ARM Holdings (ARM)

 

ARM: Tech titan on sale

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ARM is empowering widespread technological change yet, the shares are cheaper than they have been for some time.

If you were to search for a wellspring of technological change, you’d probably start with ARM, the company that designs microprocessors, manufactured into silicon chips by semiconductor companies and embedded into electronic devices, most notably smartphones.

The company begins its annual report describing how ARM designed microprocessors are being incorporated into smart products that could become ubiquitous in future: cars, watches, headsets, thermostats, wind turbines, internet and telephone networks, and streetlights.

In the year ending 31 December 2015 ARM earned 15% more revenue than it did in the previous year, and 31% more in adjusted profit. Cash flows are prodigious, return on capital enviable. It grew market share, incorporating mobile devices, and also its new priorities: network infrastructure, servers, and embedded devices (the so-called Internet of Things), to 32%. In 2014, its market share was 30%. The year before that it was 28%… A growing share of a growing market.

ARM licences microprocessor designs to semiconductor manufacturers, for a fee, and earns royalties when they ship silicon chips incorporating ARM based microprocessors. A growing stream of licences increases revenue now, and future revenue from royalties. ARM signed 173 new licences in 2015, ten more than in 2014, bringing the total number of active licences to 1,348. Customers shipped 15bn ARM-based chips in 2015. It’s impossible not to read about ARM and get bamboozled by really big numbers.

The company reports sharp rises in the adoption of its latest most expensive technology (ARMv8) in smartphones and in the number of ARM engineers working on new types of products. Lest there is any doubt it’s seeking to entrench its competitive advantage, it reports 17% of its engineers are working on technologies that might not enter the commercial world for ten or twenty years.

Rapid growth over the last decade is due to the almost universal adoption of ARM-based silicon chips in smartphones. The company enjoys 85% market share of the mobile market segment, in which ARM includes tablets, and “ARM addressable laptops”.

But the fact that ARM expects the mobile market to grow at only 7% a year to 2020, far less than the 30% growth rates achieved in earlier years, may be tempering investors’ enthusiasm for the shares.

A share price of 935p values the enterprise at nearly £13bn, or about 39 times adjusted profit. The earnings yield is 3%.

For the vast majority of companies that valuation would be ridiculously high, but it’s something of a low for ARM.

ARM won’t find it as hard to keep growing as smartphone manufacturers now that their market is maturing, because it does something fundamental, that can be used in any “intelligent” device where size and power matter. Users will also continue to demand more powerful ‘phones, which require more processors, and more efficiency from each processor.

Much depends on how fast other markets grow, though, and the share of other markets ARM takes. The company expects 9% compound annual growth across the board (including mobile) to 2020 and it discloses its share of each target market, the size of the market, and projections for 2020. For example, ARM currently has less than 1% share of the low-power server market, which is worth $20bn. In 2020 it’s targeting a 25% share of what will then be a 20bn market. It’s not predicting the kind of explosive growth it experienced in the smartphone market, but substantial growth across numerous markets.

The future is unknowable but given ARM’s 25 year heritage and the cumulative expertise that implies, as well as its privileged and entrenched position as industry enabler and owner of efficient chip designs that it continuously improves and expands, I expect great things.

Though I can’t know they will be great enough to match the market’s still great expectations, the more the valuation edges down, the more likely it becomes.

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