NVIDIA forgot that crypto crashes are bad for business

Those who fail to learn from history are doomed to repeat it. Increasing demand for graphics cards from cryptocurrency miners is not a new phenomenon for NVIDIA (NVDA -0.76%). Nor is the inevitable crash requested when crypto bubbles burst.

NVIDIA’s second quarter results were about as bad as expected. The company warned earlier this month that it would come in well below its previous outlook as demand for gaming graphics cards weakened. Inventory levels at channel partners had been inflated, leading to a significant drop in purchases. NVIDIA’s gaming revenue fell 44% from the previous quarter.

There were several factors driving lower gaming demand, but the collapse of cryptocurrency prices may be the biggest. NVIDIA’s graphics cards are used to do the number crunching needed to mine various cryptocurrencies, and as the return on investment for miners disappears as prices fall, so will the demand for NVIDIA’s products.

Painfully predictable

The collapse in NVIDIA’s gaming revenue shouldn’t come as a surprise to anyone who has followed the company for at least a few years. The exact same thing happened towards the end of NVIDIA’s fiscal year 2019. Demand for graphics cards had increased as cryptocurrency miners took advantage of skyrocketing prices, but when the bubble popped, all the demand disappeared.

NVIDIA’s gaming revenue fell 46% in the fourth quarter of fiscal 2019 compared to the previous quarter, about the same percentage decline as this time. It took until the beginning of the pandemic boom for NVIDIA’s gaming revenue to fully recover.

Data source: NVIDIA. Chart by author.

The problem NVIDIA faces is that it doesn’t have a good idea of ​​how much gaming demand is actually tied to cryptocurrency. Cryptocurrency miners buy graphics cards through the same channels as gamers, so the demand picture gets messy. Still, a fair guess this time would have been “a lot,” given the intensity of the cryptocurrency frenzy during the pandemic.

Cryptocurrency markets started imploding earlier this year, so a big drop in demand for graphics cards shouldn’t have blindsided NVIDIA. And yet it did. Again. NVIDIA let channel inventories balloon, and now it’s paying the price. The company uses discounts to move inventory, and it took $1.34 billion in costs related to current inventory and purchase commitments.

This time could be much worse than last time because a crypto crash is not the only factor. On top of decimated demand from cryptocurrency miners, the PC market is in shambles. Global PC shipments fell 12.6% year over year in the second quarter, the biggest decline in nine years. Other chip companies, i.a Intel and Microns, is also experiencing demand problems. Economic uncertainty, soaring inflation, war in Europe, shutdowns in China, and at least some demand that has been highlighted during the pandemic are all contributing to the current predicament.

A silver lining

The good news for NVIDIA is that the data center business is still doing well. Data center revenue held steady in the second quarter, rising slightly from the first quarter as demand from cloud customers remained strong. The data center segment is now NVIDIA’s largest by far, and it’s much bigger than it was the last time the company saw game sales decline. This will help mitigate the effect as NVIDIA works to reduce the channel inventory.

The big question, however, is whether demand for data centers will remain strong. NVIDIA believes that demand for GPUs on cloud computing platforms still outstrips supply, but as we’ve seen in the gaming industry, shortages can quickly turn into overabundance. If demand starts to slow for cloud computing services, it will eventually lead to lower demand for NVIDIA’s data center products.

NVIDIA’s second quarter was a disaster, and its third-quarter guidance calls for more pain. The company expects total revenue to fall another 12% sequentially, with a large decline in gaming revenue partially offset by growth in data center revenue. It will take at least a quarter of an hour before the stock situation is rectified, and perhaps longer if the demand for gaming graphics cards weakens further.

Until supply and demand fall back into balance, expect lower revenues and much lower profits from NVIDIA.