After Windows victory, chip king ARM Holdings proves its worth with stellar results and ten-year share high

Just as we were catching our breaths from ARM Holdings’ CES fair announcement of a tie-up with Microsoft, the Cambridge semiconductor group smashed all expectations with a 73% increase in pre-tax profits, to £167.4 million, at its full-year results.

Mobile phone growth remains the key earnings driver for ARM, whose technology is present in the soaringly popular iPhone and iPad. With its technology present in 98% of the world’s mobile phones, the group benefits greatly from the rapid rise in the the number of mobile handsets sold overall – but even more so because increasingly more of us are choosing to buy a top range phone such as an iPhone or a BlackBerry. With smartphone penetration now reaching 20% of the mobile market, this is just another planet aligning for ARM, as smarter phones means more chips per unit – and ARM gets paid per chip.

Windows-compatability
As announced at the CES fair, ARM technology will be compatible with the next version of Windows – at last overcoming a major hindrance for the group to break into the computing market. So when the Cambridge group announced its whopper performance in the year to December 2010, the market already had reasons to be excited and responded by pushing the stock to a decade high.

The last time things looked this good for ARM shareholders we were in the midst of the dot-com bubble, meaning a lot of the goodwill was hype. Without wanting to speculate whether ARM’s shares have further to go, it is probably safe to say there is more solid progress backing up the cheers this time.

So how has ARM managed to put itself into such a sweetspot? Part of the answer is that ARM doesn’t actually manufacture semiconductor chips, but merely designs them and licences out the designs to the device manufacturers. This emits the high-cost process of making the physical chips, and generates annual licence income from the customer. ARM also gets paid royalty income every time a device with its design is sold – meaning the group will continue to make cash for years to come even if it doesn’t lift a finger.

While ARM is the undisputed king of the UK semiconductor industry, until now, the incompatibility with Windows has held back ARM in the computer market. This remains Intel’s domain. ARM’s chips are however less energy-demanding, which makes them cheaper and more efficient to use. This is how the group managed to get such a thorough foothold in the mobile phone industry, where low power consumption for a high battery life has been higher on the agenda. But with the advent of netbooks and tablet computers, this is increasingly a top concern also for PC makers – meaning this could be a golden opportunity for ARM.

Misguided takeover speculation
In its final results statement, the company was as per usual keen to point out that its reliance on the mobile phone industry is decreasing. ‘ARM continues to sign licenses with influential market leaders in an increasingly digital world,’ said chief executive officer Warren East. While consumer electronics and embedded devices remain the major earnings driver, the group said a significant number of new licenses were signed for other types of digital products, such as computing, digital TVs, microcontrollers, smartcard and solid-state drives.

2010 has been a year of recovery for ARM and the rest of the semiconductor industry. East’s comments about expecting 2011 to return to ‘more typical growth levels’ have been echoed elsewhere in the industry. 77% of chief financial officers at leading US technology groups expect to see revenue growth this year, according to a report by BDO USA.

ARM’s shares have been partially driven by takeover speculation, but this seems unlikely with much of ARM’s strength coming from its position of independence. Apple and Intel are often listed as potential suitors, but ARM’s products are widely used by their competitors who would not be keen to buy from a ‘compromised’ supplier. ARM president Tudor Brown told Reuters: ‘All of our first-line customers are competitors with each other and we manage this sort of unholy alliance … and we manage that through being independent and equal to them all.’