By Michael V. Copeland
January 11, 2011

Intel agrees to a huge licensing deal that pays graphics powerhouse Nvidia handsomely. But, it’s not exactly a thaw in their cold war.

After canceling a Dec. 6 trial date to hash out lawsuits they had pending against each other, chipmakers Intel (INTC) and Nvidia (NVDA) announced a new six-year agreement Monday. The agreement gives Intel access to the full-range of Nvidia’s patents for graphics chips, which it needs to deploy its newly launched Sandy Bridge integrated graphics/CPU chip. Nvidia in turn, will receive licensing fees of $1.5 billion in five annual installments beginning January 18, and will continue to have access to Intel patents.

Just as important for Nvidia and its investors is removing the uncertainty of a legal battle with the world’s largest chipmaker. It also gives Nvidia some extra cash to continue its own chip designs. “We are going to build a lot more processors and they are going to integrate a lot more graphics,” Huang told Fortune. “We just thought this was a more productive way to go.”

Nvidia will not have the right to the intellectual property in Intel’s proprietary processors, flash memory, and certain chip sets. In other words, Nvidia won’t be able to go out and make its own version of an Intel compatible  – x86 – chip, though Nvidia CEO Jen-Hsun Huang says Nvidia never intended to.

The agreement is consistent with a prior licensing deal worked out between the two companies that was set to expire in March. While time was running out on that deal, the two companies were busy lobbing lawsuits at each other claiming breaches of the agreement. All pending legal disputes have been dropped as of Monday. Seems like rather than battling it out in court, both companies would prefer to have access to each other’s technology.

Why that makes sense, especially for Intel, is that until very recently, graphics chips were mostly the province of hard-core video game fans. But with HD video, video chat, and 3D rendering more and more of a selling point with consumers, the drivers of today’s PC market, the graphics capability of machines has taken on greater importance. Things like encoding and decoding HD video are so-called “parallel” problems, which as it turns out, are better suited operations for graphics chips than for CPUs. If computing is placing a heavier emphasis on these kinds of parallel problems, as Huang has been claiming for the past few years, graphics processing brawn should receive more attention, and money.

Although historically Intel was about CPUs and Nvidia has been about graphics, that convergence of functions is part of the reason the two companies stopped playing nice, and why they needed to strike this deal: Intel’s latest chip, dubbed Sandy Bridge, is all about its graphics capability. Intel needed a clear path to Nvidia licenses to be able to sell Sandy Bridge, which is shaping up to be a huge performance improvement over Intel’s last-generation chip. Nvidia, too, needed access to Intel patents to keep pursuing its own line of processors, including Tegra2, which is being built into the latest tablets running Google’s “Honeycomb” version of the Android operating system designed specfically for tablets.

And while the legal battles between Intel and Nvidia may be over, it doesn’t mean these two companies are going to be strolling arm-in-arm around Silicon Valley. On the contrary, their battle in the marketplace is heating up more than ever.

At the Consumer Electronics Show, Nvidia announced its intention to build its own processor based on so-called ARM architecture. Microsoft (MSFT) in turn, announced that its next version of Windows would be ARM compatible. Whether that turns “Wintel” into “Winvidia” won’t be known for several years when Nvidia’s ARM processor is ready for the market, but the announcement did strike a psychological blow against the old order of things.

Nvidia is also battling Intel successfully on the mobile front, stealing a good chunk of the tablet business away from Intel’s Atom line of so-called system-on-a-chip (SOC) with its Tegra 2 SOC, and getting into the smart-phone business ahead of Intel.

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