Why Microsoft Should Use Its Nvidia Option

Last year I reported that Microsoft has a deal that gives it the right to match any takeover offer for Nvidia. The chipmaker this week confirmed in an SEC filing that the pact is still active. Microsoft should pull the trigger if it wants to ensure the success of Windows 8.

From Nvidia's 10-Q filing this week. "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 agreement is a holdover from Nvidia's days as an Xbox component supplier.

Redmond shouldn't wait until someone else makes an offer. It's getting more difficult for Microsoft to make money on software that runs PCs, laptops, and mobile devices. And it's only going to get tougher.

Demand for traditional computers is falling as consumers and workers opt for tablets and smartphones. Windows 8 and Windows Phone represent Microsoft's acknowledgement that it needs to play in those markets. But third-party hardware that carries either of those operating systems won't likely be price competitive.

Tablets running open-source Google Android can sell for as little as $99 because their makers don't have to pay a fee for the OS. But devices that run Windows Phone and Windows 8 will have the so-called Microsoft tax built in. By some estimates, that's as much as $30 per device or more.

The only mobile player immune to this problem is Apple. It has its own hardware, chips, and OS, and thus isn't at the mercy of partners' prices. How Apple accounts for component costs internally is its own mystery. But it seems to be working.

Microsoft needs to adopt the Apple model. Hawking software licenses to OEMs with razor-thin margins isn't going to, ahem, cut it. Especially when those OEMs have a free alternative that's more popular than anything Redmond currently offers.

There's a big sign that Microsoft gets this. The company has announced plans to produce its own tablet, Surface, in two versions--one that runs Windows RT and one that runs Windows 8 Professional.

[ Want more details on both operating systems? See Windows 8 Vs. Windows RT: 8 Key Differences. ]

Surface RT will use Microsoft-designed hardware running Microsoft software. If Microsoft exercises its option to acquire Nvidia, it would also own the processor. Surface RT uses Nvidia's hot-selling Tegra 3 chip.

With Nvidia in the fold, Microsoft could also give Google some headaches. Google's Jelly Bean-based Nexus 7 is powered by Tegra 3, which can also be found in the HTC One X and Fujitsu's Arrow X, which I hear is big in Japan.

The benefits that Nvidia would bring to Microsoft don't stop at mobile. Nvidia bills its Kepler graphics processing unit as "the first GPU for cloud computing", and it supports the kind of enterprise VDI scenarios that Microsoft wants to facilitate through its Windows Server 8 Hyper-V virtualization engine.

The chipmaker would also give Microsoft more ammunition for the tech industry's patent wars. Nvidia has about 4,500 patents or patents pending, and it picked up about 500 key wireless patents through a deal in May involving Intellectual Ventures.

Finally, Nvidia would give Microsoft a bigger presence in the lucrative supercomputing market. Its Tesla GPU is found in three of the world's top five supercomputers, including NCSA's Blue Waters, which can sustain performance at 1 petaflop. Nvidia, to boot, is highly profitable, posting $119 million in net income in the most recent quarter. And its coffers are full. Nvidia sits on $3.28 billion in cash and equivalents.

Microsoft originally attained right of first refusal on Nvidia as part of a deal that saw Nvidia become the a GPU supplier for the Xbox. The irony is that Nvidia no longer makes chips for the console--but its present value to Microsoft runs far beyond that.

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