The bears are loosening their hold on

Nvidia

(NVDA) - Get Report

, the graphics chipmaker whose stock has more than doubled this year.

Short-sellers, who aim to benefit from a stock's decline by selling borrowed stock and buying it back later at a lower price, have bet heavily against Nvidia, wagering that rising competition will choke off growth. Though Nvidia says they're wrong, its stock has dropped 27% since peaking June 7.

But now, some bearish investors are saying that it could be quite a while before Nvidia falls further. Two people who were short the stock say they covered in recent months, because Nvidia's near-term outlook simply looks too good. Other short-sellers have fled as well: Short interest, though still substantial at 19% of the float, has fallen 14% since June and 32% since its March peak. Falling short interest and strong fundamentals could spell a rally, holders say.

Gravity

Investors such as David Tice, a portfolio manager at the

Prudent Bear

fund who is short the stock, say Nvidia's growth is unsustainable. Technological change will inevitably create a rival with an unmatchable edge, predicts Tice, who expects the stock to fall to $15 from its current $73.

"We believe that this is mostly a graphics chipmaker that has been dominated by the Xbox news," Tice says, noting that much of Nvidia's revenue comes from the stagnant PC industry. Moreover, short-sellers have made a fortune over the last 15 years betting against the leader in the graphics chip market, he adds: "The history of the graphics chip market is littered with companies like Nvidia."

Rise and Fall
Short interest retreats ahead of stock decline

Source: Nasdaq

But Nvidia's vice president of investor relations, Michael Hara, says 2002 revenue-growth targets aren't predicated on either the success of the Xbox or a recovery in the PC market. (Revenue jumped 136% in the year ended Jan. 28, hitting $735.3 million.) Xbox revenues, estimated by outsiders at $50 million this year, aren't even included in the analyst consensus figures, Hara says.

Hara points out that Nvidia has entered the mobile and chipset markets this year, nearly tripling its potential market size. "We have ability to outgrow the market for some time because our share is so low today with regards to all those markets," Hara says.

Indeed, one investor who used to be short the stock says that Nvidia isn't a good short right now because of this expansion. "There are not a lot of near-term catalysts to drive it lower," the former short says. "The business is growing like a weed."

Weed, Dude

And the business seems to be growing at rivals' expense. More than 50 competitors have dropped out of the graphics market in the past few years, making

ATI

(ATYT)

Nvidia's only real challenger. ATI's

Radeon

chip competes with Nvidia's GeForce products for a spot in the PCs built by companies like Dell.

In the first calendar quarter, Nvidia grabbed 9 percentage points of the overall graphics chip market, according to Scottsdale, Ariz.-based

Mercury Research

. Nvidia's share hit 29%, while ATI saw its take fall to 16% from 22% in the fourth quarter. In the so-called standalone sector -- where the graphics chip is sold separately rather than being integrated into other products -- Nvidia grabbed 16 percentage points of market share, ending the first quarter with 53%. ATI's share, meanwhile, fell to 29% from 40%.

As for the supposedly inevitable leadership change in the graphics chip market, Nvidia's Hara says that technological advances in graphics mean that graphics companies no longer compete on price and timing alone.

"The barrier to entry for 3D graphics is so high that we don't see any more venture start-ups," Hara says. "The number of engineers is limited."

Opportunity Knocks

John Thornton, an analyst for the

AIM Global Telecom & Technology

and

AIM New Technology

funds, says there's room for both Nvidia and ATI in the graphics chip market. He notes that Nvidia has beaten consensus estimates for four quarters running, even as other technology companies have struggled to turn a profit. In addition, future earnings estimates continue to rise.

"I think we feel like it's a pretty good opportunity here," Thornton says. The stock is trading at "roughly 40 times the January '02 earnings estimate, and long-term growth is listed at 37%."

But the bears aren't going away. Even the investor who covered his short position thinks Nvidia will falter sooner or later. "Eventually this thing will play itself out and it will be a short again," the investor says. "It's a question of timing."