ARM Holdings Taps Success In Smartphone, Tablet Craze

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ARM Holdings, long the power player among chip designers for smartphones and tablets, has curbed investor concerns of waning potential and is poised for a strong 2014, analysts say.

They see several possible growth drivers forARM Holdings ( ARMH ), as customers such asApple ( AAPL ) and Samsung roll out new products. There's also word thatGoogle ( GOOG ) might design its own server processors using ARM Holdings technology, according to a Bloomberg News report last week.

"I think ARM is in a phenomenal position headed into next year," said Evercore Partners analyst Patrick Wang. "It is firing on all cylinders."

ARM Holdings is the second-largest firm by market cap in IBD's Electronics-Semiconductor Fabless industry group, afterQualcomm ( QCOM ), and beforeBroadcom ( BRCM ),Avago Technologies (AVGO) andXilinx (XLNX).

Wang noted that ARM Holdings' stock rode a roller coaster over the past couple of years, dipping below 23 per share in mid-2012 and seesawing the middle of this year before recovering in the fall to approach 50 in October. It now trades just shy of that.

For the downs, Wang and others have most recently blamed headlines generated by would-be competitorIntel (INTC), which has made known that it wants to carve out a big share of the smartphone and tablet market. This, the thinking went, would come at ARM Holdings' expense.

Rivals And Alliances

Intel, the world's largest semiconductor company, has dominated the arena of chipmaking for conventional personal computers, but ARM, which counts Intel competitor Qualcomm among its partners, has virtually shut Intel out of the smartphone and tablet space. Yet Intel, at its investor day in November, touted expectations that sales of Intel-based tablet computers will surge past 40 million next year, a jump of more than 300%, with smartphone growth to follow.

"I never want to discount Intel," Wang said. "Intel has deep pockets and they really want a piece of this market."

But, he added, Intel executives also said they would consider making microprocessors based on competitors' designs, presumably including ARM Holdings, And since the latter earns royalties on its chip designs, the Intel concession "would seem to balance things out" for ARM Holdings.

With the Intel head wind seemingly diffused for now, Wang said, ARM Holdings is now "my top large-cap pick for next year."

Other Wall Street analysts have been upbeat too, issuing outperform and buy ratings.

An easing of Intel pressure is hardly all that puts wind into ARM Holdings' sails.

The Cambridge, England-based company designs the chips that go into iPhones, iPads and a plethora of other smartphones, tablets and other mobile devices. It earns royalties on every ARM-powered device shipped -- accounting for about half its revenue -- and collects licensing fees for products in development that use its chips.

Despite a 2% year-over-year decline for the semiconductor industry in the third quarter, processor royalty revenue rose about 14% for ARM Holdings, according to the company. That missed estimates, but its licensing income swelled nearly 50%, beating expectations. And earnings per share rose 39% on 28% higher revenue, with both beating consensus views.

Analysts have expressed concerns about the saturation of high-end smartphones. There are fewer royalties to be had if most people in the market for such a device already have one and sales slow. But many analysts think this could be offset by greater volumes of mid-tier smartphones being sold in high-growth markets such as China and India.

Equally important, on the high-end front, was the move made this year by Apple to shift from the standard 32-bit chips to 64-bit chips in its iPhone 5S.

Wang said the change was "huge" for two reasons. One, Apple is a major ARM Holdings customer, and two, others will follow Apple's lead.

Future Devices

Samsung already has said it will follow suit in 2014. And ARM Holdings generates higher levels of royalties on the faster 64s, making each shipment more profitable.

"If not for Apple, others would have taken their sweet time getting to it, but now it becomes essential. And that's a nice tail wind for ARM heading into next year," Wang said. "I think ARM really got its mojo back with the Apple move, because ARM is only as good as its customers."

William Blair & Co. analyst Anil Doradla agreed. "I like the story; I like the fundamentals," he said in an interview.

Doradla has a "market perform" rating on ARM Holdings "strictly on valuation," meaning he is not yet convinced that there is room for substantial advancement for the stock. He said the 64-bit chip development could help drive growth, and expansion of the mid-tier smartphone market in developing countries should provide another boost.

"That market is going to be very positive," he said. But he thinks the stock may need another "upside surprise" to advance substantially.

Wang said Apple may be the one to deliver such a catalyst. Looming from Apple in 2014 is a larger, roughly 12-inch iPad, expected to have a keyboard and other features associated with notebooks and personal computers. It could change the world of business travel, Wang said, and potentially "change the PC landscape." That could boost business for ARM Holdings as well.

"I think that if and when it comes out -- and all signs indicate it in fact will come out -- that's the next leg of growth for ARM's stock," he said.

In the latest news out of the company, ARM Holdings on Friday said it acquired graphics lighting company Geomerics, and that its technology could accelerate the transition to photorealistic games in mobile.

ARM Holdings CEO Simon Segars said on the firm's third-quarter earnings conference call that it is increasingly licensing its chip designs to more companies, and that some of these firms are plowing into cutting-edge areas such as fingerprint recognition and wearable computing, providing new growth opportunities.

"A record 48 processor licenses were signed in the (third) quarter with 24 companies," Segars said. That included 11 firms with their first-ever ARM license, "many of whom are planning to take our technology into new and emerging markets."

Looking toward the fourth-quarter's results, he said, a "record order backlog" and "robust opportunity pipeline" point to a strong quarter for licensing revenue, with a sequential rise in ARM's royalty revenue.

Analysts polled by Thomson Reuters on average forecast EPS at 26 cents for the fourth quarter and 98 cents for 2013, then $1.24 in 2014.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: AAPL , ARMH , BRCM , GOOG , QCOM

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