Is There Still Value In The ARM Space? Yes: In IAR Systems AB

| About: I A (IARSF)

If you have had any interest for the growth in smartphones and tablets the last couple of years, you are likely to have heard of the company ARM Holdings (NASDAQ:ARMH). As a designer of one of the most popular energy efficient computer chips, its stock has seen a sevenfold increase in value the last five years as the proliferation of mobile devices has continued to grow. Embedded systems, built with processors based on ARM's design, and often manufactured by companies such as Qualcomm (NASDAQ:QCOM), Texas Instruments (NYSE:TXN), Broadcom (BRCM), and lately also NVIDIA (NASDAQ:NVDA), can be found in a large variety of applications ranging from cars to medical devices and consumer electronics. Granted a notoriously difficult industry to analyze, the semiconductor companies mentioned above have all prospered from this growth in mobile devices and embedded systems.

While I am confident these companies are familiar to the reader, there are other companies in the value chain of the ARM space to explore. Today I would like to briefly look at one such company: IAR Systems AB (OTC:IARSF), listed on Nasdaq OMX Stockholm.

IAR Systems AB is a developer of computer software used in the development of embedded systems. Founded in 1983, it is in fact a world leader in its field, having grown from a local Swedish company to a global player with ten offices all over the world and 14,000 customers in various industries. IAR Systems AB's products, two of the most popular being IAR Embedded Workbench and IAR visualSTATE, are used to create fast, efficient programming code with minimum power consumption and memory requirements while at the same time simplifying workflow and handling integration of tools and systems. Its main competitor would be Green Hills Software, a privately held company with headquarters in Santa Barbara, CA. More often though, IAR Systems AB have to compete against tools developed internally by its customers.

Despite being a leader in its field, the company is not well known amongst investors. Up until the first quarter of 2011, the company was part of a conglomerate with three other companies with few commonalities. In Q1 2011, the other companies were sold or listed separately and the parent company changed its name to IAR Systems AB.

Looking at the financials from IAR Systems latest report, released on February 7th:

  • Revenue growth was 15% in 2012 with total sales of 230 MSEK, approximately 36 MUSD, divided across Europe (33%), US (42%) and Asia (25%)
  • The EBIT-margin has risen from a mediocre 8,3% in Q1 2011 to a much better but still far from impressive margin of 16,5% in Q4 2012. The long-term trend is promising with an EBIT-margin in 2009 of just above 4% and in 2010 of 7%. Management targets an EBIT-margin of 20% over a business cycle, so there should be further opportunities for margin expansion going forward.
  • Net results for 2012 were 2,68 SEK per share, up 36% from 1,96 SEK in 2011.
  • With its strong net cash position of 49,3 MSEK the board is proposing to double the dividend to 2 SEK per share, giving the stock a dividend yield of 5% at current stock price of 40 SEK per share.
  • The market cap is 468 MSEK, approximately 74 MUSD.

The company has a long track record and a good reputation and strong brand in the industry. Revenues have shown stable growth and the underlying market growth is moderate to strong. Management has proven to be able to increase EBIT-margin and EPS for several consecutive years. Downside risks are limited due to the company's diverse and large customer base, both industry wise as well as geographically. Furthermore, the company collaborates with all leading silicon vendors worldwide, ensuring the software supports a very large set of processors and architectures.

This stock offers an attractive mix of a pure play investment in the growing market for embedded systems and the popularity of ARM-design, but without the volatility of a traditional semiconductor business. The investment case has largely sprung from the company's improvements of its EBIT-margin. At current rate of 16,5% in Q4, this software company is still well below Management's target level of 20% and what could be expected from a world leader within its field. Priced at a P/E-ratio of 15 and P/S-ratio of 2 on historic 2012 years net profit and sales, there is plenty of value in IAR Systems AB.

Disclosure: I am long OTC:IARSF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: As an OTC ADR with very low trading volume, there are significant liquidity risks. This article is not a recommendation to invest; please do your own research and consult a professional advisor

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