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Updated from 8:36 a.m. EDT

Ending months of speculation, graphics chipmaker

ATI Technologies


cinched the deal to sell graphics technology for


(MSFT) - Get Microsoft Corporation Report

next version of the Xbox game console, elbowing out current chip supplier


(NVDA) - Get NVIDIA Corporation Report


On the news today shares of ATI jumped 82 cents or 6.7% to $13.07, while Nvidia gave up 63 cents or 3.8% to $16.15.

Analysts weren't shocked that Nvidia's ties with Microsoft should come to an end. The two have had an often-contentious relationship, resorting to arbitration to settle a dispute over the price of its Xbox chips.

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On its most recent conference call, Nvidia was "definitely guarded in the way they talked about any future relationship with Microsoft," says Brian Foote of Ryan Beck & Co. "The model we had assumed that business was going away."

In the most recent reported quarter, Xbox sales accounted for 19% of Nvidia's $460 million in total revenues.

Meanwhile, ATI over the past year has rolled out new products that have challenged Nvidia's historic dominance of the graphics chip market. "ATI does have some multimedia prowess that Nvidia does not," says Foote, adding that he was nonetheless surprised by the timing of the announcement and win by ATI. His firm has no banking business with either company.

But others say the deal was largely expected -- not because ATI has a technology edge, but because of the history of friction between Nvidia and Microsoft. "Since March when Nvidia had its analyst day, they had been posturing that they weren't interested in Xbox 2," says Pacific Crest analyst Michael McConnell. "There's been speculation for months that it was ATI's business to lose, so I'm personally very surprised by the moves in both stocks." Pacific Crest hasn't done banking for Nvidia or ATI.

Likewise, a note from Pacific Growth Equities says, "Much of the risk that Nvidia would not win the next generation Xbox deal has already been built into its share price." It hasn't done banking for either company.

However, Pacific Growth estimates that the next generation Xbox won't be on store shelves until the 2005 holiday season.

McConnell agrees, saying the new business for ATI "is not going to be impactful to their P&L 'til 2005 or 2006 at the earliest."

ATI has suggested Microsoft will subsidize its development costs and said it will be paid on a royalty basis.

In that vein, ATI is clearly aiming to avoid the troubles that have plagued Nvidia, which in July 2002 was forced to take a charge partly due to an inventory build of Xbox chips. "I think that's why ATI turned to a royalty-based agreement. It precludes any ability for Microsoft to get more aggressive on price," explains McConnell.

Today Microsoft said it made the decision "after reviewing the top graphics technologies in development and determining that ATI's technical vision fits perfectly with the future direction of Xbox."

The news exacerbated a slide in Nvidia shares that began two weeks ago when the company said manufacturing problems with a new chip would leave second-quarter revenue at the low end of guidance. The company

further lowered its earnings outlook when it reported its second quarter last week.

Nvidia's shares have steadily fallen from a high of $25.20 this time last month to their current level of just over $16.