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iPhone’s Component Ecosystem: ARM Holdings

Posted on Thursday, Aug 30th 2007

In this post, we will be analyzing ARM Holdings as part of the serieson the major players in the iPhone’s component ecosystem. The processor in the iPhone is based on an architecture licensed from Britain’s ARM Holdings, popularly referred to as an ARM Core.

ARM Holdings Plc.(Nasdaq: ARMHY) is the world’s leading semiconductor intellectual property (IP) supplier with total revenues of £263.3 million ($483.6 million) in 2006. Its technology is used in most of the advanced digital products, ranging from mobile, home and enterprise solutions to embedded and emerging applications. Its business is organized into three segments: Processor Division (PD), Physical IP Division (PIPD), and Development Systems Division (DevSys).

The company’s business model has a high gross margin of around 90% and involves the designing and licensing of IP to a network of Partners. These Partners use ARM’s IP designs in their microprocessors, peripherals and system-on-chip designs and pay ARM license fees for the original IP and a royalty on every chip produced. The average royalty rate in 2006 was 6.7 cents and about 90% of the mobile phones contain ARM products. In fiscal 2006, it acquired Falanx Microsystems AS., Soisic SA., and PowerEscape, Inc.

For the second quarter of 2007, ARM Holdings reported dollar revenues of $129.2m, an increase of 8% over the year-ago period. The fully diluted earnings per share prepared under US GAAP were 0.64 pence (3.87 cents per ADS) compared to earnings per share of 1.00 pence (5.57 cents per ADS) in Q2 2006. Total dollar license revenues grew by 15% to $59.3 million, compared to $51.7 million in Q2 2006. License revenues, which accounted for 46% of group revenues, comprised $45.3 million from PD and $14.0 million from PIPD. Total dollar royalty revenues in Q2 2007 were down 1% at $47.4 million compared to $48.1 million in Q2 2006. Royalties in the quarter were affected by normal seasonality, the semiconductor industry inventory correction, and lower foundry utilization levels. Royalty revenues, which accounted for 37% of group revenues, comprised $40.1 million from PD and $7.3 million from PIPD.

The iPhone sales as such might not contribute much to ARM’s revenues. However, the impact of the iPhone on the mobile phone industry as well as the laptop industry and the move toward convergence devices would be highly beneficial for ARM. Its stock is trading between $8 and $9. The company is well-aligned with the convergence trend, and should see good growth in the upcoming years. I don’t think investors understand why this company is important, and hence, the trading volume and analyst coverage is pretty low. Could be a bargain.

ARM Holdings plc (ARMHY)

This segment is a part in the series : iPhone’s Component Ecosystem

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Thanks for the analysis of ARM’s financial performance. Great to be reminded that it is possible to be successful as an IP company, but is ARM the exception that proves the rule?

I would question your stock price suggestion though, based on your info and the Yahoo finance info about the ARM ADR, the company is worth $6.5B which is 12x sales and 50x p/e. Not obviously undervalued!

Curtis Abbott Wednesday, September 5, 2007 at 5:44 PM PT

Yes, Curtis, you are right. Undiscovered, but not necessarily undervalued. I should rephrase it as underhyped.

Once stocks get “discovered” they also enjoy the trading volume and hype based lustre, which is missing in this case.

As for building businesses around IP, Tessera is a good story, as is Qualcomm. Qualcomm’s got some problems nowadays, though.

Sramana Mitra Wednesday, September 5, 2007 at 8:19 PM PT

Sramana – Good suggestions re QCOM and Tessera. I tend to think about RMBS (I met with Bill Davidow one time where he told me he’d never do that again, too much work).

I got to thinking about something else, not sure the 6.7 cents/unit royalty adds up. If royalty is 1/2 of revenues (you say 46%) it suggests about 3B cellphones are produced annually, which is a bit high. I wonder…

Curtis Abbott Thursday, September 13, 2007 at 11:13 PM PT

Hi Curtis,

Yes, Rambus is also an IP business model case study. About it being too much work or taking too long, I would say Tessera also was a very long drawn winter before things started falling into place. Qualcomm is quite different, and overall, a much greater company than either of the above.

In terms of ARM royalties, besides mobile phones, the royalty figures also include chips from a broad range of product applications including smartcards, microcontrollers, automotive, connectivity devices, hard disk drives and many others. Your figure of 3B is not far from the aggregate shipments of 2.45B units in 2006 for which ARM received royalty.


Sramana Mitra Sunday, September 16, 2007 at 11:26 AM PT