Investment View: Take another bite of Apple but ditch expensive ARM

Arm Holdings take profits. Price 665.5p
Click to follow
The Independent Online

What's better than being Apple? Being Arm Holdings, the company that provides the chips powering all those ridiculously popular gadgets.

Yes, the fans are again going to be queuing outside Apple shops around the world when the iPad mini hits the shelves on 2 November.

They'll buy the thing despite the fact that they probably already have "big" iPads, iPad 2s, iPad 3s, all six iPhones, and every one of the myriad generations of iPod that have been made. Not to mention MacBook Airs, Pros and the rest.

Lucky old Apple. Lucky old Arm, whose chips Apple relies upon for iPhones and iPads and iPad minis and which therefore will take a cut from every sale. No wonder its shares have been going bananas.

If the mini can successfully take on rivals such as the Kindle Fire, it might provide some relief for Apple shareholders who have had a rough ride recently.

Two successive, disappointing quarters, with lacklustre sales, have seen the shares struggling to say above $600 (£374). A month ago they were at $700.

At about 11.5 times forecast earnings for the year ending 30 September 2013 they're looking quite cheap. If you can find a stockbroker who'll sort out the transaction at a sensible dealing cost, then buy.

Arm is anything but cheap. Its shares trade on a lofty multiple of nearly 47 times this year's forecast earnings. As you might expect with a valuation like that, the dividend yield is minimal.

But Arm, you see, doesn't just sell to Apple. So even while the iconic tech company has been wobbling, there have been other purchasers for Arm's chips.

Arm's products, in fact, are all over your home. You just don't realise it. In last week's third-quarter results the company announced another 29 processor licences signed for a broad range of applications, including chips for televisions, hearing aids, automotive braking systems, and other consumer electronics in addition to all those smartphones and tablets.

It is the best British company that no one has heard of. And this showed in last week's third-quarter figures with revenues up 20 per cent at £144.6m, and pre-tax profits up by 22 per cent at £68.1m, both of which were ahead of the City's forecasts.The results look even better when you consider that other tech companies have shown signs of weakness recently. It's not just Apple which has disappointed.

It wasn't so much the iPad mini which lit up Arm's shares, it was those results.

But Arm was nonetheless cautious about the fourth quarter, although the company will still most likely meet full-year guidance, perhaps because its customers have struggled.

Analysts at broker Charles Stanley also point out that 2011 saw a significant pull-forward of revenues from the first quarter of 2012, so it will be harder to look good by comparison.

In other words, Arm is going to have to run some to justify its shares' exalted new valuation. Can it do this?

It is a superlatively well-run company, located in "Silicon Fen" near Cambridge.

Arm's business model is clever – it licenses chips for others to make and use taking an upfront fee for each licence sold and enjoying an ongoing "backlog" of revenue from each sale. That backlog is running at record rates right now.

It is quite true that Arm has made a habit of exceeding expectations, and time and again has looked over-valued, only to produce results which go some way to justifying the valuation.

But, with a global economy still in less than stellar health, and its customers feeling the strain, the company is looking at some headwinds at the moment. It would only take a mild disappointment in the next quarter's results to send these shares into a tailspin.

Long term I would want to be a holder of Arm. You should have some of its shares in your portfolio. But in the short term, I fear they will endure a choppy ride and are high enough. Consequently, I'd be inclined to take some profits.

But don't hesitate to buy them back in after the shares have fallen to a more sensible level.