ARM Holdings (ARMH) is reportedly in talks to acquire Israeli security firm Sansa Security for $75 million to $85 million. A report in the The Wall Street Journal cited "two people familiar with the matter." Sansa develops security systems for mobile phones and memory chips, which both play key roles in the Internet of Things (IoT) market of connected chips in everyday objects.

Cisco estimates that the number of IoT connected devices worldwide will double from 25 billion in 2015 to 50 billion by 2020. But that growth has sparked fears that new security problems with connected objects -- like smartwatches, smart locks, smart light bulbs, smart cars, and even smart toys -- could arise. Sansa could help address those fears.

Let's take a look at why Sansa would be a good strategic fit for ARM, and what an acquisition could mean for rival Intel (INTC 0.41%).

The IoT will connect everyday objects to the Internet. Source: Cisco.

ARM's IoT strategy
ARM doesn't manufacture any chips. Instead, it licenses its designs to companies like Qualcomm (QCOM -0.85%), Samsung (NASDAQOTH: SSNLF), and Apple (AAPL -0.28%). ARM-designed chips, which became known for cheap and power-efficient designs, power 95% of smartphones and the majority of tablets worldwide.

Building upon those mobile foundations, ARM designed Cortex-M embedded microcontrollers -- which accounted for nearly a fourth of its cumulative licenses last quarter -- to expand into the IoT market. The Cortex-M class includes ARM's next-gen processors Teal and Grebe, which are designed for IoT use in connected cars, health monitors, and smart home devices. ARM recently claimed that those new designs would provide nearly twice the battery life of older Cortex-M designs.

To connect those embedded chips together, ARM introduced mBed, a real-time operating system (RTOS) for IoT devices, last year. ARM then acquired Dutch security specialist Offspark and integrated its security software into mBed. An acquisition of Sansa would complement that acquisition by further securing ARM's embedded designs.

Intel's IoT strategy
However, Intel doesn't plan to let ARM take over the IoT market unopposed. Intel dominates the PC and server markets with its beefier x86 chips, and it plans to leverage that strength to expand into the IoT market.

That's why Intel established a dedicated IoT group, which includes tiny devices like the button-sized Curie module and the SD card-sized Edison "micro-microcomputer." Last year, revenue at the new unit rose 19% annually to $2.14 billion as its operating income climbed 12% to $616 million.

Last December, Intel launched an IoT platform for partners like Accenture (ACN -2.33%) and Dell. Like ARM, Intel offers its own RTOS, VxWorks, which runs on x86 and ARM-based processors. It also enhances the security of IoT devices with technology it gained from the acquisition of McAfee in 2010. Intel bundles those solutions together in a management system called Wind River Edge, which helps customers build industry-specific IoT solutions.

Intel's Curie module. Source: Intel.

A more hackable world
ARM and Intel are making their embedded chips more secure for IoT uses, but reports indicate that there is still plenty of room for improvement. A study conducted by Hewlett-Packard (HPQ -1.03%)last July found that 70% of common IoT devices like thermostats, smart TVs, and webcams, could be hacked. Each of the 10 devices that HP examined had roughly 25 vulnerabilities.

Speaking at the Mobile World Congress in Barcelona this year, James Lyne, global head of security at security firm Sophos, discussed how to hack these devices. In a demonstration, Lyne showed the audience how to hack into Internet-connected CCTV cameras with a simple brute force attack that is easily blocked on modern PCs. He also noted that wireless power systems could be hacked in the same way. Lyne pointed out that nearly anyone, regardless of technical skill, could simply copy and paste the code online to run the hack.

This means that we could see ARM and Intel make additional security-related acquisitions in the near future to prevent their devices from being hacked.

The key takeaways
For ARM investors, expanding into the IoT market is a mixed blessing. Its licensees might sell more IoT chips, but those lightweight designs also generate lower royalties. ARM doesn't disclose the exact difference, but Liberum Securities analyst Eoin Lambe estimates that ARM's IoT designs are actually 70 times less profitable than the high-end ones found in Apple's iPhones.

Nonetheless, ARM needs to expand beyond the saturated mobile market, and the IoT market is a solid choice -- it hasn't gained much ground against Intel in PCs and servers. Looking a few years down the road, ARM devices could account for a large portion of the IoT market and a security firm such as Sansa could boost its success.