FTSE 350 technology hardware & equipment: High-tech poised for high growth

Certainly, the so-called 'megatrend' that has driven this is far from over, either – smartphone sales are expected to climb 28 per cent this year to 917m; tablet sales will climb at an even sharper rate, up 42 per cent to 166m units. And, as these devices become more sophisticated they need more chips, meaning further strong flows of royalty revenues for the likes of Arm (ARM) and Imagination (IMG), which sell their designs for others to manufacture rather than fabricate chips themselves. Arm's partners shipped 2.2bn chips in its third quarter, generating a 27 per cent increase in royalty revenues; Imagination saw royalties leap 66 per cent in the last six months, and both are on course for further royalty growth well in excess of the market in 2013.

Arm and Imagination's operational gearing means both enjoy high margins and strong cash generation. But investors should nevertheless be wary of the resultant lofty valuations, not to mention the ever-present challenge chip designers face in keeping one step ahead of technology cycles and avoiding 'design-out'. For the sector's biggest constituent, Arm, that's less of a worry, but few others are safe.

Take graphics chipmaker Imagination, for example This year, high volume licensee Texas Instruments said it was exiting the smartphone market, and despite recent strong financial performance there has been what broker Numis described as a "crisis of confidence" around the group's continued relevance in the chip industry. Wireless chip giant Qualcomm has developed its own graphics processor, which it's integrating into its Arm-based processor chips, Snapdragon. That approach is increasingly demanded by phone and tablet manufacturers as they attempt to squeeze more functionality into ever smaller devices – for chipmakers it can generate higher margins and prevent design-out.

In answer, it's since decided to splash out $100m (£62m) on the acquisition of lossmaking US chip designer MIPS, which will help it develop integrated chips that includes both graphics and core processing functions, but there are concerns, though, that it will still remain a relative minnow. "Fundamentally, we believe Imagination's proposed acquisition of MIPS makes strategic sense. However, it faces an uphill task in making MIPS' CPU architecture relevant once again, in an increasingly Arm-dominated world," said broker Liberum. But broker Numis believes there is still plenty of room in markets such as automotive, industrial and home networking. Around half of Arm's 200 licensees are in the mobile space.

The sector's second best performer last year, CSR (CSR), is certainly evidence that such technology challenges are not insurmountable. We recommended the shares as a speculative buy in May at 213p on the basis that the market had failed to recognise the steps it had taken to transform its business from one focused on low-value connectivity chips for mobile phones – technology that was increasingly being incorporated into rivals' multi-function chips – to a more diversified business with leading positions in higher-margin segments. That process was accelerated by a deal to offload the low-margin connectivity division to Samsung in August, and the shares leapt.

With its restructuring largely complete, such spectacular one-off gains can't be expected this year from CSR, but the foundations are in place for steady profit increases this year, once again from targeting non-mobile segments such as home business, automotive and health. It's a similar story at mobile antennae and materials group, Laird (LRD), which is also starting to see the benefits of judicious acquisitions and disposals throughout the year, and a strategic review by its new chief executive. Cash profit margins are rising as a result, which along with steady dividend growth should help it close its hefty rating discount to sector peers in the year ahead.

Similar dealmaking is likely to continue across the sector in 2013, because the fast moving nature of the industry means that companies are always seeking to bolster their technology capabilities – as small UK chipmaker IQE (IQE) did last week with its acquisition of Kopin Wireless – or are snapped up by predators looking to do the same.

That's especially true for US chip giant Intel, which has struggled to replicate its success in PC processors in mobile devices with its Atom chips. Arm is often touted as a likely target, and there are certainly many big technology companies that would like to get their hands on its intellectual property. But its price tag may be too rich, even for cash-rich technology buyers, and competition issues may prevent an approach from Intel or even Qualcomm, now the world's third-largest chipmaker. A more manageable morsel would be Imagination – Intel already holds a 16 per cent stake, with Apple also owning another 9 per cent of the company.

One thing is for certain – this won't be an industry that stands still this year.