Interactive Investor

Good reasons to grab ARM Holdings

22nd July 2014 12:04

Lee Wild from interactive investor

In a rollercoaster year, chip designer ARM Holdings is currently on a dip. Its share price is down over a quarter so far in 2014 amid rising costs and dwindling growth in royalty revenue. But after a decent second-quarter, investors have chased the shares up 5% to 871p and there are good reasons why others should follow suit.

Revenue rose 17% in dollar terms during the three months ended June to almost $310 million (£181.59 million), and sterling sales climbed 9% to £187 million. Steady operating margin at 48.9% meant underlying pre-tax profit grew 9% to £94.2 million.

Licence revenue rocketed 42% during the quarter to almost $126 million, easily beating City forecasts. And a sequential drop in the order backlog is expected to reverse when big contracts come through during the third quarter.

Yet despite shipping 2.7 billion ARM processor-based chips - up 11% on last year - average royalty per chip fell from five cents to 4.6 cents. That's because sales of low-cost ARM-based microcontrollers and smartcards grew faster than more lucrative chips into smartphones and tablets. Electronics operators selling off older 3G handsets ahead of switching subsidies to 4G handsets also explains the meagre 2% increase in dollar processor royalties to $121.2 million.

However, the company still expects to outperform the overall semiconductor industry in the second half of 2014 "as more chips are sold to OEMs building more advanced devices, which typically utilise more ARM technology."

"The 41 processor licences signed in the second quarter were driven by demand for ARM technology in smart mobile devices, consumer electronics and embedded computing chips for the Internet of Things, and include further licences for ARMv8-A and Mali processor technology," says chief executive Simon Segars.

Analysts at Investec Securities expect to halve forecasts for second-half growth in royalty revenue to a more modest 15%, although there could be a surprise toward the end of the year "once the 4G phone cycle takes hold."

Strip out over £1 billion of net cash, worth 76p per share, and ARM shares trade on less than 28 times Investec's earnings per share forecasts for 2015 of 28.7p. That drops to less than 23 times for the year after, below the historic average. Persistent takeover rumours spice up the investment case.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.