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Ashraf Eassa
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  • Reflections On ARM 7 comments
    Mar 11, 2013 1:03 AM | about stocks: ARMH

    As someone who is fairly public with his calls here on Seeking Alpha, I will tell you that I get a lot of flak. For every couple of folks who appreciates the effort I put into a piece, there's always that individual that takes my work personally and sends a particularly hateful message to my inbox. I get it, especially whenever I make a bad call (and believe me, it happens; I'm only human), and sometimes it can be downright demoralizing. Sure, the "red" in my account hurts too, but I usually have enough convictions in my position to be able to wait it out (and I don't risk enough on any one position to crater my portfolio if it turns out I'm really wrong)

    Today, I'm going to take a step back and analyze just what's "going wrong" with my call on ARM Holdings (ARMH), a company that I have been wrong on thus far (short recommendation at $37 - $38 on November 28th). But first, let me explain my motivation for writing this.

    People Hate Short Sellers

    It's unfortunate, but sometimes a piece of "hate mail" really sticks out to the point where I feel it necessary to respond. This particular message was sent to me filled to the brim with ad hominem attacks:

    (click to enlarge)

    In this message, I am accused of "causing subscribers to lose their hard earned money". making "psychotic statements", and for being completely clueless. Now, I have to defend myself and point out that I did not recommend shorting ARM until the stock hit the $38 level, so anybody following my advice is down only a mere 12%. Not the best call on the planet, but certainly not the biggest wealth destruction move ever. One sizable correction and anybody who followed me can get out unscathed (or just sell a LEAP put and call it a day, but I digress...)

    Further, I need to defend myself on the accusation of "psychotic statements" -- everthing I write is backed up with hard data when applicable, and when I take liberties to "guess" on where I believe the industry is going, it is usually accompanied with reasoning that is, to the best of my knowledge, based on factually correct notions. I could be wrong, but I certainly take issue with being accused of beingdishonest.

    On the issue of being "clueless", I will simply defer that judgement to my readers at large, as my perspective is likely to be colored by the notion that I am, in fact, biased towards myself!

    Anyway, this article is being written to be useful, so I'll get to the point that I'm trying to make: analyzing my mistake with respect to the ARM short position.

    Investing Versus Trading

    When it comes to taking any position (long or short), you have to ask yourself a couple of things:

    • Am I taking a long term position or a short term position?
    • Are you taking a position on what you believe regarding the fundamentals, or are you trying to swing trade?
    • Can you afford to be wrong in the near- to medium term?
    • Can you afford to be wrong in the long term? If so, what would cause you to give up?

    A quick look at ARM's chart shows a stock that's actually quite nicely intact:

    (click to enlarge)

    Look at that...beautiful! Stock is above the 50 DMA, the 50 DMA is above the 200 DMA, and ARM's CEO is great at rallying up the investment community on why ARM is the best company ever.

    If you're looking for a near-term trade, then I would look at waiting for the stock to test the 50 DMA. If it can hold that level, then it might be a good idea to buy the bounce, but if it breaks through that on heavy volume, then it's probably best to sell/short it. I'll leave it to hardcore charting software and chart experts to make that call.

    But if you're in this for the long term and actually have a thesis in mind, then you have to come up with what you think the company is worth (multiple, and then your model of future earnings/growth rate). If your model suggests that the risk/reward looks good, then make your particular bet and have the means to remain solvent no matter what. Hedge appropriately, have an exit strategy, and so on. I personally think the stock is worth $20 - $25 per share, and I further believe that upside risk is probably about $3 - $5 from here, so I'm still shorting. However, someone else may have an entirely different view/model, and I certainly respect that.

    But see, it doesn't matter that my initial call at $38ish is down -- so what? $5/share? Again, that's 11% so not exactly breaking my bank, especially as I still believe that in the end, I'm going to make money. But I have to deal with the idea that I could be wrong, and I have to accept that it could cost me money.

    Am I Wrong?

    When a position goes against you, it is imperative to ask "why" it's going badly. In order to truly know your position, you need to have a exquisite understanding of the opposing view. So, as ARM continues its rise, I ask myself, "am I wrong?"

    To answer this question, I ask the following sub-questions:

    • Do the 2014 earnings estimates on which the forward multiple is dependent look reasonable?
    • Are the main drivers of the stock price still intact?
    • Does it look likely that the thesis that I have in mind will play out within a reasonable time frame?

    Right now, I believe ARM is flying high because of its dominant position in smartphones and the multiple growth opportunities that the Street sees in servers, internet of things, and so on. The expectation is that in 2013, revenue growth will slow slightly to ~15% from 2012's 19%, but then accelerate in 2014 to post 17% growth. The idea, then, is that since ARM's IP licensing/royalty model offers fairly substantial earnings leverage, that EPS will grow quite substantially over these next couple of years from $0.70/share in 2012 to $0.85/share in 2013 and $1.12/share in 2014 (note the dramatic acceleration into 2014).

    My view is that such acceleration, especially by the end of 2014, will be impeded primarily by Intel's (INTC) increasingly aggressive push into the smartphone/tablet space (35% of ARM's net income comes from these spaces), which should, at the very least, keep ARM from raising royalties on its licensees in a bid to compete with Intel, which has a very favorable cost structure for this kind of business. I also think that a potential dark horse in the form of Imagination Technologies, especially with all of the key MIPS (MIPS) CPU IP, could emerge as a viable alternative for low cost core/graphics IP for the rapidly growing, low cost smartphone/tablet spaces which further caps any potential royalty license rate increases on ARM's part.

    I could be wrong, but that is the bet that I am choosing to make, especially as past history has shown Intel to be a voracious competitor in the end markets that it chooses to compete in, albeit it is not always quite "first".

    As far as I'm concerned, those 2014 estimates are far too high, and my thesis will either be proven or disproven as 2013 marches on, especially as we see Intel become much more fierce a competitor in tablets in the second half of 2013. Smartphone share gains, I expect, don't really have a material effect on ARM's growth rate until 2014.

    So as far as a long term thesis, I still see no reason to believe it to be false, but in terms of purely short term drivers, I don't see an immediate catalyst to help compress ARM's valuations. It is very likely that I will continue to be "wrong".


    Shorting a stock on valuation is tough, especially when the catalyst is seemingly nearly a year away. I expect this position to continue to be "painful", and I wouldn't be surprised if I keep looking like I'm "wrong" for the near future. Short positions are tough to hold, and I could end up coming out of this looking completely wrong, but before writing me off as someone who spouts "psychotic" statements, understand that there is a rationale here. I want to make it clear that you should only follow this trade if you believe that the negative catalysts that I believe will show up will actually show up. In short, my articles are a starting point for further research, and incremental datapoints as they become available. I try my best to make good calls, but I'm only human.

    Disclosure: I am short ARMH.

    Additional disclosure: long INTC

    Stocks: ARMH
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Comments (8)
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  • Ashraf


    No doubt you are aware that voicing an opinion in public will undoubtedly garner the attention of the odd vitriolic response, it just comes with the territory.
    Your excellent piece on Andy Zaky (Apple Investment) should make all your readers aware (if they have read it) that no one is infallible and that those that make a decision to invest in the market are ultimately responsible and accountable for their own actions.


    Great writings and ideas, keep it up.
    11 Mar 2013, 01:38 AM Reply Like
  • Author’s reply » Thanks, Bowtie.


    I would also like to point out that I intentionally made this article available via the Instablog platform (i.e. non-paid) to avoid any accusations that I am merely trying to capitalize on a response to very serious criticism.
    11 Mar 2013, 01:55 AM Reply Like
  • Ashraf,


    You do great work, my friend. I am a follower who respects your ideas even if I don't always agree. You make a reasoned case for your positions and that, rather than being consistently correct, is why I read your work. I don't expect perfection in predictions. I expect sound reasoning and careful thinking. Ad hominum arguments suck and can really hit hard. Ignore them. Keep up what you are doing.
    11 Mar 2013, 10:02 AM Reply Like
  • Author’s reply » Thank you, drcarl. I hope to continue to provide you, and the rest of my readers, with quality, informative work.
    11 Mar 2013, 12:14 PM Reply Like
  • Anyone who invests or trades based solely on an article shouldn't be investing anyway. Ashraf, I appreciate your articles along with the other writers on SA. However, I don't invest based on what you and the other authors write. I just use your articles as starting points or a way to connect some dots along my due diligence journey. Ashraf, I appreciate your courage to publish articles that can cause you to receive some nasty backlash. You obviously do your homework and know your stuff. Those who do not follow up on what you and others recommend by doing additional due diligence deserve to lose their money. Keep doing what you are doing. For every bone head that has to feel better about themselves by tearing another person down, there are a handful that truly appreciate your work and effort. Thank you.
    11 Mar 2013, 12:04 PM Reply Like
  • Author’s reply » You're quite welcome, jaych79. I write my articles to be helpful pieces of research :)
    11 Mar 2013, 12:13 PM Reply Like
  • Ashraf,


    As far as I'm concerned, your rarely wrong, from a tech perspective. However, consumer markets that these gadgets are sold into are, unfortunately not as nearly educated as someone like you. People buy what is cool, which is not always what is the best. Further the stock market follows the consumer market. It is often a case of the blind leading the stupid!


    So what is a reasonable person to do, when irrationality reigns supreme? I say keep doing what your doing, educate people on the technical aspects of these stocks and stick to your guns. The longer the irrationality lasts, the bigger the fall once it breaks.
    15 Mar 2013, 12:52 AM Reply Like
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