Yesterday, Bloomberg reported that Facebook might be working on developing its own ASICs, a move followed by Alphabet’s similar initiatives in developing its own TPU (Tensor Processing Unit is also an ASIC). The report is based on a job posting on Facebook’s career page which states the need to hire a manager to build an end-to-end SoC/ASIC, firmware, and driver development organization.

We believe that such move is a threat to the GPU market in general and Nvidia in particular as data center operators are moving towards developing their own processing units, a process which is way cheaper (Nvidia’s operating margin is higher than 30%) and even faster.

“Your margin is my opportunity” – Jeff Bezos

At this stage, it is impossible to know the extent of this threat as we do not know exactly how much of the datacenter tasks are based on repetitive computing, the only area where ASICs can operate. However, we believe the risks are significant as Nvidia’s customer base is concentrated. While the company did not have any customer representing more than 10% of sales in 2017 (probably due to the crypto hype), it had a customer that represented 12% in 2017 and 11% in 2016. Such concentration of customer base makes the initiatives of developing in-house processors by the top cloud operators a high risk for Nvidia (Microsoft is developing its own FPGAs, Alphabet is continuously improving its TPUs, and Facebook is expected to work on ASICs too).

It’s also worth mentioning that two quarters ago Elon Musk was asked whether Tesla would install Nvidia’s Drive PX3 platform into its coming vehicles, the answer was not encouraging for Nvidia and surprisingly the market did not react. Take a look.

If Tesla believes that it is able to achieve the same level of performance with its Drive PX2 platform, although the PX3 is 10x faster, then we should ask; to what extent speed in GPUs matters? If Nvidia were in a position where its customers are not demanding upgrades, competition may catch up with the company and its moat would diminish.

Sure, these are very long-term issues and the current stock price may not reflect these risks anytime in these 2-3 years, however, investors should know what type of risks that may arise in the future.

We believe that Nvidia stock is not expensive, yet not cheap. The stock trades at 32x this years’ earnings which seems reasonable for a company that is growing more than 30% per year and converts nearly all its net income to free-cash-flows. However, at these levels, we remain on the sidelines after selling our entire stake at $190 per share. We prefer waiting for a pullback that will come sooner or later than re-entering the stock at current levels.

Celeritas Investments.