There is a real show going on in the computer graphics industry. Often share prices within a sector will move in unison as product market conditions change, supplies of raw materials tighten and expand, competition increases, and stock market sentiment shifts. Some of the players in the industry will invoke these circumstances to explain their shifts. One look at a chart of three main players in the computer graphics industry, however, shows that differentiation is taking place.
I'll focus on three companies: ATI Technologies(Nasdaq: ATYT) , the major graphics card supplier for original equipment manufactures (OEMs) such as Dell (Nasdaq: DELL) and Gateway (NYSE: GTW) ; 3dfx (Nasdaq: TDFX) , the leading retail vendor for graphics cards; and nVidia (Nasdaq: NVDA) , the upstart chip maker that has taken over the top dog position in the industry, in terms of market capitalization.
ATI has almost quadrupled sales in the last three years, but its stock has not appreciated in two years. It has been cut almost in half this week after it announced that it would lose six or seven cents this quarter rather than earn $0.13 to $0.14 as analysts had expected. Revenues have not dropped, but gross margins will fall to about 21% this quarter from 33% last quarter. That appears to have been caused by tightening memory and silicon supplies, but more especially from cutting prices to major OEM customers. Its retail products have faced pressure from nVidia and Intel (Nasdaq: INTC) .
3dfx seems determined to shoot itself in the foot at every turn. The company used to have the most innovative technology in the industry. Since it acquired STB Systems last May and began to make its own graphics cards (rather than just the processing chip), however, its margins have dropped right into the toilet. Even though its revenue has more than doubled, its cash is washing away in a swirl of high production costs and SG&A (sales, general and administrative) expenses.
The company recently made a bold move to try to secure its future. It agreed to acquire GigaPixel Corporation for 15.6 million shares, or about 38% of the company. GigaPixel is an intellectual property company that has designed a 3-D core technology that has the promise of high performance with low memory and power requirements. If its technology plays out, it will be ideal for the "consumer appliances" market, such as cell phones and handheld computers. That may prove a wise strategic move in the future, but the acquisition will not add one dime to revenue until fiscal 2002, over a year from now. Meanwhile, it will have huge in-process R&D costs to amortize on a non-tax-deductible basis.
What's more, 3dfx announced today that its latest generation Voodoo 5 card will not be available tomorrow as promised. The release date had already been pushed back from late April to late May. The really amazing thing about it is that the company had numerous press releases associated with the product launch this week. Management said only two days ago in its conference call that Voodoo 5 would come out this week, and that the company had implemented production schedule visibility in order to overcome problems with product delays that it had experienced in the past. Can you believe it? Why should anyone believe these folks anymore?
Meanwhile, while 3dfx has not executed, nVidia has leapt into the breach. Its products have taken over the high-end business, capturing four of the top five OEM contracts for upgraded PCs. Furthermore, the company snatched the contract to design the 3-D graphics for Microsoft's (Nasdaq: MSFT) x-box, its answer to Sony's Playstation game console. Who did nVidia snatch this contract away from? GigaPixel.
Take a look at the gross margins for these three companies over the last four years:
The lesson here, I think, is not to become a commodity manufacturer. ATI always was, but it didn't used to have such pricing pressures on it. Now that those pressures have picked up, its margins will continue to shrivel away. 3dfx was a premium product, but it went into manufacturing and became mired in the commodity side of the business, so that it failed to execute on its high-end products. nVidia has taken the high road, stayed light, and focused on improving its technology -- and its shareholders have been rewarded.
When you're investing, look for the company in the industry that stands out. In computer graphics, nVidia has become that company.
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