Big.LITTLE - A Breakthrough Infrastructure

| About: ARM Holdings, (ARMH)
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With the intense smartphone battle going on, the need for a breakthrough platform is becoming more pervasive. Poor battery backup and slower processing have been pain-points for smartphone users for a long time now. As we enter into 2013, users should be looking for new technologies which would quench the need of a better platform. The big.little processor architecture for the next generation chips is one such example. It is a new architecture by ARM Holdings plc (ARMH) which provides an amazing combination of high performance and less power consumption. The motive is to develop a multi-core processor which can automatically adjust to the changing computing needs. The first set of big.LITTLE has a powerful Cortex-A15 processor which is 50% faster than the current processors and the economical Cortex-A7 which is the most energy efficient processor from ARM. I think, this unique combination will be a wave creator for the future generation of smartphones (few slated to launch this year) and will give a competitive advantage to ARM in the Smartphone/Tablets market.

The Trigger

Recently, the Consumer Electronic Show 2013 at Las Vegas brought some positive news for ARM Holdings. In the show, Samsung announced the launch of its latest processor 'Exynos5 Octa' which is the first chip to include big.Little technology. Samsung's upcoming products under its flagship brand Galaxy Note III and Galaxy S IV are expected to use this processor for enhanced performance. The stock reacted positively to this news and it reached its highest level of ~$42 since 2001. I feel this huge demand of big.little technology is a strong indication towards the improving royalty revenues for the company.

The Battle Evolves

This technology will further heat up the race between ARM and Intel Corporation (INTC). The launch of the big.Little technology would further aggravate risks of Intel for losing its market share in the Smartphones market. This was clearly visible in its fourth quarter results declared recently. Its revenues were down by ~3% to ~$13.5 billion and the net income fall by ~27% to ~$2.5 billion. Even though it is still unbeatable in the PC space today, its roadmap needs a turnaround as far as the smartphones are concerned. An important move in this direction would be its upcoming launch of a new Smartphone platform at the MWC (Mobile World Congress) in Feb '2013. It will include new Atom processors based upon 22nm and 14nm processes for lesser power consumption. Via these processors, Intel is targeting at the rapidly growing market for low-end Smartphones especially in the emerging economies.

The Ultimate Winner

One company which should benefit this year from the race of enhanced processors would be ASML Holdings (ASML). The company provides semiconductor processing equipment used in the circuits, chips etc. It has a vast portfolio of lithography systems and is strategically positioned as the processor industry's key supplier. To enhance its position, ASML recently acquired Cymer Inc. for ~$2.5 billion for developing more advanced semi-conductor devices. Cymer is the largest supplier of ultraviolet light sources which will help ASML to make small and better chips for the future smartphones and tablets. Via this acquisition, ASML would enhance its capabilities to develop new technologies for its customers. I expect ASML earnings to grow by ~29% annually for the next two years mainly driven by its top-line growth. Also, this acquisition will enable the company to strengthen its leading position in the industry with some big names as its customers.

What Investors Should Expect

Coming back to ARM Holdings, another favorable aspect on which I place my confidence is its royalty revenue which is currently ~50% in the total revenue. ARM's average growth rate in the royalty revenue has outpaced the industry growth rate by ~10-15% in the last three years. This was mainly driven by its high value Cortex A chips shipments which have doubled this year. Cortex A accounted for around 9% of the total shipments (up from 5% y/y) in the company's last earnings. However, it contributed ~35% to the royalties of the company. Its Cortex A designs which are heavily used in smartphones and tablets, are more expensive than its traditional designs which explains the higher profitability. Looking at its huge success in the Cortex A chips and taking into account the upcoming big.LITTLE architecture using Cortex A chips, I expect the overall royalty revenue to grow at ~24% CAGR in the next two years.

I believe this is good entry point in ARM's stock for the investors for near as well as long-term returns. The Smartphone market is growing at a rapid pace and is expected to account for ~54% (up from 46% in 2012) of the total cell phone market in 2013. This leaves a huge opportunity for the company to grow its revenues and increase its market share. I expect the company's EPS to grow annually at ~27% for the next four years as compare to its ~20% CAGR growth delivered in the last 8 years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.