Fitch Rates NVIDIA's 5- and 10-Year Senior Notes Offering 'BBB+'
NVIDIA plans to use net proceeds to prefund the repayment of the $1.5 billion principal amount of convertible notes, which are deep in-the-money, and for general corporate purposes, including shareholder returns. The senior notes will be senior unsecured and rank pari passu with NVIDIA's senior unsecured debt, including the convertible notes and RCF. The senior notes include customary investment grade covenants, including limitations on liens, and provide certain Change of Control protection.
KEY RATING DRIVERS
Secular Growth Drivers: Fitch expects secular demand will drive solid revenue growth across NVIDIA's specialized platforms over the intermediate term, particularly within gaming and data center markets. Richer gaming experiences, increased broadband penetration in developing markets and eSports expansion in conjunction with NVIDIA's significant installed base will drive solid demand in the company's largest end market. Robust hyperscale adoption of deep learning platforms and virtualization should drive strong data center platform growth, albeit from a smaller base. Strong positions in advanced infotainment within automotive and increasing adoption of virtual reality across a variety of verticals also will drive growth.
Higher Profitability and Margins: Fitch expects structurally higher profitability and profit margin expansion from a richer sales mix and operating leverage. Fitch believes NVIDIA's focus on leveraging its core graphics platforms, combining algorithms and graphics processing units (GPU), across markets with faster growth should drive higher profit growth with modest incremental research and development (R&D) investments.
Specialized platforms sales represent a growing portion of overall revenues with 87% for the last-12-months (LTM) ended July 31, 2016, versus 84% for fiscal 2016 and 72% for fiscal 2015. Fitch expects operating EBITDA margin will range in the mid - to high-20s through the intermediate term versus the low - to mid-20s historically.
Solid FCF Through the Cycle: Fitch expects $750 million to $1 billion of annual FCF, driven by solid top line growth and strong profitability. NVIDIA's platform development focus and outsourced manufacturing reduces investment intensity, and also supports cash flow. Fitch expects FCF margins at the upper end of a 10% - 15% range through the intermediate term with additional upside from lower than anticipated cash taxes.
Significant Off Shore Cash Build: Fitch expects the significant majority of NVIDIA's pre-dividend free cash flow (FCF) will be offshore, adding to the company's already sizeable offshore cash position of $4.9 billion at July 31, 2016 (the significant majority of which is located outside the U. S.). Fitch believes NVIDIA's pre-dividend FCF mix roughly approximates that of its revenue, roughly 85% of which is outside the U. S. As a result, a continuation of current shareholder return levels may require repatriation of offshore cash or incremental borrowing.
Significant Technology Risk: Fitch expects significant technology risk over time, given increasingly challenging process technology transitions, intensifying competitive landscape and rapid industry innovation. Fitch believes investment requirements could intensify, resulting in profit or FCF margin contraction. Competing technologies may also set standards in emerging markets, potentially constraining NVIDIA's growth prospects.
Concentration to Gaming Markets: Fitch expects NVIDIA will remain concentrated to gaming markets through the intermediate term, given strong gaming demand. Gaming was 57% for the LTM ended July 31, 2016 and could approach 60% through the forecast period. Nonetheless, given secular growth drivers from richer experiences, expanding broadband access, eSports and virtual reality, Fitch expects gaming will support consistent and solid operating performance until non-gaming markets gain greater scale.
Fitch's key assumptions within the rating case for NVIDIA include:
--Solid revenue growth through the intermediate term, driven by robust adoption of the company's GPU platforms within strategic markets, including hyper-growth from adoption of deep learning in the data center, gaming growth moderating through the forecast period from 20% growth in fiscal 2017, low - to mid-single digit growth in professional virtualization and mid-teens growth in automotive following hyper-growth in fiscal 2017.
--Operating EBITDA margins remain in the mid - to high-20s through the intermediate term, driven by solid revenue growth and expectations for improving yields at the company's current process geometry now that the company has achieved scale, offset by ongoing development investments.
--Annual pre-dividend FCF of $1 billion to $1.25 billion, driven by solid profitability growth and low capital intensity, with a significant majority of pre-dividend FCF generated offshore.
--Continuation of heightened annual shareholder returns, including 10% dividend growth and $500 million of gross share repurchases.
--NVIDIA could borrow to fund domestic cash shortfalls through the intermediate term.
A negative rating action could result from:
--Expectations that annual FCF will decline below $500 million, from reduced profit margins or higher investment intensity related to development or process node transitions; or
--Expectations for less robust top line growth from lower adoption of NVIDIA's GPU platforms across non-gaming markets, signaling reduced technology leadership; or
--Total leverage sustained above 2x from higher than expected debt issuance to support shareholder returns.
Fitch believes positive rating actions are unlikely over the intermediate term, in the absence of:
--Significantly greater revenue and FCF scale (double current levels), supporting technology leadership and customer adoption; and
--Reduced exposure to gaming from significant and balanced growth in non-gaming markets.
Fitch believes liquidity will remain sufficient through the intermediate term. Liquidity at July 31, 2016 was supported by $5 billion of cash, cash equivalents and marketable securities, the significant majority of which was located outside the U. S. NVIDIA will bolster liquidity upon completing the arrangement of and entering into an undrawn RCF. Fitch's expectation for $750 million to $1 billion of annual FCF through the intermediate term also supports liquidity. Total debt at July 31, 2016 was $1.5 billion and consisted primarily of $1.5 billion of senior unsecured convertible notes due December 2018.
FULL LIST OF RATING ACTIONS
Fitch assigns the following ratings:
--Senior unsecured notes 'BBB+';
--Senior unsecured RCF 'BBB+'.
Fitch currently rates NVIDIA Corp. as follows:
--Long-Term Issuer Default Rating 'BBB+';
--Senior unsecured convertible debt 'BBB+'.