Nvidia ( NVDA) finally announced an acquisition on Monday, but it wasn't the deal the Street was expecting.

Though the rumor mill had been abuzz for weeks that Nvidia would get swallowed by chip giant Intel ( INTC), it turned out that Nvidia was the one looking to bulk up. The Santa Clara, Calif., graphics chipmaker plunked down $357 million to acquire PortalPlayer ( PLAY).

Nvidia CEO Jen-Hsun Huang described the deal as bringing together the two key ingredients of next-generation electronic devices: the application processor and the graphics chip.

"With the products created through this combination, we intend to drive the next digital revolution, where the mobile device becomes our most personal computer," said Huang.

The combination was in many ways one of necessity for the two chipmakers, which have found themselves under increasingly challenging circumstances.

Nvidia has been taking steps to diversify itself away from a maturing PC industry, by expanding into consumer electronics such as cell phones and game consoles. The pressure has been particularly acute since Nvidia's graphics rival ATI Technologies joined forces with Advanced Micro Devices ( AMD) last month.

For its part, San Jose, Calif.-based PortalPlayer has been desperate for any kind of a succor after the company lost its business providing chips for Apple Computer's ( AAPL) popular iPod nano in April.

Despite PortalPlayer's setbacks, investors bid the stock down in afternoon trading Monday, owing to the meager premium that Nvidia ponied up. PortalPlayer shares were recently off 7 cents to $13.29.

Under the agreement, Nvidia will pay $13.50 in cash for each outstanding share of PortalPlayer common stock, a 19% premium compared with the average closing price of PortalPlayer on Friday. But the offer was only slightly higher than PortalPlayer's Friday closing price of $13.36.

Nvidia's shareholders were happier with the deal, pushing the company's stock up 3.4%, or $1.10, to $33.70 in midday trading.

Pacific Growth Equities analyst Satya Chillara applauded the deal and the price, which is actually just $161 million, net of the cash on PortalPlayer's balance sheet.

Chillara says he assumes PortalPlayer might even lose the remaining chunk of its Apple business -- providing the chip for the video iPod -- when Apple introduces its next-generation video iPod.

Even so, he contends that Nvidia is not getting damaged goods.

The real value of the deal is the chip design team that Nvidia gets, Chillara argues. "To assemble a design team like this takes time. That's the way to look at it," he says.

"Anything they can get back from Apple is icing on the cake," says Chillara, whose firm does not have banking relationships with Nvidia or PortalPlayer.

In fact, the combination of Nvidia and PortalPlayer technology could further Nvidia's chances of getting designed into future iPods. PortalPlayer's system-on-a-chip technology is very complementary with Nvidia's graphics chips, say analysts.

Today, the bulk of Nvidia's revenue comes from the graphics chips that enable PCs to display lifelike, three-dimensional graphics at speedy frame-rates. But in the wake of AMD $5.4 billion acquisition of ATI -- the other maker of graphics chips -- Nvidia could have a tough time competing head to head with a deep-pocketed industry giant.

And AMD's recent announcement to incorporate ATI's graphics capabilities directly into its microprocessor is a further threat to Nvidia's business of providing discrete, or add-on, graphics chips for PCs.

That's why there's been so much speculation that Nvidia and Intel would have no choice but to hook up.

Instead, it appears Nvidia is pushing forward with its strategy to spread its graphics chips beyond PCs.

Consumer electronics devices such as cell phones and game consoles represent less than 10% of Nvidia's revenue today. But the company is hoping to expand that business, particularly by focusing on the cell-phone market, where the massive unit volume eclipses that of PCs.

While Nvidia has had some success selling graphics chips to cell-phone makers, it faces a fundamental challenge in that cell phones are highly cost-sensitive products. Adding a specialized graphics chip into a handset adds to a phone maker's total bill of materials.

By integrating the graphics capabilities with the application processor, Nvidia can offer phone makers a single chip with the same functionality but a more affordable price than two separate chips.

It also helps with power consumption, a key consideration in mobile electronic devices.

"You want it to be very cheap, very reliable and very low cost," says Roger Kay, president of market researcher Endpoint Technologies Associates.

Defense also may be motivating Nvidia.

If Nvidia doesn't embrace integration, its nascent cell-phone ambitions could run into the same problem the company is encountering in the PC industry.

"If you look at the graphics guys, their big problem economically has been that over time the discrete graphics business goes away," says Kay. "Whatever you do in discrete, a year or so later can be replicated."

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