Why ARM Will Keep Winning

| About: ARM Holdings, (ARMH)

There is a basic misunderstanding about ARM Holdings (NASDAQ:ARMH), usually embodied by headlines like "Intel Faces New Competition from ARM. "

Intel (NASDAQ:INTC) and ARM Holdings aren't competitors, not the way Intel and AMD (NYSE:AMD) are. They are barely in the same business, and their financials prove it.

Intel is in the business of designing, marketing, and making computer chips. It's fully integrated. ARM licenses computer chip designs. Or to put it another way Intel is a hardware company, ARM is basically a software company.

If you just look at the financials, as Mark Hibben did last week at The Motley Fool, Intel should be able to squash ARM like a bug. Intel is a $53 billion company, ARM has sales of about $900 million/year. (They're British, so you have to turn their 577 million pounds into dollars in your calculations.)

The ARM challenge is about Intel's business model. The chip world has gone fabless. Hardware has become software.

When Apple (NASDAQ:AAPL) licenses an ARM design, they basically get a software file, and intellectual property, that have to be turned into a finished design, then manufactured before they become part of a product. This means Apple can make the resulting design proprietary to Apple, adding its own tweaks. It then goes to a third-party foundry for production.

In theory this third-party foundry could be an Intel foundry. But Intel also designs chips, and produces the kind of intellectual property that's ARM's stock in trade. The problem is that Intel's operations are integrated - the Intel design becomes part of an Intel chip that Intel then makes. The only protection an Intel buyer gets is compatibility, and that's not protection.

It's all a delicious irony because, as another Fool wrote, ARM began 25 years ago as a spin-off from a failed Apple competitor, called Acorn. Acorn couldn't compete with Apple in finished products. Now Intel finds it tough to compete in simple designs.

The retirement of CEO Warren East is an opportunity to get in a little cheaper than you otherwise would. ARM is ferociously expensive, relative to earnings, but I heard the same arguments many times before I got in, last September, and since then I'm up 40%.

I understand Ashraf's argument about short sellers circling ARM, based on valuation, and the short interest could be adding something to the stock's current price because, as was said over a century ago, "He who sells what isn't his'n, must buy it back or go to pris'n." This is a much more fundamental call.

I wouldn't reconsider my position unless Intel were broken up into design and fabrication units. That would force a reconsideration because it would enable Intel to sell its designs to multiple third parties easily, and give it the power to tweak those designs so they are customized. A split-up would also enable Intel to compete more closely with Samsung to win the fabrication business of companies like Apple.

I don't expect that to happen any time soon. Thus I expect today's investments in ARM will be made good, with server and embedded chip companies buying the designs as mobile companies have in the past, long before Intel wakes up and smells that coffee.

Disclosure: I am long ARMH. 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.