ARM Holdings (ARMH) has had a terrific run up over the last five years, going from about $5/share to a high of $31.55, primarily on significant penetration in the smartphone and tablet markets. While the smartphone and tablet markets are growing quite well, and while there is hope that the ARM ecosystem will begin to gain a foothold in the traditional PC space as well as the server markets, ARM itself isn't going to be the main beneficiary of such a shift in the computing world. Why?
Well, first, it's important to understand exactly what ARM Holdings does. It designs microprocessor cores, as well as graphics processing units, for use in a wide variety of embedded applications, from toasters and refrigerators to solid state drives and smartphones. These "core" designs are then licensed to companies who take these cores, design what is called a "system-on-chip" [SoC] around these cores, and then those SoC designs are sent to fabrication plants to have the devices actually built.
For each device sold, ARM Holdings receives a royalty. This is why, despite such large market penetration of their designs, for the trailing twelve months, the company took in a mere $798.50M in revenues and had a net income of $201.92M. The company is by no means unsuccessful, but it is also trading at 54.88x past earnings and 28.82x forward earnings, leading me to believe that there are better deals in the ARM world. Here are my favorite ones:
1. Taiwan Semiconductor Manufacturing Corporation (TSM)
Taiwan Semiconductor is the largest pure-play fabrication company, manufacturing chips for the whole gamut of fabless semiconductor designers, such as Qualcomm, Marvell, NVIDIA, and many others. The barrier to entry in the fabrication space is incredibly high and as semiconductors become even more prevalent, there will be an increased need for fabrication capacity.
The company is trading at 17x past earnings and 12.89x forward earnings. In addition, the company yields 2.90% on an annualized basis. I believe that one of the safest ways to invest in semiconductors is to buy the companies that all of the other semiconductor manufacturers need.
2. Qualcomm (QCOM)
Qualcomm is one of the leading producer of wireless baseband chips in addition to one of the leading developers of ARM based SoCs. The interesting thing about Qualcomm is that it develops its own CPU cores based on the ARM instruction set, so it is not bound to the relatively slow release schedule that ARM has for its core designs. In addition, with the purchase of Advanced Micro Devices' (AMD) mobile GPU division in 2008, Qualcomm also develops its own graphics processors for its SoCs.
Qualcomm trades at 16.96x past earnings and 13.59x forward earnings. In addition, the company has a fairly massive net cash position of about $14B, so it has ample resources to invest in securing fab capacity, invest in R&D, increase the dividend, and buy back shares.
Qualcomm is certainly a solid performer with a nice, clean balance sheet, and a very strong competitive position in the industries in which it competes.
3. NVIDIA (NVDA)
NVIDIA is one of the leading designers of graphics processing units that are used in everything from smartphones to high performance computing clusters and everything in between. The company is betting large on the ARM ecosystem with its "Tegra" line of SoCs. The company uses standard ARM core designs coupled with its own graphics technology, which is among the best in the industry. However, management has been aggressive in talking up its upcoming "Project Denver", which is an NVIDIA-designed CPU core that runs the ARM instruction set. The target markets of "Project Denver" are both the traditional PC ecosystem, as well as the server market.
The company is trading at 16.79x past earnings and 14.68x forward earnings, which seems reasonable for a growth company. There is a nontrivial degree of risk here: the competition among the ARM SoC vendors is fierce and it is by no means guaranteed - or even likely - that ARM based chips will be able to take significant share from the x86 chips from Intel (INTC) and AMD in the PC space - but the strong presence as a GPU vendor, coupled with the success of the "Tegra" line for smartphones and tablets, makes this stock attractive to own.
4. Marvell (MRVL)
Marvell seems to me the most under appreciated and diversified company on this list. It develops a multitude of semiconductor devices, including network processors (wired and wireless), controllers for storage (hard disk drives and solid state drives), application processors, and a whole lot of other chips. Marvell, like Qualcomm, licenses the ARM instruction set for the microprocessors it designs, but it designs its own cores, as well as its own SoCs. The company has its hand in almost everything semiconductor.
The company is trading at an incredibly cheap 12.08x past earnings and an even 7.78x forward earnings. The company has no debt, and a strong $2.20B cash position. Book value per share is an astonishing $8.74. Further, the company yields a generous 2.16% and has a buyback program of $2.5B in place.
Additional disclosure: I may initiate a long position in MRVL within the next 72 hours.