One of Intel's (NASDAQ:INTC) biggest missteps over the past decade was losing the mobile chip market to ARM Holdings (NASDAQ:ARMH), which stole the show by licensing its cheap, low-power mobile chip designs to a wide variety of chipmakers. Those chipmakers did the heavy lifting, while ARM collected the design royalties.
Over the past few years, Intel tried to gain mobile market share with mobile subsidies and cheap reference designs. It also widened its moat against ARM with new chip designs for Internet of Things (IoT) and wearable devices. Meanwhile, ARM started creeping into Intel's backyard with Chromebook and data center designs.
Both stocks have had a rough start to 2016 -- Intel has fallen 17% and ARM has declined 12%. Let's take a look at why these two stocks fell, and which one looks like the better investment at current prices.
Intel's fourth-quarter earnings report, released on Jan. 14, initially looked solid. Sales rose 1% annually to $14.9 billion and beat estimates by $110 million. Unfortunately, Intel's data center sales only rose 5% to $4.3 billion for the quarter and grew 11% in 2015 -- well below its prior target for 15% annual growth through 2018. Intel blamed that miss on macro weakness weighing down enterprise demand worldwide.
Without that engine of growth, Intel must rely more on its sluggish Client Computing (PC and mobile chip) business, where revenue slipped 1% annually to $8.8 billion last quarter and fell 8% for the full year. Intel's smaller IoT and volatile memory businesses are still growing, but they only generated 9% of its 2015 sales. Analysts expect Intel's total sales to grow 7% in fiscal 2016.
ARM generates most of its revenue by collecting royalty fees from existing customers and licensing fees from new ones. Last quarter, sales rose 14% annually to $408 million, beating estimates by nearly $10 million. Royalty revenue surged 31% annually to $217 million for the quarter and 31% for the full year, thanks to rising shipments of higher-royalty chips with multiple or 64-bit ARM cores. Growing demand for its Mali GPU designs also bolstered royalties.
However, tech licensing revenue declined 2% to $158.5 million for the quarter and only inched up 1% for 2015. ARM noted that drop was "cyclical" due to a lull between the signing of 20mm licenses and upcoming 10nm/7nm ones. ARM signed 51 new processor licenses during the quarter, down from 53 in the prior-year quarter. For 2016, analysts expect ARM's revenue to rise 11%.
Intel's earnings dipped 1% annually to $0.74 per share last quarter, which still beat expectations by $0.11. However, operating income declined annually across all three core businesses -- Client Computing, Data Center, and IoT. For the full year, the Data Center business reported 6% operating income growth, but the Client Computing and IoT businesses respectively posted 21% and 12% declines.
Intel's growth in data center profits indicates that its 99% share of the server market still gives it plenty of pricing power. However, its decline in Client Computing profits indicates that PC demand remains sluggish while mobile subsidies -- obfuscated when Intel merged the mobile and PC units -- remain high. Its decline in IoT profits also indicates that R&D costs and competition in that fledgling market are rising. Between the fourth quarters of 2014 and 2015, Intel's operating margins dipped from 30.6% to 28.9%.
Last quarter, ARM's earnings rose 14% to $0.37 per share, which missed estimates by a penny. The core problem for ARM was that rising shipments of higher-margin 64-bit and multi-core chips couldn't fully offset the tepid growth in licensing fees. Meanwhile, R&D costs rose 10% annually last quarter and accounted for 23% of sales. As a result, ARM's operating margin slipped from 51.4% in the prior-year quarter to 50.5%.
Valuations and dividends
Looking ahead, analysts expect Intel's earnings to rise 10% annually over the next five years, while ARM's earnings are expected to grow 17%. Those forecasts give Intel and ARM 5-year PEG ratios of 1.2 and 1.6, respectively. Therefore, Intel looks cheaper based on long-term forecasts, but neither stock's PEG ratio has fallen below 1 -- the key threshold for "undervalued" stocks.
Intel pays a forward annual dividend yield of 3.6%, which is much higher than ARM's forward yield of 0.7%. However, Intel hasn't consistently hiked its dividend annually, while ARM has raised its dividend for three years in a row.
The winner: Intel
ARM has stronger top- and bottom-line growth, but its business model is more cyclical and top-heavy than Intel's. ARM's annual shifts between royalty and licensing growth are unpredictable, and there's a threat that low-margin chip designs for IoT and cheap smartphones will start outselling higher-end ones. Intel's growth looks more sluggish, but its cheaper valuation and beefier dividend look more dependable in this volatile market.