Has ARM Holdings Gotten Ahead Of Itself?

While ARM Holdings (NASDAQ: ARMH  ) indeed plays a critical role in the mobile future of computing, the company's current valuation seems a little overly optimistic.

Even though ARM's place in the value chain is unique, I've questioned the company's ability to effectively monetize its chip architecture designs, which led me to sell my own shares nearly a year ago. Since getting out, shares have continued to rally and are up nearly 60% in the past nine months, trading over $42 just last week.

ARMH Chart

ARMH data by YCharts.

Has ARM gotten ahead of itself?

In fact, the only thing that knocked ARM back a couple dollars from that high was a downgrade form Morgan Stanley on valuation concerns. That wasn't the only analyst expressing concern, and other skeptics include Benchmark (to hold) and Bernstein Research (to underperform). As skeptical as I was last April about ARM, I'm even more doubtful now.

On one hand, royalty-bearing unit shipments continue to soar along with adoption of smartphones and tablets, although the average royalty rate per unit has been on a steady decline over the years.

Source: ARM.

This chart is separated between prior years and ARM's 2012 results through the third quarter. The company is on track to increase royalty units again in 2012 if it can collect royalties on at least another 1.7 billion chips.

At the same time, shares now trade at nearly 80 times earnings and 21 times sales, yet revenue only grew by 18% last quarter.

Instead of investing in ARM, its licensees create more value within the chain and therefore garner more profits. That's precisely why I own shares of both Apple and Qualcomm, two of the few companies that license an architecture instruction set in order to create custom ARM-compatible processing cores (Swift and Krait, respectively).

ARM's monstrous run over the past year has it now priced to perfection, and in this case even its solid prospects don't quite justify the valuation. That's why I'm giving it an underperform CAPScall today.

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  • Report this Comment On February 19, 2013, at 2:29 PM, nofoolingforme wrote:

    So sorry you jumped ship when you should have stayed on board. I read many articles a year ago saying it was overpriced when it was in the twenties. They were wrong then, just as you are now.

    You are right when you say that ARMH is unique and though it seems ubiquitous already, its applications are only now beginning to be exploited.

    People's phones will be linked to every other device in their lives, from their televisions to their toothbrushes. More and more, people are able to monitor and control their appliances and other household activities wirelessly and remotely with their mobiles. You can tap into your home security system, turn on the oven, turn up the heat and do so many things now, and it is only the start. One day you will be able to tuck your kids into bed, when you are miles away.

    The kind of chips that ARMH develops and licences makes these things possible and no one else is in the game to any degree. Yes, Intel and others will be wedging their way into this lucrative area, but, there will be so much demand for this technology that ARMH will continue to have plenty of space to expand and increase profits.

    If investors sell now, they will be regretting it like you must be kicking yourself for bailing out a year ago. It is not too late for you to buy back in and profit.

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