Investment View: Keep faith with Arm despite the Intel challenge

  • @TheIndyBusiness

Intel's desire to break Arm's dominance of the mobile chip market hasn't been any secret. But it is only quite recently that the City has really started to fret about it. Arm shares, flirting with an £11 close in May, have since lost almost a third of their value – a stunning fall.

Intel's assault on a market that has been dominated by Arm is no small part of the reason for that, and the shares are now about where they were at the beginning of the year, although the wider stock market is ahead.

Has this created a buying opportunity? The stock faced critical comment from its analysts a couple of weeks ago, notably those at Numis, who downgraded their rating on the company to "reduce".

Overall opinion is almost evenly split on where the shares will go, with nearly as many "sells" or their equivalents as "buys", and plenty of analysts plumping for intermediate ratings (hold, or equal weight, or even neutral).

Arm designs and then licenses chips. It generates healthy revenue from its "backlog" of licensing fees from the people who make and use those small pieces of silicon in all sorts of devices (you'll find them in things all over your home, although the company is best known for smartphones and tablets). That keeps things tickety-boo at its Cambridge HQ.

There is still a great growth story in Arm. The company reckons the amount of internet-connected devices could treble to 30 billion by 2020 as the number of middle-class consumers who can afford them explodes.

Even with global growth still looking torpid, millions more people are joining the middle-class party in places like China and India, and in other economies still enjoying respectable growth levels, every year. These people often use the novelty of a disposable income to buy gadgets.

Intel would be silly not to try to get its hands on part of this market, and it has signed deals with the likes of Motorola and Lenovo, which will be joining its platform. Samsung announced last month that it will use an Intel chip in one of its tablets, giving the US giant an entry into a very important market.

That certainly should be a concern to Arm. It shouldn't be a killer. The growth that Arm is predicting suggests there should be room for two at the table, and the company will be alive to the threat it faces. None the less, all this does mean taking a more sceptical view of Arm's valuation. That is still pretty high. The shares trade on 37 times this year's earnings, although that falls to just 30 times next year. Unsurprisingly for a technology stock, you don't buy for the yield, which is barely above a half a per cent for this year.

By some metrics, the stock has actually been oversold. But when you consider its PEG, the valuation might now be more or less right. PEG is the price-earnings ratio divided by the annual growth in earnings per share. The lower the figure, the cheaper the share is. Using figures published on Digital Look, it currently sits at 1 (par), rising to 1.5 next year. So the shares still aren't exactly screaming bargains.

However, another factor to bear in mind is Arm's rarity value. There simply isn't much like it on the FTSE 100. And its quality. This isn't some badly managed corporate behemoth – it has been very well run for years.

It is true that Warren East, the long-time chief executive, is stepping down in favour of Simon Segars, another Arm veteran. Mr East is a CEO who was worth his salt, having taken sensible long-term strategic decisions that have built the business into a quiet titan. But the company has handled the transition with aplomb, and I wouldn't worry too much about Mr Segars trying to fix what isn't really broke.

With the shares at 665p last year, I said hold for long term but consider taking some profits. Not a wise move really. My thought process was informed by the concern about Intel before the wider market had woken up to it. Those that decided to heed my long-term recommendation should be reasonably happy. But what about now?

All Arm really needs to start heading higher again is a few deals, a couple of upbeat trading statements. That would be enough to reassure the market, and get investors steaming into the stock. It's a tough one to call. But on balance I would rate Arm at least a solid hold at this level. And it may pay you to tuck away a few more. Accumulate.