Will ARM Holdings Outperform Its Peers This Year?
Bobby is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
ARM Holdings (NASDAQ: ARMH) develops the technology that makes many of today’s “smart” devices run at the speeds modern life requires. Its designs are in a surprising number of products. The company is currently the market leader in tablet processors - almost one-third of the world’s tablets have an ARM processor. In fact, ARM Holdings is the company behind the processor that powers the popular Apple iPad.
But, that isn’t what makes this company really shine – its strategy does.
See, ARM Holdings doesn’t make its microprocessors. Instead, it develops the technology and then licenses other companies to make them. That way, ARM Holdings doesn’t have to actually “make” anything and its focus its operations solely on product development. To date, ARM Holdings has licensed its technology roughly 850 times to nearly 300 different companies. The following is a small sample of the companies that have licensed the right to make ARM Holdings processors: Texas Instruments, NVIDIA, Broadcom, Marvell, Panasonic, Samsung and Toshiba.
ARM Holdings has enjoyed an array of key developments as of late. NVIDIA, Qualcomm and Texas Instruments are using ARM based microcontrollers (MCUs) in their latest tablet and laptop prototypes running Microsoft’s Windows 8 operating system. Marvell is using ARM-based chips in the next generation of Google TVs. Texas Instruments is using ARM9 processor-based systems for developing both Smart Grid and smart meter solutions and is developing a new series of Samsung and LG smart TV families based on ARM processors. And, really this is just a small sampling of what is in store for ARM Holdings – but does that necessarily mean that the company is a good investment?
The market certainly supports its business model. The processor market has become more fragmented as the complexity of physical IP and processor design has increased, in turn making the market more IP design driven – and that is where ARM Holdings comes in. It is basically a company to which semiconductor companies can outsource their research and development. ARM Holdings makes its money by charging an upfront license fee and then collecting ongoing royalties, usually at a percentage of the manufactured chips’ pricing. But, the best part is that the technology can be used across multiple platforms.
Interested? Well, there is something I have to point out. ARM Holdings is a UK-based company that trades in the US as American Depository Receipts (ADRs). This is just a mechanism for allowing a non-US based company trade on American platforms. So, investors buying into ARM Holdings have the choice – either invest in ARM shares on the London Stock Exchange (LSE), ticker symbol ARM.L, or invest in the company’s ADRs through NASDAQ, ticker symbol ARMH. It doesn’t really affect your investment in the company – prices rise and fall, dividends are paid and the stock can be traded like any other stock. In this case, ARM.L does not pay dividends while ARMH does so it is worth doing your homework.
ARMH recently traded at $28 a share on a mean one-year target estimate of almost $30, making its predicted upside roughly 7%. The company also pays a 17 cents dividend (0.60% yield). It is priced high at 32.37 times its forward earnings, which is a bit high, but analysts are expecting solid earnings growth from the company. ARMH’s earnings are expected to grow at an average rate of 17.50% a year over the next five years, outpacing industry expectations of 14.53% and market expectations of 10.60%.
Entropic Communications (NASDAQ: ENTR) is a chip company with a bright future. It recently acquired Trident Microsystems’ set-top box (STB) system-on-a-chip (SoC) business, which will allow the company to expand its product line while gaining scale and an existing customer base. Entropic is involved more in televisions and multimedia content. Its OEM customers include such names as Cisco, Roku, TiVo, Westell, LG and Samsung, while its service provider customers include Time Warner Cable, DIRECTV, Dish Network, Comcast, Cox and Verizon.
Entropic recently traded at just over $5 a share with a mean one-year target estimate of $7.90 a share, making for almost 50% upside. It does not pay a dividend. The company is priced low at just 9 times its forward earnings. Analysts predict Entropic’s earnings will increase by an average of 16.67% a year over the next five years. I think this company looks like a buy. ARMH just doesn’t have these numbers. I think ARMH could eventually but Entropic would still make a good shorter term play.
Cavium (NASDAQ: CAVM) also designs processors. Some of its clients include General Electric, Radisys and Emerson. It recently traded at $29.50 a share on a one year target estimate of roughly $31.50, making for roughly the same expected upside as ARMH, only Cavium does not pay a dividend. The company is priced lower than ARMH, with a forward price to earnings ratio of 28.38, but the difference is marginal. Plus, analysts are expecting even greater earnings growth from Cavium, forecasting an earnings growth increase of 19.40% a year on average over the next 5 years.
ARMH’s dividend gives it a an advantage over Cavium, but Cavium is also a good company. I think it comes down to how bullish you are over ARMH’s outlook, like its involvement with Apple. Right now, ARM processors power iPads, but who knows about down the road – maybe the company could unseat Intel (NASDAQ: INTC) as the company that makes the processors for Apple’s MacBooks.
Intel is famous for its processors. After all, over 80% of the world’s PCs have Intel inside, but it has fallen short in the tablet and mobile market. Right now, its processors are in just 16% of the world’s tablet, roughly half that of ARMH. Intel recently traded at $28.58 a share on a mean one-year target estimate of $28.33, suggesting that analysts on average expect flat performance from this company. It pays an 84 cents dividend (3% yield ), which does help. The company is also priced low at 10.87 times its future earnings but its earnings growth estimate is a little low at 11.61% per annum on average over the next five years.
Intel has a lot of new developments which could change all this – like chips that are so heat and power efficient a quad-core processor can be put in a 13” MacBook Pro. Intel is also hedging its bets with its Ultrabook, a laptop designed to rival the MacBook Air in design and performance starting at just $699. All in all, I like Intel’s proactive approach but it is losing some ground to ARMH.
Mindspeed Technologies (NASDAQ: MSPD) takes a somewhat different approach. It has partners that supply or complement its software application efforts, silicon needs, turnkey ODM solutions and design services. In turn, Mindspeed puts it all together. This company recently traded at $5.50 a share and has a mean one-year target estimate of $7.85, representing a predicted upside of roughly 45%. It does not pay a dividend. At this price, Mindspeed has a forward price to earnings ratio of 13.05, which is fairly low.
Analysts expect Mindspeed’s earnings to grow at an average rate of 18.33% a year over the next five years. Growth at that price really just can’t be ignored. Plus, I like its business model. I think it may not be ideal over the long term – there is something to be said for keeping things in-house, especially as it pertains to cost savings – but it allows the company to be proactive anytime a change is warranted.
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