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The Surprising Sell Case For ARM Holdings Plc

Today I am looking at an eye-opening reason why shares in ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US) are in jeopardy of suffering a severe negative re-rating.

Bloated share price overlooks rising competition

ARM Holdings has established itself as a heavyweight player in the semiconductor market, the widespread adoption of its architecture over the past decade in the red-hot smartphone and tablet PC markets prompting explosive progress in the share price.

The emergence of major rivals such as Intel onto ARM’s territory has steadily ramped up in recent years, but in my opinion the market does not currently factor in the potentially earnings-cracking impact that these competitors could wreak upon the Cambridge chipbuilder. Indeed, the rate of new product development, not to mention the efforts of these firms to court tech manufacturers across the globe, threatens to derail ARM’s stranglehold on the phone and tablet markets.

Earlier this month Intel unveiled a new range of SOC (or ‘system on a chip’) processors known as Quarks. The new processors, which are due for sampling in the fourth quarter, represent an upgrade on the company’s existing 22nm Silvermont Atom chips — the Quark line is around 20% the size of its older counterparts and uses 90% less power. Indeed, Liberum Capital considers the range as a major competitor to ARM’s cortex-M and Cortex-R chips in popular low-power devices.

Tech giant trading at double the price of its peers

ARM Holdings was recently dealing on a P/E rating of 47.1 and 38.2 for 2013 and 2014 respectively, far in excess of the technology hardware and equipment sector’s prospective average of 25.6. The firm’s stunning multi-year earnings growth justifies investor faith in the firm, but I believe that share prices have overshot what I would consider reasonable levels considering rising uncertainty over future revenues.

In addition to the  effect of galloping competition in ARM’s key markets, the threat of falling royalties from the critical smartphone market in coming years also threatens to hit revenues. Global smartphone sales are set to top 1bn for the first time in 2013, according to research house International Data Corp, but sales growth is being driven by a shift in consumer behaviour towards cheap handsets. Combined with market share gains from major rivals, the prospect of lower royalties from these low-cost devices threatens to pressure ARM’s top-line looking ahead.

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> Royston does not own shares in any of the companies mentioned here.

See all articles by Royston Wild