More on ARM
ARM Q1 results
ARM continued last year’s strong growth in both the original ARM business and the Artisan acquisition, with total pro-forma revenues up 23% in dollar terms. It is interesting that the original ARM business is growing much faster (27%) than PIPD, the former Artisan (12%). Operating margins in the original business have strengthened quite substantially to 32.4% (pre-exceptional). In both businesses royalty revenue growth was well ahead of growth in licensing revenues. This is to be expected as new licensing opportunities will be harder to obtain but it is mildly negative as licensing is a leading indicator of royalties.
Although per-unit royalties were slightly higher than in the previous quarter (8.1 cents against 8.0) but this is nonetheless lower than the level in 2004 (or any previous year) and is further evidence in favour of our expectation of a long term downtrend. Although ARM takes a more optimistic view it is worth remembering that to maintain royalty rates in the long term ARM needs to keep moving customer’s to new technology and, as the previous generation of processors becomes powerful enough for a wider range of tasks, the incentive to upgrade could fade. Of course this is highly unpredictable and consumer demand for new functionality, particularly mobile products, could keep ARM’s customer’s upgrading for decades.
We are more optimistic about long term demand for volumes and are confident that the market will continue to grow as continually lower manufacturing costs make inclusion of this type of technology in a wider range of devices, and thanks to the proliferation and increasing sophistication of mobile devices.
The strong growth justifies the 21× prospective PE, with the PEG only just over one. This is in fact rather cheap in the context of the potential ARM’s market has for sustained long term growth, However, as we have previously commented, we dislike the element of acquisitive growth. While the original businesses dominant market share in many segments (mobile phones in particular) is likely to be maintained, ARM is not as entrenched in non-mobile devices and faces substantial competitive threats - although these are in smaller parts of ARM’s businesses. The key concern is the ability to maintain unit royalties at a sufficient level to maintain unit royalties so that high volume growth continues to be translated into high revenue growth.
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