ARM Holdings (NASDAQ:ARMH) is a developer of processor, graphics, and other system-on-chip-related intellectual property. It doesn't design full system-on-chip products for sale to end users; rather, it designs key elements that other companies can build upon to make a differentiated end products. In the mobile space, its key partners include Qualcomm (NASDAQ:QCOM) and MediaTek.
ARM gets paid a "cut" of the selling price of a system-on-chip that uses its IP (such as a processor core, graphics, and so on). The more ARM content on a given chip there is, the higher the royalty rate is that ARM charges. This incremental content can come in many forms, but the "big" transition that ARM is likely to see over the next couple of years is the shift to 64-bit computing.
64-bit means higher royalty rate
Today, the vast majority of mobile applications processors that bear royalties to ARM are 32-bit (with the notable exception being Apple's (NASDAQ:AAPL) custom 64-bit ARM-compatible core known as Cyclone). But the next generation processors from heavy-hitters like Qualcomm, MediaTek, and Samsung will all either license ARM's 64-bit processor designs (the Cortex A53 and/or the Cortex A57) or sport custom-designed 64-bit ARM compatible processors.
The royalty rate per processor for a 64-bit core should be a fair bit higher than the royalty rate commanded by a 32-bit core, which means that even in the absence of unit growth, ARM would see an uptick in royalty revenues. But as ARM is exposed to the growth in smartphones and tablets, and given that its partners command the lion's share of the processor revenue in those markets, ARM will likely see both robust unit growth as well as royalty-rate growth.
big.LITTLE adoption seems to be strengthening
ARM currently offers two 64-bit processor cores: the Cortex A53 and the Cortex A57. In bid to improve the energy efficiency of mobile system-on-chip designs, ARM offers a technology known as big.LITTLE. The idea here is that when you need performance, the larger A57 cores handle the workload. But for less demanding tasks, the less power hungry A53 cores can do the trick and save battery power while doing it.
While big.LITTLE hasn't been particularly well implemented to date, Qualcomm's Snapdragon 808/810 processors -- slated for launch next year -- will implement the Cortex A57 and Cortex A53 processors in such a configuration. It will be interesting to see if Qualcomm can do a really good implementation and if it ultimately yields real-world benefits.
Nevertheless, with Qualcomm and others adopting big.LITTLE, ARM is getting a larger royalty percentage per chip since a big.LITTLE configuration usually involves licensing 6-8 CPU cores, up nicely from the 2-4 that we typically see today. Once again, these cores will be 64-bit, so ARM wins twice there.
Foolish bottom line
As the world transitions to 64-bit ARM processors in mobile, ARM should benefit from the royalty increase from 32-bit cores to 64-bit cores. Additionally, it seems that uptake of big.LITTLE is quite good so that provides an additional tailwind to ARM over the next couple of years. Keep in mind, though, that ARM does trade for a rather rich 30 times fiscal 2015 earnings estimates, suggesting that some of this enthusiasm may be baked into the share price.
Ashraf Eassa owns shares of ARM Holdings. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Qualcomm. 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.