Fool Duel: Buy MIPS, Sell ARM

There's nothing like a good rivalry. Whether it's Frazier vs. Ali, Giants vs. Redskins, Seminoles vs. Gators, or bulls vs. bears, a good conflict always inspires deep thought and great conversation.

That's why I'm facing off against fellow Fool Evan Niu today. We're not particularly famed antagonists ourselves, but we're on separate sides of a very hot investor clash: ARM Holdings (Nasdaq: ARMH  ) against MIPS Technologies (Nasdaq: MIPS  ) . I'm here to defend MIPS' long-term growth prospects against ARM's already mature and overvalued business.

The tale of the tape
In the blue corner, we have defending mobile processor champion ARM. The company's processor technologies currently power the trillion-dollar mobile revolution. Whether you're looking at smartphones or tablets running Android, iOS, BlackBerry OS, or Windows Mobile, there's probably an ARM-based chip inside.

In the green corner, there's a little upstart called MIPS. More commonly found in network routers and home entertainment systems today, MIPS is making its way into Android tablets and smartphones as we speak.

Metric (TTM unless otherwise noted)

MIPS

ARM

Year Founded (not TTM) 1984 1990
Gross Margin 98.5% 94.4%
Revenue Growth (17.6%) 21.0%
Price/Sales 4.9 16.5
EV/EBITDA 30 49

Source: S&P Capital IQ as of Feb. 3, 2012. TTM = trailing 12 months.

ARM and MIPS are alike in many ways. These are no Johnny-come-latelies, but seasoned veterans with decades of operating history. Both run extremely profitable business models based on licensing chip technologies to actual processor designers, and their products are known for high performance in small, low-power packages. And both stocks look expensive in the context of the semiconductor industry: Blue-chip rival Intel (Nasdaq: INTC  ) sports a price-to-sales ratio of 2.5 and EV/EBITDA of just 5.4 today.

Twins separated at birth? Not quite.
But as much as these stocks look alike, they're also fundamentally different. One company has had most of its fun and should be peaking any day now, while the other is on the rise.

MIPS was late to the smartphone party. Like Intel, the firm was stuck on the sidelines as Apple (Nasdaq: AAPL  ) created whole new industries with the iPhone and iPad, and as competitors started to rush into the new space. Over the last five years, ARM shares have soared nearly 290% while MIPS is down 23%, trading largely sideways throughout the mobile revolution.

ARM investors surely deserved this jump. Mostly thanks to Apple and Google, mobile computing has exploded and ARM reaped the rewards along the way. But the greatest growth is actually several years behind the company now, while MIPS is just getting hungry.

That's just wishful thinking, dude!
Over the last five years, ARM's adjusted earnings have jumped an average of 19% annually on 13% higher sales. That's the growth that powered phenomenal shareholder returns. Kudos, applause, maybe a medal is in order. But that's all in the past.

For the next five years, analysts expect ARM's earnings growth to slow to 15% a year. That's deceleration, my friend. But the stock is priced for astronomical growth.

On the flip side, MIPS has actually been shrinking lately as the networking and home entertainment sectors have run into their own challenges. That's why the stock is so much more affordable than ARM's. But in the next few years, Wall Street projects 19% compound annual earnings growth.

And there's a mobile wind at MIPS' back. MIPS-powered Android gadgets are only just making their way into stores in America and China these days. But MIPS chips power the first next-generation Android 4.0 tablets, code-named Ice Cream Sandwich.

Not only did MIPS deliver a competitive product, but it beat ARM to the punch. It's a transformative moment in the ARM and MIPS rivalry. Building on this success, MIPS should find its way into a plethora of Android devices in 2012 and beyond. All of this happened merely a year after MIPS decided to pursue the mobile market in the first place.

So the ARM story should repeat itself in MIPS with outsize market returns to follow. Meanwhile, ARM must contend with plenty of new competition as both MIPS and Intel are going after its strongest traditional markets. Heck, even Advanced Micro Devices (NYSE: AMD  ) is talking tablets nowadays, though that company thinks the smartphone market is too crowded to be worthwhile. I'm pretty sure the historic stock run is over for ARM, while MIPS still flies under Mr. Market's radar.

I rest my case, Evan. Buy low and sell high, my friend.

Check out my colleague's attempt to turn this rivalry on its head, then vote with your feet. I've got a big, green thumb on MIPS and a red one on ARM in my all-star CAPS portfolio and Evan votes the other way around. Now it's your turn to grab a totally free CAPS account and tell the world who the real winner is.

Fool contributor Anders Bylund owns shares of Google but holds no other position in any of the companies mentioned. The Motley Fool owns shares of Google, Apple, and Intel. Motley Fool newsletter services have recommended buying shares of Google, Apple, and Intel. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Check out Anders' holdings and bio, or follow him on Twitter and Google+. We have a disclosure policy.


Read/Post Comments (6) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 06, 2012, at 7:31 PM, jameskm03 wrote:

    You are both wrong. Intel is now laser focused on mobile as their future growth and outspend these two companies combined in R&D. Medfield is a big step forward but over the next few years we'll see Intel win because they can get their footprint down to 22 nm and then 14 nm years ahead of anyone else. It's going to be a bloody battle but Intel is to big and good at what they do.

  • Report this Comment On February 06, 2012, at 10:50 PM, lanceim59 wrote:

    I agree with the previous comment.

  • Report this Comment On February 06, 2012, at 11:14 PM, jdwelch62 wrote:

    Me, too!... :-)

  • Report this Comment On February 07, 2012, at 9:38 AM, Minow wrote:

    I think as a result of Intel being late to the show (mobile) they made a bid on MIPS, and ARM won't stand by stand idly...because they need to capture more growth or market share, maybe a biding war erupts over MIPS, that's if their truly worth the growth!

  • Report this Comment On February 07, 2012, at 1:35 PM, jdwelch62 wrote:

    @Minow: Not sure about that. I think Intel is committed to using Intel Architecture (IA), that is, x86 architecture, in mobile devices, and are not interested in acquiring MIPS for their IP, if that's what you're implying. I could be wrong, of course...

  • Report this Comment On March 10, 2012, at 3:08 PM, ibankingcrooks wrote:

    The real future is not in mobile, its micro controllers. There will be 10x as many microcontrollers as there are mobile devices.

    That war is just beginning. The Cortex M3 and M4 are decent products, but MIPS could still make serious inroads. Their microcontrollers are better in a lot of ways.

    MIPS needs to get with the program with design wins here, before they miss this boat also.

    ...and Intel has no chance in mobile. Perhaps in Windows tablets - but still unlikely. If anyone should buy MIPS it should be AMD.

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