Can ARM Holdings Continue Growing in the Long Run?

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Oct 29, 2014
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ARM Holdings (ARMH, Financial) recently posted financial results for the third quarter. It saw relatively strong demand in a wide range of end markets for its chips used in smartphones digital TVs, and tablets. However, it wasn’t enough to beat the analysts estimates for revenue, though its earnings per share were in line with analysts’ estimates. Nevertheless, the chip designer made a slightly better forecast for revenue for the fourth quarter that beat the expectations.

Results and expectations

The Cambridge, England-based chip designer reported revenue of $320 million, an surge of 12% as compared to $ 274.39 million in the same quarter a year earlier. Its net earnings for the quarter rose 16% to $0.29 per share. The analysts had been modeling earnings of $0.29 per share on the revenue of $321.2 million for the third quarter.

Looking ahead for the fourth quarter, the chip designer expects revenue of $350 million, which is better than analysts’ estimates of $349 million. It expects its performance to increase in the fourth quarter and into 2015. It is additionally expected to benefit from chip makers such as Qualcomm (QCOM, Financial), Nvidia (NVDA, Financial), and many others from its licensing and royalty businesses. These companies not only pay an upfront fee for licensing a particular ARM processor design, but also pay a royalty for every chip produced using the design. Moreover, its royalty revenue continues to surge more than the average industry. It grew around 11%, which is greater than the industry revenue growth of 10%.

Growth opportunities ahead

The chip designer has shipped more than 3 billion ARM processor-based chips. Its shipment during the third quarter increased 19% year-over-year, representing an additional 500 million chips. It should also gain from these additional chips that went into many other devices such as embedded sensors, smart cards, and microcontrollers.

In addition, it is observing incremental revenue as Internet of Things move from wireless payment in payment cards to wearable devices such as smartwatches, pedometers and manufacturing and logistics systems that should fuel its growth in the long run. Also, its ARM-based microcontrollers grew 55% year-over-year and the company expects this trend to continue in the future.

ARM also recently launched a completely new software platform and a free operating system that will streamline and improve the formation and deployment of Internet of Things (IoT) products. This embedded IoT device platform provides integrated solutions for Internet protocols, security and standards-based manageability that are elevated for energy and cost-controlled devices. Moreover, this embedded operating system will enable the companies to create and deploy smart sensors and controllers into their products using this integrated operating system.

The companies can exploit this light-weighted operating system that offers standard connectivity support to devices such as Bluetooth, Wi-Fi, and LTE as well as web protocols such as HTTP and CoAP. Also, its embedded device server that exists on its customer’s servers facilitates creation of connectivity to the IoT devices and enables them to effectively accomplish their IoT network. It also provides high functionality services that are run across the entire IoT network comprising data aggregation for aggregation for analytics, enabling firmware updates across all nodes.

It is additionally expected to benefit from the $35 smartphones. These smartphones are leading its mobile technologies to the next billion consumers. Moreover, these smartphones includes both of its Multi-core Cortex-A fast processor and the Mali graphics processor. The chip designer looks great to tap this fantastic opportunity in the developing markets. Royalty revenue from the expansion of market segment will certainly enhance its performance for both the top and bottom lines over the time.

Furthermore, the chip designer will benefit from its server and networking infrastructure. Recently, HP (HPQ) declared that it will be using two of its new ARM-based servers 64-bit ARM based server and TI's Keystone II chip server to enhance its HP Moonshot portfolio. PayPal already utilizes its TI Keystone II chip server. Also, HiSilicon and TSMC have created the first multi-core ARMv8-A-based chip using TSMC's 16 nanometer FinFET process. Companies such as IBM and Canonical will be exploiting their server software on ARMv8-A based servers. This should certainly accelerate growth for the company going forward.

Conclusion

ARM Holdings looks great as its design chips are being sold in 95% of the smartphones, tablets and digital devices. Also, the company continues to earn its revenue from licensing fee and royalties that should accelerate its top line growth. Moreover, the analysts are estimating CAGR of 19.03% for the next five years, making the stock very prosperous in the long run. ARM Holding is currently trading at the trailing P/E of 68.32 and forward P/E of 28.33, which means that it has good growth prospects.