ARM Holdings (ARMH, Financial) is a British multinational company, based on Cambridge, England, and one of the biggest software and processors producers worldwide, designing processors for both computers and mobile devices. Also, on the field of GPUs (graphic processing units), ARM Holdings is leading the Android and iOS operating tablets market with more than 50% of the market share.
The company holds many intellectual properties (IPs) and patents. In fact, it's patented chip blueprints and technology are used in many different products such as real-time safety (cars’ ABS) and smart TVs. This allows the company to collect not only up-front license fees, but also royalties on any microchip sold using the company's blueprint design.
ARM Holdings´ Economic Moat
The company provides many other giants in the tech segment (Samsung Electronics Co., Qualcomm Tic (QCOM, Financial), Broadcom (BRCM, Financial), Taiwan Semi (TSM, Financial), Apple (AAPL, Financial) for its iPods and iPads, and Google (GOOG, Financial) for its Chromebooks) with microprocessors' blueprints, especially for mobile devices. In fact, their blueprints are now rated as an industry standard; app and software developers are also used to ARM's chip architecture. This ensures a long term of incoming royalties, which will add up to all the licence fees it collects up-front. This business allows ARM to boast a gross margin of 94%.
It is particularly this library of patents and designs that provides ARM Holdings with an economic moat that maintains it in a leading position on the mobile devices market. For other company to create and develop a new product to take share from ARM's market, it would have to make a billionaire investment (with no guarantees of success), while also being careful not to infringe ARM's IPs, or any other of the hundreds of small companies’ patents that produce very similar products.
Future Competition with Intel
Intel Corp. (INTC, Financial) is said to be developing x86-based architecture processors, that consume less energy than ARM’s ones. But it still has the enormous tasks of reducing its R&D costs on said product, and changing an industry standard set by ARM's designs (and we would still be talking about just one product in the wide variety of ARM's portfolio). If this still were to happen and ARM Holdings and Intel were to “duopolize” the mobile processor market, it would still leave just ARM Holdings on other mobile components markets (baseband and connectivity chips, mainly) and on non-mobile chip markets (such as top-boxes, server processors and microcontrollers).
A wide variety of patents (and IPs) on so many different products throughout mobile and non-mobile markets —used by leading firms of each industry — provide ARM with an edge on many markets that currently are a long way from peaking.
Management Changes
Management-wise, former CEO Warren East paved the way for the company's mid- and long-term growth, mainly by acquiring more technologies, products, and either IPs, or patents. He accomplished to ensure the company’s future growth. Simon Segars, the new CEO, knows just how to keep the business on track, he's been on the firm, on executive positions, alongside East since 1991.
ARM vs Industry Median vs Main Competitor
Holding this stock seems like a good idea if we think in the mid or long-term, since the markets that the company manages aren't yet fully developed, more people around the world are adopting mobile devices like tablets and smartphones (basic and high-end ones), and royalties for the company are still to keep growing, alongside dividends for shareholders. Though prices on the stock may be volatile, down the road I can only see growth for this company.
Taking a look at the metrics and comparing them to the industry median, we can see why ARM Holdings remains on the top positions:
| ARMH | Inudstry Median | Competitor (Intel Corp.) | History | |
| Operating Margin | 36.10 | 2.40 | . 27.40 | MAX: 36.10 |
| Net Margin | 27.9 | 1.4 | 20.6 | MAX: 27.9 |
| Revenue Growth | 21.3 | 6.5 | 18.5 | |
| EPS Growth | 54.8 | -0.5 | 40.4 | |
| Cash to Debts | 123.33 | 6.21 | 0.84 | No Debt |
| F-Score | 6 | - | 5 |
-As we can see on the table, ARM has enough cash to cover all of its debt, while Intel has been issuing new debt (USD11.3 billion in the past three yars), and its operating cash flow is very different from its reported net income.
- Along with the company’s sustained growth ARM’s operating margin continues to grow, surpassing lower pastones, and setting a new peak in its history.
- Comparing the numbers with the company’s history, we can see a sustained rate of revenue and earnings growth.
The only downside to ARM seems to be its valuation. The stock trades substantially above industry means, at almost 85 times the company’s earnings and 19.2 times its sales (versus Intel’s respective 13.2x and 2.39x). However, ARM’s valuation seems quite justified.
ARMH’s Growth Facing the Mid- and Long-Term Future
For the future we can expect ARM Holdings´ royalty stream to grow, as people increasingly adopt mobile devices, both high-end smartphones and tablets. Moreover, we cannot forget about the innovative nature of the company, which bets on the development of new products, therefore continuing to create more IPs, licence fees and royalties.
Although the company may not display the best numbers in its history, it is still ranked better than most of its industry peers, and its main competitor. In addition, with the royalties it will be collecting for every Samsung Galaxy, iPhone, iPad and iPod sold, among other products, the dividends have no other way to go but up.
Disclosure: Victor Selva holds no position in any stocks mentioned.
