As the market for high-end smartphones has been witnessing a decline in the U.S., it does concern many chipmakers. ARM's Holdings (NASDAQ:ARMH) is one of the chipmakers that won’t feel the heat of this declining smartphone market as we discuss in this article. The company is also focused on various diversification moves which again will yield higher revenue in the future. The company generates revenue from various royalty and licensing fees that it gets from various manufacturers of mobile phones and equipments.
ARM's current royalty revenues are derived from licenses signed many years ago. ARM gets royalty from various companies like Freescale, ST, NXP, Xilinx, etc., that use ARM design for chip making. It also sells its technology to system companies like Samsung, LG, HTC and Amazon which dominates the high volume market like tablets, Digital TV, mobile phones and many more. The upfront license fee and ongoing royalties are typically based on a percentage of chip prices.
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The company’s royalty revenues are around 30% higher than revenue procured from licenses. Licensing revenue illustrates that it receives more revenues from customers for the first time, but this also adds on to the royalty revenues from the repeat customers. Revenues also include other income, namely selling software and tools, and providing services such as support and training. This "other" income contributes roughly about 10% to the total revenue.
Recent announcements from Qualcomm, Marvell and Mediatek are keen on ARMv8 based chips for mid-range and high-end smartphones and tablets will have a positive impact in the future quarters of ARM
Customers’ appetite for features in the low cost smartphones is rising, which requires more processing power in the chips. An investor should also consider the fact that the low cost smartphone market is growing in various Asian countries which does benefit chipmakers like ARM Holdings.
The company is looking to diversify in various other markets like networking and servers. This step by the company is primarily due the cloud market which is the future and creates a market for various server and networking applications.
Another big market that ARM foresees is the Internet of things. Analysts and researchers anticipate this to be a trillion-dollar market. ARM can also benefit from this with its strategic move for diversification.
ARM to Benefit
Despite saturation of certain markets the pace of ARM’s growth should not be slowed mainly due to the following facts.
Consider that the emerging economies and the positive population growth with increasing middle class income creates an organic growth opportunity as the need moves from feature phones to smart phones/tab. MicroMax, one of the leading low-cost smartphone manufacturers in India, has ARM inside.
Almost 90% of ARM revenue is from the mobile phone market, but the enterprises solution market contributes only 5%. This is the market which will positively leverage the top line of ARM as it now focuses on the enterprise solution market. This segment comprises of mobile/wireless infrastructure, corporate networks, storage devices, etc. So, ARM’s future seems to be bright as it ventures into this segment with its strategic diversification plans. Although it may face stringent competition from big players like Intel, it will be interesting to see how this plays out.
The company also anticipates growth in revenue from the "Embedded Solutions" segment. The main market is automotive, industrial control and various others. This provides anti-lock braking systems and smartcards solutions. As of now, ARM occupies about 10% of this market. We do see a huge space for ARM to grow in this segment.
ARM is a debt-free company. The company already enjoys being the leading vendor for chips to mobile phones manufacturers. It further plans to diversify in the growth market which can influence its top line.
ARM also anticipates a strong demand for Cortex M class processors which are used extensively in microcontrollers, embedded connectivity chips and smartphones, making it a good long-term buy.