and researchers might be able to get around the ban by simply using NVIDIA’s servers located in other countries. While the US ban is designed to prevent this type of behavior, in practice it might be impossible to enforce.

For these reasons, we believe that any concerns regarding sales to China are being blown out of proportion.

Of course, NVIDIA can’t tell this to investors.

If they were to reveal that they have solutions to get around US laws, it would give lawmakers an opportunity to develop even tougher laws to prevent the Chinese from getting access to NVIDIA’s latest chips.

Instead, NVIDIA management has decided to play it safe to give themselves some breathing room and an opportunity to blow out sales expectations next year.

Regarding NVIDIA’s competition – the path to developing a chip that can compete with the H100 is a long and expensive one. Although it's possible that companies like Amazon, Google, and Meta could develop advanced AI chips, it’s unclear whether it will actually make business sense for them to do this.

One of the major benefits of the H100 is its flexibility – in addition to AI, it can be used for financial applications or video rendering. 

The flexibility of the device means that the company can sell the same device to a wide variety of customers at a competitive price.

The graphics processors developed by Amazon, Google, and Meta will likely be far more expensive than the H100 since these companies won’t achieve the kinds of cost savings NVIDIA gets from producing a large number of devices.

There are also questions about whether Amazon, Google, and Meta even have the capability to produce a chip that can compete with the H100.

NVIDIA has decades of experience, a massive portfolio of patents, and a well-oiled team of highly skilled workers at a time when skilled workers are in limited supply.

All of these advantages suggest that these companies aren’t likely to be able to mount a serious threat to NVIDIA anytime soon. 

More than anything else, we believe that NVIDIA will remain the undisputed champion of AI processors in 2024 and the warnings about China are a clever ploy by management to be able to continue to smash earnings expectations next year. 

Given the recent sell-off in NVIDIA over the past week, we wouldn’t hesitate to buy the stock.

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