Trouble On ARM’s horizon?

ARM Holdings' (LONDON:ARM) place at the heart of the smartphone industry has both been hugely profitable for the business over the past few years and beneficial for those of us wanting a glimpse into the future of a turbulent, unpredictable industry.
 
The company boasts that its technology reaches 75% of the world’s population, with 60% of all mobile devices containing an ARM chip. Its reach in the smartphone field is even further, with 95% of all devices powered in some way by ARM technology.
 
As the ubiquity of smartphones has truly taken hold, ARM’s dominance of the market – and well known relationship with Apple Inc (NASDAQ:AAPL) – has resulted in some stunning growth. From the beginning of 2009 to this year, ARM’s share listing increased well over 1000% in value. Shares peaked at a value of over £1,000; it became a key constituent of the FTSE 100 and a lesson for any investor looking to capitalise on a new technology in a smart way.
 
Since then, though, the company has struggled a little. Its shares have sagged to around £830 over the course of the year, flirting alarmingly with the £800 level in recent days after its most recent earnings call. Now, with no more earnings reports to turn things around in 2014, analysts are beginning to question whether ARM’s dip in form is temporary, or part of a wider malaise.
 
The slump in the company’s fortunes reflects a number of factors; from fears surrounding the microprocessor market, fears in ARM’s business model, and turbulence in the smartphone industry overall.
 
On Thursday October 9 the CEO of one of ARM’s major competitors, Steve Sanghi of Microchip Technology Incorporated (NASDAQ:MCHP), sent a ripple through the markets when he proclaimed that he believes ‘that another industry correction has begun and that this correction will be seen more broadly across the industry in the near future’. Mr. Sanghi may be the CEO of a substantially smaller company than ARM, and made his comments over in the USA, but his comments still hurt its share listing.

Not as much, though, as it hurt ARM’s competitors. ARM lost around 4% of its value after the statement,  as Intel (NASDAQ:INTC) dropped 6% and Texas Instruments (NASDAQ:TXN) 9%.
 

ARM, Intel, Microchip Technology and Texas Instruments as Steve Singh’s comments made the headlines on October 9. Chart from IG’s share trading platform .
 
Understandably, it was Microchip itself that took the brunt of the market’s ire– Mr. Singh’s statement arrived alongside a downward revision for projected revenue, after all. The full statement had wide implications across the industry, however: other microprocessor companies would be hurt soon, and other mobile companies would soon follow suit.
 
Whilst ARM wasn’t hurt as much by Microchip’s pronouncement as others, it lost a lot of value a few days later after announcing earnings that didn’t match what the markets were expecting.  In many ways it was judged harshly by traders. The estimation of $321 million revenue was always optimistic, and whilst ARM missed it narrowly, it matched estimated earnings per share and increased both revenues and earnings.
 
Growing revenue by 12% was deemed not good enough for a stock dependent on growth though, and there was something else within ARM’s earnings that set alarm bells ringing; ARM’s licensing and royalty revenue has not matched pace with its processor shipment. In short, ARM’s original intellectual property – 42% of its total revenue – is not generating as much profit as it used to.
 
That is partly due to the rise of newer technologies that don’t generate as much money as smartphones and tablets, but also because major partners like Apple and QUALCOMM (NASDAQ:QCOM) tend to design their own chips, with just a few parts and licenses needed from ARM.
 
The current state of the smartphone industry doesn’t really help matters. The major players in recent mobile technology – Samsung, Blackberry, Sony and to an extent even Apple – have all hit trouble recently. Despite new innovations, phone sizes and models there is a feeling that the current state of iterative mobile development needs to change.
 
The Internet of Things and wearable tech have been mooted as possible next steps, but neither has yet fully captured the public imagination. ARM has placed itself well to take advantage of new technology, and over the past 15 years has proven its ability to innovate and stay ahead of the times. As a company that’s still dependent on massive growth, it’s going to have to prove that all over again in order to thrive.
 
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Written By: Patrick Foot