Everybody Chill! The Nvidia-Microsoft Pact Is Actually 11 Years Old.
Information Week is reporting a peculiar story about a deal between the graphics chip maker Nvidia and software giant Microsoft that effectively gives Redmond the right to match any offer for a stake worth 30 percent or more of Nvidia’s outstanding shares by any other company.
In light of recent events, in particular Nvidia agreeing to make ARM-based chips that will be used in forthcoming notebooks and tablet devices and thus setting up a new competitive dynamic with chip giant Intel, the revelation takes on new significance. Note my use of the word “new,” which this arrangement is not. (Update: An Nvidia spokesman tells me the arrangement between Nvidia and Microsoft has been disclosed every quarterly filing for more than a decade.)
Listed in the “Risk Factors” section–“buried deep” as Information Week puts it–of Nvidia’s most recent 10-K filing with the U.S. Securities and Exchange Commission is the following text:
On March 5, 2000, we entered into an agreement with Microsoft in which we agreed to develop and sell graphics chips and to license certain technology to Microsoft and its licensees for use in the Xbox. Under the agreement, if an individual or corporation makes an offer to purchase shares equal to or greater than 30% of the outstanding shares of our common stock, Microsoft may have first and last rights of refusal to purchase the stock. The Microsoft provision and the other factors listed above could also delay or prevent a change in control of NVIDIA.
When I first read it, I thought the date was a typo. Surely this deal was struck in 2011? Then I started looking back through filings from prior years. I went all the way back to the year 2000, when Nvidia filed a 10-K405, a variant of the 10-K that before 2003 indicated that the filing company hadn’t reported its insider trading activity in a timely manner. Here’s the relevant text from that year:
On March 5, 2000, the Company entered into an agreement with Microsoft in which the Company agreed to develop and sell graphics chips and to license certain technology to Microsoft and its licensees for use in a product under development by Microsoft. The agreement provides that in April 2000, Microsoft will pay the Company $200 million as an advance against graphics chip purchases and for licensing the Company’s technology. Microsoft may terminate the agreement at any time and if termination occurs prior to offset in full of the advance payments, the Company would be required to return to Microsoft up to $100 million of the prepayment and to convert the remainder into preferred stock of the Company at a 30% premium to the 30-day average trading price of the common stock.
So for whatever reason Information Week has decided to call attention to an 11-year-old arrangement. If its news to you, you probably don’t have any reason to read Nvidia’s SEC filings. Having been disclosed something like 55 times (five times a year give or take over 11 years), it’s obviously not news to anyone who routinely does read them, such as analysts, investors and pretty much anyone who pays reasonably close attention to Nvidia.
What the arrangement does explain is this, which may be a revelation–if you’re just tuning in to the Nvidia story: Why it hasn’t ever been acquired, or even come close. Nvidia has over the years been the target of repeated takeover speculation, occasionally with Apple or Intel named as the possible acquirer. Robert Cringely wrote just such a column in 2009, arguing that Intel would step up. To Information Week’s credit, Cringely seemed unaware of the role that Microsoft would necessarily play in such an attempted transaction. Speculation about Nvidia being targeted for a buyout has tended to ebb and flow with Nvidia’s stock price since 2006 when its main rival, ATI Technologies, was taken by Advanced Micro Devices.
The arrangement states that if a third party offers enough cash for a stake in Nvidia that amounts to at least 30 percent of the equity, Microsoft has the right to match that offer before Nvidia accepts it. And it is still in force. But it’s helpful to consider it against the backdrop of what was going on in 2000. Permit me, then, to revisit some ancient history.
In 2000, Microsoft put up $200 million to help Nvidia, then a young company with only $375 million in annual sales, to design a chip for what would eventually be called the XBox. In the six days after the deal was concluded, Nvidia’s share price nearly tripled, while trading volume in the shares surged by a factor of six. In fact, it was such a big deal for the company that an Nvidia employee got in trouble with the SEC for insider trading.
Nvidia was a participant in a graphics chip business during a period that proved extremely volatile. Companies that had led the segment were going out of business or splitting into pieces. Later in 2000, Nvidia would go on to buy out the assets of its bankrupt rival 3Dfx Interactive. Another graphics outfit, S3, broke up into pieces, one portion of which wound up in the hands of VIA Technologies, the Taiwanese chipmaker, while the other pieces became SonicBlue, a consumer electronics concern that before the age of the iPod was notable for acquiring the maker of the original Rio MP3 player. (I did say it was ancient history, didn’t I?)
Anyhow, Microsoft needed a hedge in case Nvidia failed to deliver the needed chip. As you can read above, the original terms called for Nvidia to pay back $100 million in cash, and the rest in equity, in the event that Nvidia failed to meet its commitment. Once it delivered and became a strategically important supplier, the deal terms changed to allow Microsoft the right of first refusal in the event that Nvidia was approached for an acquisition, or an investment stake of 30 percent or more.
Also at the time, it was still being prosecuted by the federal government for alleged violations of antitrust laws, making an attempt at an outright acquisition on Nvidia out of the question. In making a big bet on Nvidia’s technology, Microsoft would have wanted to ensure that the young company wasn’t vulnerable to an easy takeover by someone, say Sony, who might have endangered Microsoft’s supply of a critical component.
Fast forward to today. Before its $8.5 billion deal to acquire Skype, Microsoft had more than $50 billion in combined cash and short-term investments, and could, at least on paper, put up the $15 billion or so that would be required to acquire Nvidia if it came to that, which it won’t.
Why not? First off, any such deal wouldn’t likely pass muster with antitrust regulators. The U.S. Department of Justice and Federal Trade Commission might sign off on it, but does anyone believe that the hypersensitive European Commission would be so willing? With Nvidia mounting a reasonable challenge to Intel, it would seem to tighten an integration of hardware and software in one place (Apple notwithstanding). This is, after all, the same European Commission that set a record with the $1.45 billion fine it dealt Intel in 2009 just for playing super-tough against AMD. Forget it.
And if that’s not reason enough to doubt a potential takeover of Nividia by Microsoft, or anyone else for that matter, look at Nividia’s share price. The time for an acquirer to move on Nvidia was a little less than a year ago, when its shares were trading at less than $10 and the company had a market capitalization of less than $6 billion. Now trading at a valuation north of $11 billion, reporting decent profits and holding about $2.7 billion in cash as of May 1, Nvidia is doing just fine on its own. Though CEO Jen-Hsun Huang, who was interviewed by ATD’s own Ina Fried at D@CES earlier this year, probably looks back fondly on the $200 million he got from Microsoft 11 years ago.
So? Everyone chill out. There’s really nothing new to see here. Instead, listen to this great, aptly named John Lee Hooker tune, with Carlos Santana sitting in on guitar. It’s not new either. But it’s a lot more interesting.