Even if regulators were inclined to approve the transaction, equipment manufacturers and system integrators are guaranteed to raise an outcry. Competition between Nvidia and AMD-ATI has benefited customers in the form of technology innovation and price reductions.

Also, the emergence of a single-source supplier in the discrete graphics IC market could significantly hurt equipment vendors in the event of a manufacturing glitch at the new entity.

An AMD source also cited the x86 cross-licensing agreement the company has with Intel, an arrangement that could require extensive renegotiation if Nvidia were to purchase AMD.

Then there is the challenge of absorbing what would be the largest acquisition in Nvidia's history. While Nvidia has made small to midsize purchases in the past, the company has limited experience integrating a major rival and would have to resolve architectural platform issues not just with AMD but also with the old ATI.

Nvidia's fabless operating structure could also produce some hiccups. Totally dependent upon foundries for its wafer supplies, Nvidia has never had to manage a fab and could run into problems understanding the new business model.

"Nvidia is a fabless company, and I don't see how they are going to make that transition into a fab operator if they were to buy us," said the AMD source. "Nvidia buying AMD makes no sense."

He is not alone in that sentiment. In fact, other sources insist that Nvidia could, for now, continue to grow steadily in its core discrete graphics IC market, even as Intel and AMD-ATI chip away at the segment by offering integrated solutions.

Nvidia appears to have chosen this option, according to recent comments from Huang. Pressed by analysts during the company's latest quarterly conference call to explain how Nvidia will continue to compete as graphics integration becomes more pervasive, Huang said his company believes in "heterogeneous computing," whereby the GPU co-exists with the CPU.

"Billions and billions of dollars of R&D have gone into making that CPU as good as it can be ... but they'll never scale very well from here on out," Huang said. "We believe that the world needs a heterogeneous computing model where the single-threaded, flexible CPU is combined with or collaborates with a massively parallel processor—in this particular case, the GPU."

There is some danger in that position, however. If Intel and AMD-ATI continue to expand their integrated offerings or even increase their presence in the discrete graphics market, Nvidia's share could dramatically shrink.

As Mercury Research's McCarron pointed out, the discrete graphics IC market is expected to remain strong and healthy for the foreseeable future because of its scalability and the options it offers system builders.

Nevertheless, even McCarron conceded that integrated platform solutions are the wave of the future because they offer improved stability, energy efficiency and better time-to-market—all attributes that OEMs and PC system integrators need to improve their cost structure and increase profitability.

Intel is the clear leader in the overall graphics IC market (discrete and integrated chip sets), with a 42 percent share at the end of the fourth quarter, followed by Nvidia with 34 percent and AMD-ATI with 18 percent. Although Intel has not reentered the discrete IC market, it might be moving in that direction and possesses the technology know-how and resources to easily grab market share from the current market leaders.

"AMD's Fusion will make it hard for Nvidia to sell chip sets with embedded graphics in the AMD space, and the discrete graphics space is declining," said Nathan Brookwood, a principal analyst at Insight64 (Saratoga, Calif.). "Intel is doing this, too."

If Intel starts to supply discrete ICs again, this would eliminate one of the fundamental challenges Nvidia could face if it wants to purchase AMD-ATI: regulatory concerns about a market monopoly.

In that case, Nvidia could conceivably proceed with plans to acquire AMD, but it would still have to deal with a host of other problems. n

—With additional reporting by Rick Merritt and Junko Yoshida.