Probably the biggest growth driver in the technology sector right now is the ongoing shift to mobile computing and the products and components that make this transition possible. It is in this paradigm shift that ARM Holdings (ARMH) has gone from a little-known market participant to a nearly household name; a close partnership with Apple (AAPL 0.64%) that ties the iPhone to the ARM-based processor has not hurt that effort, either.
As things currently stand, despite the fact that the semiconductor industry is facing some real challenges, both the smartphone and tablet markets are growing rapidly. There are some real risks that must be addressed -- both in terms of direct competition and a shrinking potential customer base -- but the company appears to be in good shape heading into 2013. Given the totality of the circumstances, ARM is a buy at current levels.
Where is the market going in 2013?
In a recent report from Gartner, the firm lowered its growth estimates for 2013 based on various factors. Principal analyst Peter Middleton said, "The looming fiscal cliff, ongoing European debt crisis, slower emerging market growth and regional tensions have all played a part in reduced growth projections for semiconductor revenue in both 2012 and 2013." He further noted that high inventories at the outset had aided in supply outpacing demand for the immediate term.
Of particular importance for ARM are the projections that center on those chips used by Apple -- licensed from ARM -- to make its devices function : "The 'Apple effect' is expected to remain pronounced in 2013, helping drive strong NAND and application-specific integrated circuit (ASIC) revenue growth of 17.2 percent and 9.4 percent, respectively. Gartner counts the A4, A5 and A6 application processors from Apple as ASICs, because these are custom processors, designed and solely used by Apple." The conclusion, therefore, is that while the industry is experiencing a general slowdown, the chips most known for driving ARM's business are still expected to experience nearly double-digit growth.
Risk factors
As fellow Fool Malcolm Wheatly discussed recently, consolidation in the semiconductor space and increased competition in the mobile space are among the most significant risk factors facing ARM in the year ahead. On the issue of consolidation, quoting from the company's annual report: "About half of ARM's revenue comes from direct licence sales to semiconductor companies. If there are fewer semiconductor companies, then ARM may have fewer customers to sell to." The ability to diversify among customers is a critical element for businesses in this space, as demonstrated by the reliance that Cirrus Logic (CRUS -0.26%) has on Apple for an ever-increasing amount of its business. The annual report went on to say, "Consolidation in these parts of the industry could represent a loss to ARM's future licensing business."
On the competition front, DIGITIMES recently reported that Intel (INTC -0.38%) is set to roll out a completely new smartphone platform at the Mobile World Congress at the end of February: "Intel is expected to unveil a new smartphone platform, and new Atom processors based on 22nm and 14nm processes featuring lower power consumption, at the 2013 Mobile World Congress (MWC) in Barcelona, Spain, during February 25-28. The products will be crucial to Intel's competition with ARM in the global smartphone market, according to handset component makers."
Intel has been noticeably marginalized in the U.S. segment of the mobile arena, but is not likely to stay there. Earlier this year, Intel and Google (GOOGL 1.27%) announced a deepening partnership around the international launch of Google's Motorola RAZR line. At the time, Intel was expected to enhance its smartphone offering, specifically in an effort to compete in the 4G LTE space. LTE is primarily a U.S. phenomenon, as many non-U.S. venues are still transitioning to 3G. Intel's ability to push rapidly into this space should not be overlooked, but it is likely to be gradual -- good news for ARM and others.
Additional revenue streams
Fortunately for shareholders, ARM is not resting on its laurels and continues to push into new markets. The company recently announced a joint venture with Gemalto from the Netherlands and Germany's Giesecke & Devrient to create a mobile security business called Trustonic. The purpose of the company is to create a totally secure space on your smartphone that is independent of the OS for heightened security. As more personal information moves to your smartphone, security concerns will continue to rise. While it is premature to speculate on numbers, the move is a positive sign of the company's efforts to drive its business on multiple levels.
In general, ARM appears to be very well positioned moving into the new year, with its relationship with Apple as a centerpiece of the company's continuing success. While monitoring key relationships (like the one with Apple) is important, the company is clearly making positive steps. When these factors are combined, the stock is a buy at current levels.
