ARM Holdings (NASDAQ:ARMH) is one of the prime players in mobile and PCs, as it licenses its technology for numerous devices. However, ARM's performance in 2014 has left a lot to be desired. The company has lost almost 20% of its market capitalization so far this year, even though it reported solid earnings growth in the first quarter. In addition, ARM's valuation is quite expensive, as the stock trades at 106 times last year's earnings. But then, due to the fact that its technology is used across a number of devices, it could be a good buy on the pullback, especially because of its prospects and fundamentals.
Products gaining traction
ARM's long-term prospects look strong, as its products are in good demand. ARM's most advanced ARMv8 processor technology is gaining good traction, with five licenses being signed by four semiconductor companies during the first quarter of 2014. These semiconductor companies plan to develop chips for automotive infotainment systems, carrier networks, and high-performance computing.
Apart from these, Marvell (NASDAQ:MRVL), MediaTek, and Qualcomm (NASDAQ:QCOM) are developing multi-core ARMv8-based processors for use in mid-range and premium smartphones and tablets. In addition, Broadcom (NASDAQ:BRCM) and Freescale (NYSE:FSL) also plan to deploy ARMv8-based chips into data centers and enterprise networking equipment. ARMv8 has now become the computing platform of choice for future chip designs in mobile computing, as well as in consumer electronics, data centers, and networking infrastructure.
ARM also sees improving industry environment in the second half of the year, which should reinforce its prospects going forward. There's a robust pipeline of licensing opportunities for ARM, based on the general assumption that the semiconductor industry will improve in the second half. The company signed 26 processor licenses last quarter for a wide range of end applications, from smartphones to enterprise infrastructure to wearable technology, and expects the momentum to continue in the future.
Customers signed six of the 26 licenses for ARM's Cortex A series technology, including five licenses for ARM's latest Cortex-A53 and Cortex-A57 processors. ARM also experienced healthy demand for its Cortex M class processors, which are widely used in microcontrollers and embedded connectivity chips, as well as smartphones. In addition, this chip is also found in Internet of Things applications and wearable devices.
ARM is also expanding its customer base. In the first quarter, eleven Cortex M class processors were licensed, which includes four companies that have taken their first ARM processor licenses. ARM has also signed four more Mali graphics licenses and five more POPs during the first quarter.
ARM is seeing strong traction in the end-market. For example, in the first quarter, underlying processor royalty revenue increased 8% year-over-year. Its customers shipped 2.9 billion ARM processor-based chips, which represents an additional 300 million chips and an 11% increase on a year-over-year basis. A major chunk of these additional chips were used in enterprise networking, infrastructure equipment, and microcontrollers used in everyday objects that are becoming smarter, like watches, washing machines, touchscreen controllers etc.
End-market growth is strong
ARM is growing robustly, with sales of smart consumer devices, such as smartphones, tablets, and digital TVs increasing. Most of these products have an application process that utilizes the Cortex A class processor, having a higher royalty percentage per chip.
ARM's solutions are also finding adoption in new designs, from small cells to base stations to virtualized networks. The company sees huge opportunity for ARM-based services, with data centers and cloud computing companies looking to optimize their services.
In addition, demand is now expected to come from the second generation of wearable devices and Internet of Things applications, as they have robust designs, are well-built, and provide easy-to-use software services. ARM expects to benefit from the growing ecosystem of these devices, as many of them use ARM chips. It is also easy for developers to create new products, coupled with growing innovation within mobile devices too. In addition, entry-level smartphones are now available at an unsubsidized rate for less than $50, which makes them affordable for the largely untapped consumer markets in India, Africa, and South America.
ARM has continued its investment in R&D and has grown the engineering teams working on advance processors and graphics products, with around 120 people hired in the first quarter, and the investment is expected to continue in the second quarter as well.
So, ARM's prospects look strong. The company's focus on product innovation and the increasing demand for its products should help it deliver long-term growth. In addition, ARM's balance sheet is strong, while its valuation going forward also looks impressive.
ARM has a forward P/E of 30, indicating that earnings growth is expected going forward. Its cash position remains strong at $989 million, while its debt is quite low at just $13.9 million. Also, ARM's earnings are expected to grow at an impressive CAGR of 20.05% for the next five years, above the industry's average of 15.70%. Hence, investors should consider buying ARM shares on the drop, as it looks like a solid long-term prospect.
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