American technology companies have become pawns in the China trade war. The great ones are adapting in remarkable ways.
Platitudes aside, the reveal was Nvidia diversifying away from China. That's a big deal.
Innovative companies like Nvidia are an American treasure. As the maker of best-in-class graphics processing units, its hardware became a staple inside early Microsoft (MSFT) - Get Report Xbox and Sony (SNE) - Get Report PlayStation gaming consoles. However, engineers quickly discovered that CUDA, the underlying parallel computing software code, had wider applications for general computing.
Jensen Huang, the chief executive officer, moved quickly to exploit the opportunity. He partnered with leading technology companies to push GPU-based computing into other sectors. He reached out in 2006 to the academic community with software development kits and application programming interfaces. The decision put Nvidia hardware at the center of a new computing movement.
Siemens partnered with Nvidia in 2007 to build the world's first 3D ultrasound machine. Tsubame 1.2, a supercomputer built by the Tokyo Institute of Technology, became the world's first GPU-based supercomputer in 2008. Three years later, the Tianhe-1A, a Nvidia powered machine based at the Chinese Academy of Sciences, became the fastest.
As Nvidia GPUs moved into data centers, research facilities and universities, sales soared, reaching $3.5 billion by the end of 2011.
Today GPUs play a vital role in artificial intelligence. They are used in the development of everything from material science to communication networks, industrial robotics and self-driving cars. This should be a good thing for Nvidia.
Unfortunately, Chinese and American politicians are in the middle of a trade war. Citing national security concerns, hardliners in the U.S. Senate have been pushing to permanently blacklist major Chinese businesses like Huawei, the world's largest maker of telecommunications equipment. Currently, American companies need to get special waivers to sell their semiconductors, peripherals and software. Nvidia logs 30% of its sales from China.
That's why the Smart Everything Revolution is a big deal.
Huang sees an opportunity to build a new computing platform at the edge of the network, where most of the data is created. Small boxes attached to light posts, buildings and communications towers will process timely information on the fly, and bounce the rest of the data to cloud-based data centers. In theory, everything will become connected, or smart.
It's a bigger idea that tech enthusiasts call the internet of things.
The connective tissue would be the Nvidia EGX Supercomputing platform, a combination of cutting edge hardware and software based virtual radio access networks.
It's not a coincidence that Frederik Jedling, chief executive at Ericsson, joined Huang onstage in Los Angeles. The telecom equipment company has struggled to match Huawei in the race to build out cost competitive fifth generation wireless networks.
The collaboration with Nvidia will help the Swedish company merge AI, the internet of things and 5G networks. This combination should appeal to large telco companies looking to build new business models, while remaining neutral in the trade war.
The Smart Everything Revolution is Nvidia at its best. It's an adaptive, innovative solution, with the potential to do for the internet of things, what CUDA did for supercomputing. It also comes at a time when politics make diversification away from China desirable.
Nvidia shares used to be easy to recommend. Managers put the company in the middle of all of the most exciting computing applications. For a time, the firm could do no wrong. When cryptocurrency became a thing, and software developers rushed to building bitcoin mining rigs, naturally they turned to Nvidia GPUs. Almost overnight, a new $300 million business developed.
Bitcoin mining eventually succumbed to falling cryptocurrency prices. More recently Nvidia has become a victim of slowing sales to Chinese data center customers and the trade war with China. The stock is down from its 2018 high of $288.70.
It's honestly too early to tell if the China data center woes have subsided. Nvidia will report financial results in November. However, it is positive that Huang is moving the company to the edge of networks, while doggedly pursing the rest of the business.
Shares trade at 28.7x forward earnings and 12.7 sales. These metrics might seem high relative to other technology companies but they are significantly below the historic norms. Huang has done a masterful job creating value for shareholders. Fifteen years ago he leveraged CUDA into an AI juggernaut.
Even with the weakness from the highs, the average compound annual growth rate is 28.2% since that time. A stake of $10,000 would have grown to $654,353.
This is definitely a stock to keep on your radar. Growth-oriented investors can add it on pullbacks.
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To learn more about Jon Markman's recommendations at the crossroads of culture and technology, check out his daily investment newsletter Strategic Advantage. To learn about Markman's practical research in the short-term timing of market indexes and commodities, check out his daily newsletter Invariant Futures
The author of this column owns no stocks mentioned.