Investors and commentators continue to ponder ArvinMeritor's (ARM) success in attaining a commanding market share of the cell phone processor market (more than 90%). And with the burgeoning growth of the smart phone and tablet markets (where it too dominates), the company is enjoying exceptional success.
This surely has been reflected in the lofty performance of its stock. Many of us aptly note the rich margins offered by ARM’s licensing and royalty fee business (with a gross margin exceeding 90%) and the fact that the integrated circuits using ARM’s processor cores are actually designed and manufactured by other companies (including Texas Instruments (TXN) and Qualcomm (QCOM), among others).
Given the success of these markets, our eyes naturally turn to Intel (INTC) and its dominance of PC microprocessors. In fact, for some years now, it has leveraged past processor designs for lower-power and less-intensive processing applications through its Atom processor business. And with the initial success of Netbooks and other applications, the unit has done well. Cracking into cell phones and tablets remains a greater challenge, though a competitive offering is expected later this year.
To this discussion, I wish to offer an additional observation. Yes, the business models of ARM and Intel vary markedly. Surely an additional consideration arises, however. In the cell phone market, handset vendors have the ability to secure fairly device-specific processors. TI, Qualcomm and others indeed offer discreet, ARM-based processors that have to be designed, programmed and optimized for individual carriers and their technologies. This micro-economy sustains an ecosystem of vendors and differs markedly from the uniformity of standards that prevails with the PC, where Intel and Microsoft (MSFT) are so dominant.
Thus, even when Intel is capable of matching the energy efficiency of ARM-based cell phone and tablet processors, it will still have to master the intricacies of maneuvering through this ecosystem to secure design wins. Given the company’s capable management, I expect it to have some success. I assume, too, that ARM will have to be similarly nimble as it attempts to enter the server market (where Intel and its standards dominate) with the low-power, multi-core offerings of its licensees. Simply put, the cell phone and PC markets differ dramatically and the dominant processor vendor in each will have to work hard to enter and really challenge the other’s incumbent position.
So where does this leave me as an investor? I have included positions in both Intel and ARM in my model (i.e., unfunded) portfolio for nearly two years. The latter stock has more than quintupled, as the world has noticed its enviable profitability and market position. But at these celestial valuations, it is hard to recommend purchase of ARM shares, even if the durability of its business model and position seems to limit downside. To new investors I can only say, you missed quite a party.
Intel stock at this juncture is a more interesting proposition. News flow and sentiment may be less supportive in the near term, but as a year-ahead holding, it will hold more promise, especially for valuation-conscious investors.