When the chips are down, buyers prefer to choose the technology they know

The semiconductor industry's woes are hitting ARC International, yet its older rival ARM is still doing well
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The Independent Online

ARC International, a Hertfordshire-based chip designer, warned yesterday it would have to cut 20 per cent of its 300-strong workforce after the slowdown in the semiconductor industry hit sales.

Those deteriorating market conditions have also made it impossible for ARC to forecast when it will sign new licences for its technology and it refused to give any guidance whatsoever. ARC's trading has deteriorated significantly since May when it promised forecasts were intact.

The global semiconductor industry has been going through one of its bleakest periods yet in recent months but, until now, British chip designers seemed to have escaped the turmoil.

It is surprising that ARC's experiences clash with those of the rival Cambridge-based chip designer ARM Holdings. ARM managed to deliver solid second-quarter growth last week in what it conceded was "a period when the semiconductor industry has experienced one of the sharpest downturns in its history".

While ARM admitted royalty revenues had weakened, it managed to offset that shortfall with higher sales from licensing and consultancy. ARC, on the other hand, had nothing to offset both a slump in royalties and a lack of new licensees.

ARC blamed its woes on the tough market conditions in the semiconductor industry. However, analysts are now questioning whether that can be the whole picture when its rival ARM is still performing so well. Are chip designers protected in a slowdown and are ARC's problems therefore company specific? Or is it just the case that ARM is proving the exception?

The troubles of the semiconductor industry are well documented with the downturn characterised by overcapacity and weak demand.

The Semiconductor Industry Association recently announced worldwide chip sales for May of $12.71bn (£8.9bn) down from $15.9bn a year earlier. The SIA also said May sales were 7.3 per cent beneath the previous month's sales of $13.72bn.

Broadly speaking, in a downturn, chip designers' royalty revenues are expected to come under pressure purely because fewer products containing the technology are sold.

However, many argue that chip designers' licensing revenues should be relatively immune because the companies they license to rarely cut back on investing in next-generation technology as it is precisely that technology which helps fuel their future growth.

"On the R&D side, the main thing you don't want to do is lose a lead on the technology and lose your competitive edge," said one analyst who did not want to be named. "I would say this is an ARC-specific problem. If it meant holding up a major project then it [a licence] would get signed off. Quite clearly ARM are managing it [signing licensees] and ARC are not."

But Bob Terwilliger, ARC's chief executive, insisted the company's problems were related purely to delays in spending on technology. "Companies are trying to manage their cash and R&D investments as efficiently as they can. We have not seen a reduction in the number of people we are engaging with. They are making the technical decisions to use the ARC but when it gets to the chief executive or chief financial officer they're saying they need to push out the signing of the order as long as they can," he said.

In the second quarter to 30 June, ARC's pre-tax losses rose to £9.4m from the £4.4m of losses in the first quarter of the year. Sales fell to £3.5m from the £3.7m recorded in the first quarter. Royalty revenues fell to £97,000 from the £128,000 seen in the first quarter and down from the £165,000 recorded in the fourth quarter of last year. Licence sales slipped to £2.9m from the £3m in the first quarter.

Furthermore, Simon Poulton, the company's finance director, said the situation deteriorated very quickly. "Right up until the last fortnight, we had every expectation that we were going to be very substantially ahead of the numbers we've come out with."

For the time being, though, the market has given ARC a clear vote of no confidence. Shares in the company closed up 3.8 per cent at 54.5p last night, valuing the business at £149m, slightly higher than the £132m of cash it still has in the bank.

That market capitalisation attributes little value to the company's core business. When ARC floated on the stockmarket last autumn at 210p a share, it was deemed to be one of the future stars of the industry. "Investors are scared witless. ARC is trading around its cash position. That tells you investors don't think it has much chance," said an analyst.

Despite that, however, other analysts have a certain amount of sympathy for ARC's situation pointing out that it is still at a much earlier stage of development than its rival ARM, whose technology has, pretty much, become a standard.

"ARC's got fantastic technology but ARM's got fantastic market share and it's been around much longer. Engineers are familiar with ARM and in these [market] conditions that's what they'll choose – the devil they know," said one analyst. ARC's experience seems to show that chip designers are not immune to downturns. That said, ARM does seem to be managing the slowdown better than most.

Analysts clearly believe ARC is also suffering from a number of company-specific problems. While it can do little to rectify market conditions, it is taking decisive action to cut costs.

Obviously, what all chip designers are hoping for is an upturn in the industry. While most suggest that is still some way off, Merrill Lynch said yesterday it thought the worst of the downturn was "now behind us".