4 Reasons to Buy This Mobile Chip Stock

I did it. I pulled the trigger and am now a shareholder of ARM Holdings (Nasdaq: ARMH  ) as of last week. I told you weeks ago that I was considering picking up shares. Here are the reasons I couldn't sit on the sidelines any longer.

One of a kind
The company's distinct position in the mobile supply chain gives it opportunities unlike any other chip company. By spreading the cost of R&D throughout the industry and licensing out the technology while collecting royalties, the industry as a whole benefits from ARM's role by saving an estimated $20 billion annually compared to if every company had to do its own R&D. These cost savings inevitably result in cheaper products for you and me. By leaving the chip fabrication to semiconductor manufacturers, the company also doesn't have to burden itself with the billions of capital expenditures associated with operating a chip foundry.

To say that ARM dominates the mobile chip market is an understatement; it owns the market.

Widespread mobile CPUs like Qualcomm's (Nasdaq: QCOM  ) Snapdragon and NVIDIA's (Nasdaq: NVDA  ) Tegra are built on ARM technology. This includes NVIDIA's recent superhero quad-core chip that just began shipping.

Other bigwig tech players supporting ARM include Texas Instruments, Samsung, and Marvell Technology. Apple's (Nasdaq: AAPL  ) custom A5 chip also uses ARM technology. The list goes on and on, with a total installed base of more than 800 licenses. ARM-designed chips are used in more than 95% of mobile phones and are starting to make their way into other computing devices.

Arm-in-arm to new markets
With Microsoft (Nasdaq: MSFT  ) already including ARM support in Windows 8 and talk of Apple testing ARM-powered MacBooks, the stage is set for an invasion into Intel's (Nasdaq: INTC  ) home turf. Even as Google's (Nasdaq: GOOG  ) Chrome OS and Chromebooks have yet to make a dent, that OS also packs ARM support.

Market analysis firm iSuppli predicts that ARM processors will take a 20% market share of laptops by 2015, foreseeing a sea change led by Windows 8 as laptop makers include the chips in favor of low power consumption, lower cost, and high performance.

Other areas for potential growth in the coming years include microcontrollers, automotive, digital cameras, digital TVs and set-top boxes, and 4G base stations, to name a few.

They always come back for more
Each license sold generates recurring royalty revenue for years to come. Royalty revenue as a percentage of total revenue has been on the rise, along with gross margin -- 94.8% last quarter. Operating margin also hit a record high at 44.5% recently.

Source: ARM Holdings investor relations.

On top of that, new license activity continues to gain momentum -- 91 new licenses inked in 2010 compared to 87 in 2009 and 61 in 2008. It takes an average of three to four years before a licensee begins producing chips and paying royalties, so all the recurring revenue from those new licenses is still in the pipeline.

Stacking up
Last quarter's revenue grew by 27% while competitor MIPS Technologies (Nasdaq: MIPS  ) recently reported a 24% drop in its sales. ARM does trade at a notably higher valuation than its competitors, but also has shown more promising growth.

Company

Price / Sales (TTM)

Sales Growth (5-Year)

Gross Margin (TTM)

Return on Equity (TTM)

ARM Holdings 17.8 11.8% 93.9% 10.2%
MIPS Technologies 3.5 5.1% 98.4% 23.3%
Intel 2.1 2.4% 63.0% 25.9%

Source: Reuters. TTM = trailing 12 months.

Even though the company's return on equity is lower, keep in mind that ARM carries no debt on its balance sheet, whereas Intel carries roughly $2.3 billion in debt. That leverage will boost return on equity when times are good, but, like any leverage, can hurt when times are tough.

The mobile market is only the first to be conquered by ARM. The momentum it has gathered will carry into multiple other sectors for potential expansion and drive sales growth for years. Consumers typically upgrade smartphones every two years -- once those pesky contracts are satisfied -- which will keep generating cash for the company from the mobile market even as ARM widens its horizons.

The long haul
There's a lot to look forward to in the coming years as a newfound ARM shareholder. The company has already benefitted from society's mobile push, which is just beginning, and I think this one will be a winner for the long haul.

Fool contributor Evan Niu recently purchased shares of ARM Holdings. He also owns shares of Apple, but he holds no other position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Apple, Microsoft, Google, and Qualcomm. The Fool owns shares of and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Intel, Apple, Microsoft, Google, and NVIDIA. They have also recommended creating a diagonal call position in Intel and a bull call spread position in Microsoft and Apple, as well as writing puts in NVIDIA. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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