Intel's Dextrous Nemesis: ARM Holdings

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When looking at building your ‘perfect’ first home, you will want an architect who can be flexible enough to design the house with your basic needs, customizing it with your personal touch. ‘Customization’ or ‘Flexibility’, the basic factor in increasing the saleability of a product is a lesson that comes too hard for folks at Intel (NASDAQ: INTC) and at the same time, it is a practice well executed by ARM Holdings (NASDAQ: ARMH).

Although, Android has the lion’s share of the Smartphone market with about 60% under its belt, the real winners of the Smartphone rage are the firms who actually make the hardware- Original Equipment Manufacturers, or OEMs. OEMs make sure that the interior supporting the pretty exterior runs perfectly.

The biggest winner amongst OEMs, in my opinion, is ARM Holdings. The company's chips power the iPhone, the iPad and the various Android phones. ARMH reported Q2 earnings (ended June 30) of £135.5 million ($213 million), beating analyst estimates of $206 million. Net profit was up by 48 percent, to £39.4 million compared to £26.6 million for the same quarter a year ago.

Its arch rival Intel is striving hard to develop a similar dominance in the mobile chip space. The major target being ARMH’s major client- Apple. Intel already has a presence in Apple in the form of the Intel chips used in their Macs and is looking to diversify its presence in the company by taking over the iPad and iPhone chip business as well.

What Works for ARM? 

Unlike other microprocessor corporations, such as AMD and Intel, ARM does not manufacture chips. It only licenses its designs as Intellectual Property (IP) allowing companies to build their processors based on those designs and tweak it based on their own custom needs.

The company’s IP based structure also allows it to be one-of-a-kind in the market and establish a self-supporting eco-system. This design oriented approach is completely contradictory to Intel’s development oriented approach in which, Intel not only designs but also develops the chips in-house and sells it to manufacturers through its sales force. This constricts the power of accommodating the buyer's specific needs.

Additionally, no manufacturing allows the company to keep its operating costs low. The company's cost of sales was only $22.58 million which is exemplary for a company this size.

More than a dozen companies, such as Samsung and Texas Instruments, have licensed ARM technology. One of the companies that ARM licenses its designs to is Qualcomm (NASDAQ: QCOM). Its product, Snapdragon, is a family of mobile system on chips (SoC) based on ARM that companies like HTC, Samsung and others use in their own smartphones and tablets. Qualcomm posted a profit of $4.5 billion last year, with sales of $14.96 billion

Intel Takes the Beating

Intel recently announced that its sales for the third quarter will be lower than expected due to a decline in demand.  Instead of $14.2 billion, Intel now anticipates $13.8 billion in revenue. With tablets cannibalizing computer sales, the inability of Intel to adapt to the changing environment (the vast majority of its revenue still comes from x86 processors used in most PCs and Macs) is being cited as the reason for the cut down in estimates.  

Conversely, the overwhelming increase in iPad sales has led to companies such as Samsung and Qualcomm who manufacture systems on a chip with technology licensed from ARM to be the major beneficiaries.

Uncertainties Ahead

ARM is looking to continue its good run at least for the next quarter citing its “record order backlog” which will let it ride will into Q3, but cautioned that macroeconomic uncertainties may impact results in Q4.

Macroeconomic uncertainty may impact consumer confidence and analysts have become wary in their semiconductor industry outlook for the second half of the year. However, overall revenues for 2012 are expected to be in line with market expectations. Current estimates for full-year revenues are around $860 million.

The Present – A Decent Picture

Overall, in Q2 ARM shipped 2 billion chips which is a 9% improvement over last year, while with industry shipments are actually down four percent. ARM also noted that processor royalties grew 14 percent year-on-year compared with a decline in industry revenues of 7 percent. Their structure has led it to have very diverse client base, as recently highlighted in a report from Nomura Equities Research which has been a key factor in ARM’s royalty revenues outperforming the wider semiconductor industry.

Investor choice

With a Market Cap over $12 billion ,EPS growth of 250% as compared to last quarter, and an annual earnings growth rate of 18.97%, ARMH has been gaining a stronghold in the market in the recent months. The momentum is on ARMH’s side, and I am bullish of its prospects in the near future.

Dive In, Investors

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Gargi27 has no positions in the stocks mentioned above. The Motley Fool owns shares of Intel and Qualcomm. Motley Fool newsletter services recommend Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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