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Arm wrestles with royalty slowdown

Arm is exposed to plenty of exciting technologies, but slowing royalty growth is a concern.
July 22, 2014

Growing appetites for mobile devices, wearable computers and connected homes, cars and workplaces are fuelling demand for microchips. That trend helped Arm Holdings (ARM), which licenses out semiconductor designs to manufacturers and then collects a royalty for every chip they ship, give a strong first-half performance that sent its shares up 5 per cent.

IC TIP: Hold at 874p

Buffeted by currency headwinds, Arm's sterling sales climbed 9 per cent to £374m - compared to a 16 per cent rise in dollar terms. Those gains reflected a 35 per cent rise in technology licensing revenues to £171m, as its technology drew customers from the mobile, consumer electronics and enterprise markets. It also signed 67 processor licences in the period, taking its total north of 1,100. And more than 5.6bn Arm-based chips were shipped last half, an 11 per cent increase.

Investors may be less impressed by the group's royalty revenues, which fell 7 per cent to £167m and inched up only 2 per cent in dollar terms. Moreover, its royalty per chip clocked in at 4.6¢ last quarter, compared to 5¢ a year earlier. And its second-quarter order backlog was 10 per cent lower than in its first quarter. Arm blamed these trends on seasonal weakness, supply-chain inventory reductions and a slowdown in the premium smartphone market.

Nevertheless, Arm's pre-tax profits - adjusted for one-off items - grew 9 per cent to £191m. And its licensing gains should feed future royalty flows, points out finance chief Tim Score, emphasising that Arm is a "very long-term business". He expects Arm to benefit from the shift to faster '4G' broadband technology, as smartphone manufacturers will need Arm's energy-efficient, low-cost microchips and access to its "massive ecosystem of partners".

Arm plans to outgrow the wider semi-conductor industry this year by selling its latest technology to device-makers - it has already signed 50 licences for its newest version 8 technology. Analysts also expect the launch of key customer Apple's iPhone 6 this autumn to re-ignite demand for high-end smartphones, lifting Arm's royalties.

Broker Investec expects pre-tax profits of £407m this year, giving EPS of 23.2p, rising to £498m and 28.7p in 2015.

ARM HOLDINGS (ARM)
ORD PRICE:874pMARKET VALUE:£12.3bn
TOUCH:873-874p12-MONTH HIGH:1,112pLOW: 811p
DIVIDEND YIELD:0.7%PE RATIO:77
NET ASSET VALUE:98p*NET CASH:£746m

Half-year to 30 JunTurnover (£m)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
2013342824.52.10
20143741468.42.52
% change+9+78+87+20

Ex-div: 3 Sep

Payment: 3 Oct

*Includes intangible assets of £603m, or 43p a share