iPhone’s Component Ecosystem: ARM Holdings

| About: ARM Holdings, (ARMH)

In this post, we will be analyzing ARM Holdings as part of our series on the major players in the iPhone’s component ecosystem. The processor in the iPhone is based on an architecture licensed from Britain’s ARM Holdings, popularly referred to as an ARM Core.

ARM Holdings Plc.(Nasdaq: ARMHY) is the world’s leading semiconductor intellectual property [IP] supplier with total revenues of £263.3 million ($483.6 million) in 2006. Its technology is used in most of the advanced digital products, ranging from mobile, home and enterprise solutions to embedded and emerging applications. Its business is organized into three segments: Processor Division [PD], Physical IP Division [PIPD], and Development Systems Division (DevSys).

The company’s business model has a high gross margin of around 90% and involves the designing and licensing of IP to a network of Partners. These Partners use ARM’s IP designs in their microprocessors, peripherals and system-on-chip designs and pay ARM license fees for the original IP and a royalty on every chip produced. The average royalty rate in 2006 was 6.7 cents and about 90% of the mobile phones contain ARM products. In fiscal 2006, it acquired Falanx Microsystems AS., Soisic SA., and PowerEscape, Inc.

For the second quarter of 2007, ARM Holdings reported dollar revenues of $129.2m, an increase of 8% over the year-ago period. The fully diluted earnings per share prepared under US GAAP were 0.64 pence (3.87 cents per ADS) compared to earnings per share of 1.00 pence (5.57 cents per ADS) in Q2 2006. Total dollar license revenues grew by 15% to $59.3 million, compared to $51.7 million in Q2 2006. License revenues, which accounted for 46% of group revenues, comprised $45.3 million from PD and $14.0 million from PIPD. Total dollar royalty revenues in Q2 2007 were down 1% at $47.4 million compared to $48.1 million in Q2 2006. Royalties in the quarter were affected by normal seasonality, the semiconductor industry inventory correction, and lower foundry utilization levels. Royalty revenues, which accounted for 37% of group revenues, comprised $40.1 million from PD and $7.3 million from PIPD.

The iPhone sales as such might not contribute much to ARM’s revenues. However, the impact of the iPhone on the mobile phone industry as well as the laptop industry and the move toward convergence devices would be highly beneficial for ARM. Its stock is trading between $8 and $9. The company is well-aligned with the convergence trend, and should see good growth in the upcoming years. I don’t think investors understand why this company is important, and hence, the trading volume and analyst coverage is pretty low. Could be a bargain.