ARM signs Intel to licence pact and knocks on the door of FTSE 100 index

ARM HOLDINGS, the upstart Cambridge group that designs micro-chips embedded in a growing array of electronics devices, yesterday got the stamp of approval from Intel, the world’s biggest computer chip maker.

Intel will pay an estimated $5m to receive licensed access to Arm’s leading-edge chip designs that are being installed in a widening number of digital devices, ranging from mobile phones, to television set-top boxes and home-based appliances. When Intel begins manufacturing a new chip incorporating the branded STrongARM microprocessor design architecture, it will pay the British firm about 10 pence as a royalty payment for each chip produced.

Though the royalty seems minuscule, the rapid growth in chip production could unleash a torrent of revenue. This year, for example, ARM expects something over 100 million chips to use its patented architecture or double the number last year. Bulls on Arm’s stock think that growth may accelerate well into the 21st century.

As that sentiment has spread among investors, the stock has skyrocketed. Yesterday’s announcement sent the stock up 193p to 1,523p, a seven-fold gain on the year and a 150 per cent rise since the summer. That puts ARM’s market value at nearly £2.9bn, leaving it knocking on the door of the FTSE 100.

“I’m excited because Intel is a very important partner and they see this as a growth opportunity,” said Robin Saxby, ARM’s chairman and chief executive. “They have ambitions in embedded chips, beyond the PC. What this is saying is that ARM and Intel will work together.”

Just last week, ARM proved it remains on target for explosive growth. Pre-tax profit for the nine months to September rose 77 per cent to £11.4m as sales grew by nearly one-half to £43.2m. Equally encouraging, operating profit margins expanded by two percentage points to 25 per cent.

At the heart of ARM is Mr Saxby’s partnership model.

With semi-conductor plants often costing over £1.0bn, and with new chips incorporating millions of transistors and expensive research and development, firms like Intel and electronic equipment makers such as 3Com, are seeking to standardise chip architecture. That saves time and money in evolving new micro-processors, the basic building blocks of the digital age.

In one sense, ARM is a relatively straight forward attempt to parlay intellectual property into a long-term revenue growth stream. What makes it different than from traditional intellectual property plays is the soaring growth in demand for chips. Increasingly, chips will be deployed in virtually every manufactured product, whether to facilitate new levels of automation or to provide feed-back on product performance to users and manufacturers. ARM’s business plan is to build a revenue stream for the next decade from its intellectual property in a market that is evolving at lightening pace.

Though ARM is now priced at over 200 times 1999 earnings, Goldman Sachs analyst Charles Elliott still rates the stock a “market outperformer”. “ARM’s p/e is demanding but investors are overlooking this at present, anticipating 40-50 per cent (annual) earnings per share growth over the next five years or more; we emphasise that in contrast to other ‘concept’ stocks, ARM is growing earnings at a rate that makes high multiples tolerable,” he wrote in a recent report.

So far, ARM has signed partnership designs with over three dozen, mostly semi-conductor manufacturers out of a total of 150 worldwide. Besides Intel, it has deals with IBM, Hewlett-Packard and Texas Instruments.

But as the chip market grows more specialised, ARM is also licensing its designs directly to electronics and network equipment makers such as Japanese video game maker Nintendo. The UK firm is also to supply its latest 32-bit ARM10T microprocessor design to Lucent Technologies which will integrate the chip into its system-on-a-chip products. That will, in turn, power communications applications including mobile phones, personal digital assistants and broad-band wide area network infrastructure.

If analysts and investors have taken heart from these examples of the ARM chip’s versatility, in the immediate term the future of the company and its 425 employees is tied to the mobile phone. Goldman Sach estimates that ARM designs have over 50 per cent of the RISC standard chip market that is being designed into more and more mobile phones.

Clearly its a good place to be, since it provides ARM with real earnings, in contrast to the losses that are the normal fare with so many technology companies. With global mobile handset sales expected to rise to more than 350 million next year from 270 million in 1999, ARM’s royalty revenues are expected to double year-on-year and account for one-fifth of total sales.

“Some markets are growing faster than others,” says Mr Saxby with perhaps just an air of understatement. “Clearly, the mobile and telecoms sector is in that category.”

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