When the chips are down, avoid costly ARM

Lex Service worth tucking away; No need to move out of St Modwen; British Biotech story is a sorry tale
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The Independent Online

But is it cheap enough yet?

But is it cheap enough yet?

It is the most important question on ARM Holdings, the chip designer, whose shares have fallen by almost two-thirds this year despite the company never disappointing the market at results time.

Results time came around again yesterday, and ARM was true to form. Revenues were higher than expected as the company had tied up more deals to license its microchip technology to semiconductor manufacturers. And profits, too, were better than hoped thanks to a reduced emphasis on lower-margin design consultancy work. Pre-tax profits in the three months to 30 June were £16.2m, up by a third on the same period last year, and 3 per cent higher than in the previous three months.

There was also a bit of reassurance on the fear that ARM may be reeling in revenues that would normally be deferred (perhaps because of a time lag between invoicing a client and delivering the goods) in order to inflate short-term growth. Deferred revenues, which had been falling, in fact increased in the second quarter, which the company said proved this measure was volatile and not indicative of future sales trends. The sceptics remain to be convinced, particularly since Warren East, its chief executive, said deferred revenues "may well fall" again in the third quarter.

The shares bounced 12p to 144p, where they continue to look overvalued, despite the apparent good news and notwithstanding a combative "buy" note from ABN Amro, ARM's broker, which said "we see the bears retreating".

The note also included a downgrade of the broker's estimates of future sales, although ABN kept its earnings forecasts unchanged. The pressure is on ARM, with sales of mobile phones slowing and their manufacturers forced to keep prices down.

Royalties from sales of devices including ARM technology are not expected to resume speedy growth any time soon. It will also need to get results from its beefed up research and development work to ensure a steady flow of new products to maintain licensing growth. A price-earnings ratio of 35 this year, falling to 28, takes too little account of the challenges. Avoid.

Lex Service worth tucking away

Lex Service has been one of the more successful, if low key, corporate reinventions of recent years. Only three or four years ago it was Britain's biggest car dealer. Then it snapped up the RAC for £437m and AutoWindscreens for £112m and flogged all the dealerships. It is now positioning itself as a motor services organisation aimed at selling finance, legal advice and breakdown services to business and residential customers. To reflect the change, the business will be renamed RAC plc from the beginning of September.

It is also pursuing the Holy Grail of cross-selling. Like Centrica, which uses its British Gas customers database to sell everything from Goldfish credit cards to AA membership, Lex wants to increase the proportion of its customers who use it for more than one service. Currently this is just 3.5 per cent. Andy Harrison, the chief executive, would like to push it closer to 10 per cent. Cross-selling is easier said than done of course, as the big banks have found. But there is clearly scope for growth here and Lex is spending £30m on IT systems to enable it to target its direct mailings more effectively.

In the domestic area, RAC has increased its number of members by 5.5 per cent to 6.6 million in a year, but still trails the AA's 12 million customers. From businesses, Lex has won new contracts with a lifetime value of £290m in the first six months of the year.

Yesterday's announcement of interim profits up 6 per cent to £33m before exceptionals, had the shares revving up 9p to 436.5p. With analysts forecasting full-year profits of £70m the shares trade on 10 times the current year's earnings. They could be worth tucking away in the glove compartment.

No need to move out of St Modwen

Not all property groups have to trade at a discount to the value of their assets. St Modwen Properties moved up 5p to 142.5p yesterday, just a penny away from its published net assets per share, after the company unveiled reassuring half-year results.

Unlike many of the dinosaurs further up the property foodchain, St Modwen is an active developer and had a series of chunky profits from disposals in the first half of the year. That resulted in a 33 per cent rise in pre-tax profit to £14.5m, even though rental income from the rest of the portfolio was barely higher.

St Modwen's properties are spread across the country and its only exposure in the South-east is in retail complexes, such as the ripe-for-repair Elephant & Castle shopping centre in London. The company's portfolio is less volatile, then, than some others. With 2,000 acres of land that could be marshalled for redevelopment, the group has plenty of opportunity to add value.

Analysts prefer to value the company on a multiple of earnings, and its shares look to be trading on 8 times. And since St Modwen aims to double the net worth of the company every five years, and since it doesn't look like getting blown off course, that multiple makes the stock look good value. Hold.

British Biotech story is a sorry tale

The British Biotech story has long seemed worthy of an Agatha Christie novel. The company suffered its dramatic fall from grace in 1998, when a whistleblower exposed how its supposed "cure for cancer" was no wonder-drug after all. Even now, lawyers are sifting the evidence in the hope of attracting shareholders to a class action against the company. But the latest chapters have been less reminiscent of an Hercule Poirot tale than And Then There Were None...

At the start of last year, British Biotech had 10 products in human trials or the late stages of work in the lab. Now it has just four. Yesterday, it formally abandoned work on a leukaemia treatment after disclosing disappointing trial data earlier this month.

At least the company's cash burn will be reduced. Its £50m pile should last three years now it does no major drug research of its own. It hopes to buy in products but is unlikely to reap royalties before the cash runs out.

The options are declining fast. The company is not an attractive merger partner (the Class Law threat is no doubt scaring partners off) and though the stock trades at a discount to its cash, that should not tempt investors in.

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