I have been thinking about ARM. The latest results are very impressive. It’s a fantastic company with a brilliant strategy, but that is reflected in a p/e off the charts. Can there possibly be more scope for growth in the shares?
The numbers are extraordinary. No less than 2.6 billion devices containing ARM chips generated royalty for the company in the latest quarter. Profits were up 44 per cent, cash increased 8 per cent during the quarter.
But equally extraordinary, given the sheer volume of products that contained ARM technology, is how low the profits were. In fact profits were £89.4 million, revenues were £170.3 million and cash holdings are now £562.4 million.
But then look again and note the margin. Profits just shy of £90 million, revenue just over £170 million.
Here is the catch: the company’s market cap is $13.57 billion. In fact its p/e is around 70.
Yes this is a very impressive company. Its chips sit in smart phones and tablets. Apple’s success has been good for ARM, but then so has the market Apple created. Android’s success is good for ARM too. But the p/e? Surely all that potential is priced in.
I am not so sure it is, and this is why.
When ARM revealed its results yesterday, its boss Warren East (who is stepping down later this year) kept referring to what he called the Internet of things, and wearable devices.
So an example of a wearable product that contains ARM type technology is the Nike Armband. You wear it on your arm – for example while you are out running – and can control your iPod with it, adjusting volume or changing tracks.
But such technology is just a taster. You have the high profile products in the pipeline: smart watches, and Google glasses, to name but two. But I see a day when we will wear all kinds of technology, some of which may interface with a smart phone, some of which won’t. 2.6 billion devices containing ARM chips may seem like a lot, but the potential applications are such that I think this number could grow massively over the next few years.
So what about ARM’s rivals – in particular Intel?
ARM has two unique selling points. First off all it leads the world in the design of chips that are very energy efficient. Its technology is ideal for mobile products, unlike Intel chips, which may boast more processing power, but require far more energy. Intel may close the technology gap, but ARM’s other unique selling point is in many ways more interesting.
ARM designs chips; it doesn’t make them. It licenses its technology out to chip manufacturers. That’s why its overheads are so low; its profits to revenue so high.
Intel is a bigger company, much bigger, because it makes its own chips.
But for hardware companies, the ARM model is very attractive. In the world of PCs, hardware companies are reliant on Intel, or maybe AMD. This puts the chip companies in a very strong position, and for hardware companies this is a worry. It is always a concern when you are so reliant on one supplier.
When it comes to ARM chips, the choice of manufacturers is huge. For hardware companies, this is very attractive. It also means, of course, very fierce price competition among the multitude of manufacturers.
It is hard to see how Intel could ever adopt an ARM type model; its overheads are too high. For Intel to just focus on licensing its technology, it would have to revolutionise the way it operates. I often use this column to talk about innovators’ dilemma. See Blackberry’s innovators’ dilemma. Once a company achieves market dominance, it can often hold on to that position through incremental improvements in its technology.
I reckon the demand for ARM type technology is set to grow enormously. I reckon that the nature of ARM’s business model gives it a massive advantage over its main rivals, and one its rivals cannot easily replicate.
ARM won’t last forever, no company does. But – as innovators’ dilemma predicts – I don’t see it falling victim to new disruptive technology until that day when silicon ceases to be the material from which chips are made, and we move perhaps to quantum computers. Or perhaps some form of nanotechnology will throw up an innovation no one has even considered yet. When that day occurs, ARM may be just another player. In the meantime, I reckon it has lots more growth to come.
These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees