The Rise of Nvidia and the Challenges for Asian Chipmakers
The Phenomenal Success of Nvidia’s Stock Price
Nvidia’s stock price has experienced a remarkable surge, more than tripling over the course of this year. One of the primary driving forces behind this unprecedented rally is the widespread anticipation of a surge in demand for artificial intelligence (AI) chips, which has propelled Nvidia’s market capitalization to over $1 trillion.
The Struggles of Asian Chipmakers
However, amidst Nvidia’s phenomenal success, Asian chipmakers – the companies responsible for manufacturing all of Nvidia’s chips – have reported their lowest earnings in years. This raises significant concerns and serves as a reality check for investors who may believe that Nvidia’s outstanding market performance will continue unabated.
Risks in the Global Advanced Chip Industry
The challenges faced by the global advanced chip industry are crucial to understanding the context surrounding Nvidia’s current situation. These risks should be carefully considered by investors who are captivated by Nvidia’s record-breaking rally. The reality is that Nvidia’s advanced chips play a pivotal role in powering the next generation of AI-related technologies, such as ChatGPT and autonomous driving. These graphics processing units (GPUs) are substantially faster than generic chips when utilized in artificial intelligence models and represent the majority of Nvidia’s sales.
Increasing Computing Power and Ample Room for Growth
Companies are ramping up their computing power by utilizing more Nvidia chips in their data centers. This trend has only just begun, indicating that there is still significant room for growth in this regard. Consequently, Nvidia anticipates revenue of $11 billion for the current quarter, a staggering two-thirds increase from the previous year.
The Role of Taiwan Semiconductor Manufacturing Company (TSMC) and Samsung
Manufacturing Nvidia’s high-end chips necessitates the utilization of the most advanced chip manufacturing technology currently available. The responsibility for producing all of the world’s advanced chips, which utilize a manufacturing process of 5 nanometers or less, falls on the shoulders of Taiwan Semiconductor Manufacturing Company (TSMC) and Samsung. Given the substantial interdependence between Nvidia and TSMC, as well as Samsung’s role in manufacturing chips critical to running the servers required for generative AI, investors interested in Nvidia should also consider investing in TSMC and Samsung. Moreover, the relatively cheap valuations of these companies make them even more appealing.
Paltry Share Price Gains and Buffet’s Exit
Despite these factors, the share price gains of TSMC and Samsung pale in comparison to Nvidia’s astronomical growth. Even prominent investors such as Warren Buffett have divested themselves of TSMC’s stock, completely exiting their positions in the first quarter. Surprisingly, the record-breaking demand for AI chips has failed to offset the weakness in earnings experienced by the world’s two largest advanced chipmakers, with Samsung’s second-quarter earnings plummeting by 96% – its lowest in 14 years – and TSMC’s net income falling by 23%, marking its first quarterly decline in four years.
AI’s Current Small Industry Share
Part of the reason behind this discrepancy is the fact that AI is still a relatively small industry. Analysts estimate that less than 5% of global chip demand stems from AI-related uses. At TSMC, nearly 90% of sales are derived from consumer electronics, smartphones, PCs, and automobiles.
The Impact of Delays and Inventory Processing
Furthermore, even slight delays can significantly affect the chip industry. Chip orders are typically placed well in advance, often once a year. During the past couple of years, chips were in short supply, leading companies to hoard inventories. Now, as they work through that inventory, orders have reduced in size.
The Limits of Chipmaking
A significant reason why shareholders of Asian chipmakers do not share the same fervor as Nvidia’s investors is their familiarity with the inherent limitations of chip manufacturing. While the unprecedented demand for AI chips may seem exciting, the reality is that chip manufacturing is capital-intensive. Constructing a chip manufacturing plant costs over $20 billion, and continuous upgrades are necessary due to the rapid advancements in chip technology. Additionally, low earnings mean that there are fewer resources available for capacity expansion.
Comparable Gross Margins and Future Prospects
At present, both Nvidia and TSMC boast comparable gross margins of around 60%. However, Nvidia holds an edge in terms of its value proposition. Its software and intellectual property provide added value and allow for the avoidance of high costs associated with chip manufacturing. Nevertheless, this also means that Nvidia’s growth potential is limited by its capacity. AI chips are projected to remain a relatively small part of chip makers’ sales for years to come. Furthermore, Nvidia needs to share chipmaker resources with key customers like Apple. For example, the launch of a new iPhone necessitates orders for hundreds of millions of high-end chips.
Additional Risks and Considerations
While the current oversupply of chips may obscure future risks, it is crucial to acknowledge the potential disruption caused by shortages of chip engineers, as well as rising military tensions between Taiwan and China. Additionally, the gaming and cryptocurrency sectors, which heavily rely on Nvidia chips, present further competition for resources.
Conclusion
In the long run, Nvidia stands to be the biggest beneficiary of the surge in AI. Its position as a market leader, combined with its software and intellectual property advantages, will likely allow the company to maintain its prominence. However, it is essential for investors to consider the risk of supply constraints and temper their expectations regarding the speed at which the AI chip market can grow.
Summary
Nvidia’s stock price has experienced significant growth, driven by expectations of increased demand for AI chips. However, Asian chipmakers, responsible for manufacturing Nvidia’s chips, have reported their lowest earnings in years, highlighting potential challenges in the global advanced chip industry. While Nvidia’s advanced chips are crucial for AI-related technologies, the industry’s overall share of global chip demand remains relatively small. Delays and inventory processing also impact chipmakers, reducing the fervor surrounding their stock prices. Moreover, chip manufacturing is capital-intensive, with limited earnings hindering capacity expansion. Despite comparable gross margins, Nvidia’s growth potential is constrained by its capacity. Additional risks include competition from the gaming and cryptocurrency sectors, shortages of chip engineers, and geopolitical tensions. Despite these challenges, Nvidia remains well-positioned in the AI surge, but investors need to consider the risk of supply constraints and the pace at which the market can grow.
Contact: june.yoon@ft.com
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Nvidia’s stock price has more than tripled this year. Expectations of unprecedented demand for AI chips have propelled the US chip designer to a market cap of over $1 trillion.
So why did Asian chipmakers, the companies that make all of Nvidia’s chips, report the lowest earnings in years?
The risks facing the global advanced chip industry should provide an important reality check for investors who believe Nvidia’s record-breaking rally can continue.
Nvidia’s advanced chips are essential to powering the next generation of AI-related technologies, from ChatGPT to autonomous driving. These chips, or graphics processing units, are thousands of times faster than generic chips when applied in artificial intelligence models and account for the majority of its sales.
Companies are increasing computing power by increasing the number of Nvidia chips they use in data centers. This trend is just getting started, which means there is ample room for growth. That explains why Nvidia expects revenue of $11 billion for the current quarter, up nearly two-thirds from a year earlier.
Making Nvidia’s high-end chips requires the most advanced chip manufacturing technology available. Together, Taiwan Semiconductor Manufacturing Company and Samsung account for 100 percent of the world’s supply of advanced chips, which use a manufacturing process of 5 nanometers or less.
The fortunes of TSMC, Samsung and Nvidia should therefore be inextricably intertwined. All of Nvidia’s AI chips are made by TSMC. Samsung makes chips critical to running the servers needed for generative AI.
This suggests that investors buying Nvidia should invest in TSMC and Samsung with equal enthusiasm. Relatively cheap valuations should add further appeal.
Yet their share price gains look paltry next to Nvidia’s. Warren Buffett was one of the most high-profile investors to dump TSMC’s stock this year, exiting completely in the first quarter. And record demand for AI chips has done little to offset the weakness in earnings of the world’s two largest advanced chipmakers. Samsung’s second-quarter earnings fell 96%, the lowest in 14 years. TSMC’s net income fell 23%, its first quarterly decline in four years.
Part of the reason is that AI is still a small industry: analysts estimate that less than 5% of global chip demand comes from AI-related uses. At TSMC, nearly 90% of sales come from consumer electronics, smartphones, PCs and automobiles.
Even delays make a difference. Chip orders are placed well in advance, typically once a year. When chips were in short supply for the past couple of years, companies hoarded them. Now, as they process that inventory, orders have shrunk.
But a bigger reason Asian chipmaker shareholders don’t share the same fervor as Nvidia’s investors is that they’re all too familiar with the limits of chipmaking.
The unprecedented demand is much less exciting when production is limited. Chip manufacturing is capital intensive. It costs more than $20 billion to build a chip manufacturing plant. Parts must be continually upgraded due to rapid change in chip technology, and low earnings mean there is less money for capacity expansion.
For now, Nvidia and TSMC’s gross margins are comparable at around 60%. In the future, Nvidia will have the edge. Its software and intellectual property add value and avoid the high costs of chip makers.
But on the flip side, this means that Nvidia’s growth is also limited by capacity. AI chips will remain a small part of chip makers’ sales for years. Nvidia needs to share chipmaker resources with key customers like Apple. For example, the launch of a new iPhone means orders for hundreds of millions of high-end chips.
The current oversupply of chips glossed over future risks. Additionally, the gaming and cryptocurrency sectors, where Nvidia chips are equally critical, compete for their offering. The disruption risks due to shortages of chip engineers and rising military tensions between Taiwan and China should also be considered.
As the machine learning models used for tasks such as generative AI grow in complexity, the growing computational power requirements can only be met by more chips. In the long run, Nvidia is positioned to be the biggest beneficiary of the AI surge. However, for now, investors need to price in both the risk of supply constraints and expectations about how quickly the market can grow.
june.yoon@ft.com
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