Recently, we wrote about the 2023 outlook and trends for overall IT spending and Big Tech capex. In summary, both are expected to be flat to slightly down. Here is what we said on the premium site:

“Overall, Big Tech has forecasted capex to be flat to slightly down y/y. However, an important theme was a shift toward higher ROI capex such as technical infrastructure and reduction in lower ROI capex, such as office facilities. After embarking on an aggressive capex program in 2021 and 2022, Big Tech has taken a pause to reassess their cost base and to reprioritize capex in light of the current macro environment.  

Put another way, the size of the capex pie isn’t expected to grow in 2023 compared to 2022, but the slice spent on technical infrastructure (i.e. Cloud and AI), will grow at the expense of labor, office facilities etc. A change in capex mix that we believe is supportive in the medium-term of NVDA and AMD.”

There is a collective shift from higher return capex at the expense of lower return capex. From an investing perspective, the key takeaway is to identify markets where demand continues to be driven by secular demand and avoid those facing cyclical demand headwinds. For example, there is continued demand for Hyperscale Data Centers and AI related investments while the memory sector is grappling with weaker consumer related demand exacerbated by excess inventory.

The key theme from Big Tech Q422 commentary was the strategic importance and focus on AI investments to enhance their competitive positioning. Here at I/O Fund, we have continually looked for opportunities to invest in this secular theme and identify companies with strong market positions and competitive product offerings led by focused management teams with an identifiable investment catalyst.

With that in mind, we thought it would be worthwhile for our readers to revisit our positive investment thesis on Nvidia. It’s one of our largest core positions.  

Simply put, as Big Tech continues to build out hyperscale scale data centers and AI based technology, they will require specialized semiconductor chips – AI accelerator chips – to provide the necessary computing power required. At the moment, the AI chip market is a duopoly with Nvidia and AMD. However, Nvidia’s position is much larger than AMD and a “better” GPU. So as Big Tech continues these AI related investments, Nvidia is the first place Big Tech will go to buy them – namely Nvidia’s H100 GPU chip. (Note: Later in the year, AMD will release a GPU to rival Nvidia and we will cover this for you including correct timing as the I/O Fund has predicted every twist and turn AMD has taken in its enormous comeback against Intel – for now, Nvidia has a near monopoly on GPUs for AI acceleration.)

Given the market dynamics outlined above, here is how Nvidia’s CEO Jensen Huang described the AI market opportunity in response to a question by Vivek Arya around the overall capex outlook. Huang’s comments focused on Nvidia driving growth from AI acceleration, rather than general purpose computing. This implies that capex can be flat while Nvidia will be serving the most valuable piece in the stack. AI acceleration, according to the CEO, will not be flat or down. A similarly positive tone echoed by Big Tech.

“And then, Jensen, the question for you. A lot of concerns about large hyperscalers cutting their spending and pointing to a slowdown. So if, let’s say, U.S. cloud capex is flat or slightly down next year, do you think your business can still grow in the data center and why?”

“Vivek, our data center business is indexed to two fundamental dynamics. The first has to do with general purpose computing no longer scaling. And so, acceleration is necessary to achieve the necessary level of cost efficiency scale and energy efficiency scale, so that we can continue to increase workloads while saving money and saving power. Accelerated computing is recognized generally as the path forward as general purpose computing slows. The second dynamic is AI. And we’re seeing surging demand in some very important sectors of AIs and important breakthroughs in AI.”

“And so, you could see that our company is indexed to two things, both of which are more important than ever, which is power efficiency, cost efficiency and then, of course, productivity. And these things are more important than ever. And my expectation is that we’re seeing all the strong demand and surging demand for AI and for these reasons.”

In light of Big Tech’s focus on higher return capex, Jenson’s comment was very informative on how Nvidia stands to benefit from Big Tech’s change in capex mix. As Big Tech continues to invest in AI infrastructure, they will need chips that provide the highest computing power and productivity with the most efficiency. At the moment, Nvidia’s H100 is the best AI chip to fulfill these requirements.

How will Nvidia benefit?

The key investment catalyst for Nvidia is the adoption and implementation of the H100 GPU by its customers. 

So without getting too technical, here is an outline of the medium and long term investment thesis.

• Nvidia’s March 2022 introduction of the Hopper H100 GPU with 80bn transistors – 48% more than Nvidia’s A100 with 54 billion – is a game-changer. Simply put, more transistors means faster speeds and increased computing power
• H100 is 6x faster and its performance is 2-3x better than Nvidia’s prior A100 GPU. H100 has 50% more memory and interface bandwidths. Higher bandwidth will create more demand for their software in the future. The ability for the GPU to connect directly to the network will avoid CPU bottlenecks
• The A100 has led company gains since Q22020, now the H100 will lead the next leg of growth. In the most recent Q322 investor call, management indicated H100 will quickly overtake A100
• H100 will power AI based and high performance computing systems. There are four layers to Nvidia’s full stack accelerated computing: hardware (AI accelerators), system software, platform software and applications. Overtime, this position will enable Nvidia to monetize more of the software stack due to vendor lock-in effects. In the Q322 call, management indicated this is effectively starting “now” at the enterprise level
• Over the long term, Nvidia will combine its hardware offering with software component primarily targeting the auto industry  
• Nvidia is taking a play out of Apple’s playbook that helped it’S market cap grow to 2 trillion.  Nvidia’s goal is to leverage their dominate position in hardware to capture the lion’s share of the software. That’s exactly what Apple did with mobile devices and software related apps and services.
• Most importantly, and not covered at the level it deserves (or at all by the media), Nvidia is going to be an AI software leader. This marks a monumental shift for a company that is traditionally hardware-only. We have written about this long-term opportunity for our premium subscribers here.
• This transformation has not yet been appreciated by Wall Street nor reflected in the stock price. Nvidia’s 2022 Investors presentation identified a $300B Market opportunity.

To use a baseball analogy, Nvidia has just begun the first inning of this transformative process.

Upcoming catalysts

Nvidia is up about 52% ytd and is due to report earnings on 2/22/23. We will be looking for continued signs that gaming has bottomed, adoption trends of H100 and whether management expects a 2H23 bounce similar to what their peers guided for. We’ll touch upon these topics after the company report earnings.

It is important to note that Gaming is still an important business for Nvidia for its earnings contribution. Gaming’s exposure to consumer-related hardware products like PCs and gaming consoles has historically been the source of cyclical growth concerns and stock volatility around earnings releases. Future growth will not come from gaming, where Nvidia is already a mature, market leader. Nvidia’s 2022 Investor’s Presentation provided future estimates which detail how consumer exposure should become less of a concern to investors. Overtime, Nvidia will transform from a gaming to an AI software focused company.

There were signs that gaming weakness had bottomed in Q322 and the market may still be focused on that in Q422. Our main focus will be on H100. If the nascent signs of H100 adoption seen in Q3 continue to grow, this will increase our conviction on Nvidia and it will begin to get attention from Wall Street it deserves as 2023 unfolds.  

Why 2023 May be a Strong Year for Nvidia:

Big Tech is not immune to the weaker macroeconomy nor consumer. This has been evident in their earnings releases. For Big Tech’s next capex act, their commentary focused on shifting capex to higher ROI investments with a focus on cost efficiency. These comments have increased our conviction that investments in AI are a key strategic priority and will continue.

From an investing perspective, it supports our investment thesis in Nvidia and AMD. Nvidia’s new H100 GPU chip has positioned it to benefit from the buildout in AI related and hyperscale data center infrastructure. Critically, given their dominant market position in AI chips, this will enable Nvidia to then monetize and gain a greater share in the software stack. In addition, AMD plans to commercially release its MI300 GPU this year.

Per the most recent AMD earnings call:

“MI300 will be the industry's first data center chip that combines a CPU, GPU and memory into a single integrated design, delivering 8x more performance and 5x better efficiency for HPC and AI workloads, compared to our MI250 accelerator currently powering the world's fastest supercomputer. MI300 is on track to begin sampling to lead customers later this quarter and launch in the second half of 2023.”

In the most recent earnings report, Nvidia management commented that the H100 adoption rate and software monetization at the enterprise level is happening faster than expected.

This month, keep an eye out for technical analysis from Knox Ridley, where he will go over how he plans to manage the Nvidia position in the portfolio. On a side note, he nailed Nvidia’s bottom with an entry of $108.51 on October 13th with a real-time trade alert. You will get his very best technical analysis on a leading position in the portfolio that the analyst team believes will fundamentally stand apart this year. Stay tuned for this!

In addition, Essentials Members will receive an earnings update on Nvidia following the earnings report to  better gauge 2023 timing and entries.

We can’t urge you enough to take your time with each stock as too many research services pump out content for content’s sake. We are a real, live portfolio that is audited, and we show you the exact process we follow to make smart investing decisions. For the February stock pick, we want to drill down deep so our readers get top notch coverage of one of our highest conviction holdings. Don’t be surprised if you get more Nvidia coverage this month rather than moving on quickly to another name. Institutions take months to research a stock, and this level of depth is exactly what we bring to retail investors.

Have a wonderful weekend and we will see you next week!