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Analysis: Nvidia's sales will get a boost with Mellanox acquisition

Nvidia Corp.'s proposed acquisition of Mellanox Technologies Ltd. could boost the company's sales as the graphics chipmaker expands into the higher-margin enterprise market, analysts said.

With Mellanox, Nvidia has a goal to sell more chips and components in data centers, which are priced higher than typical consumer products and deliver higher margins. Nvidia's earnings tumbled in the fourth quarter of fiscal 2019, partly due to weak demand for its consumer products in countries like China.

While Nvidia's data-center products are priced higher, they also are more expensive to make.

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The acquisition of Mellanox for $6.9 billion is a "financially compelling transaction" for Nvidia, company CFO Colette Kress said on a recent call discussing the deal, which is subject to regulatory and shareholder approval.

"The deal is expected to be immediately accretive to non-GAAP gross margins, non-GAAP earnings per share and free cash flow, even before assuming any cost or revenue synergies," Kress said.

The future financial impact of Mellanox on Nvidia's financials will be discussed once the deal is closed, Kress said.

For fiscal 2021, the financial year after the deal closes, consensus estimates compiled by S&P Global Market Intelligence are projecting net income of about $3.84 billion, a significant jump from the $2.86 billion profit projected for fiscal 2020. Analysts are expecting Nvidia revenue in fiscal 2021 to be $13.80 billion, growing from $11.21 billion in revenue in fiscal 2020. Mellanox's revenue totaled $1.09 billion in fiscal 2018.

The deal will be accretive to Nvidia's non-GAAP gross margins, earnings per share and free cash flow, Angelo Zino, a technology-focused equity analyst at CFRA Equity Research, wrote in a research report.

"We estimate at least $0.60 per share accretion to our FY 21 estimate," Zino wrote.

Mellanox provides greater diversification away from the volatile gaming business, and it expands Nvidia's networking and storage presence to address a $60 billion-plus addressable data center market, Zino wrote.

A richer sales mix and operating leverage from a high level of platform adoption will enable Nvidia to sustain profit margins near higher recent levels, analysts for Fitch Ratings wrote in a research note.

"Nvidia will benefit from strong positions in markets with long-term secular demand attributes, including gaming, [data center] and automotive," the Fitch analysts wrote.

However, gross profit margins could degrade over time with increased competition in deep learning and autonomous driving, according to the analysts.

On Feb. 14, Nvidia projected revenue for its fiscal first quarter of 2020 — ending April 2019 — of around $2.2 billion, a drop from $3.2 billion in revenue in the first fiscal quarter of 2019. The company expects a better half as the company chases growing markets, including artificial intelligence and automotive.

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