I’m working my way through the latest annual reports of your favourite FTSE 100 companies, looking for insights into their businesses. Today, it’s the turn of the UK’s tech titan ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US).
Shareholders
I don’t think I’ve ever looked at ARM’s annual report before. Companies with sky-high earnings multiples aren’t for me, and ARM’s rating is perennially astronomical. As such, I’ve never gone beyond a quick look at the company’s results.
It was refreshing to open ARM’s annual report and find an absence of the gratuitous half- and full-page photographs that increasingly seem to ornament company reports. An annual report is a communication by the company’s managers (directors) to the company’s owners (shareholders), and I was impressed that ARM’s managers are ‘looking after the pennies’ on shareholders’ behalf.
Just as a little experiment, I measured the frequency with which ARM used the word ‘shareholder’ compared with BP, a company whose report I also happened to have open at the time. ‘Shareholder’ appeared 17.5 times per 10,000 words within ARM’s report. The frequency of the word within BP‘s report was 12.1.
Business model
I already knew that ARM develops and licences technology designs that leading semiconductor companies incorporate into silicon chips for mobile phones and a whole host of other products.
I learned more about the business model from the annual report. ARM is paid a one-off licence fee for a company to gain access to each design, and then receives a royalty payment for every chip that contains the technology.
ARM’s strategy is to cover most of its operational costs from the licence revenues of each new technology, leaving the majority of royalties as profits. As royalty revenues are a function of cumulative licensing, royalty growth gathers momentum as the licensing base grows. I learned that royalties increased 11-fold between 2002 and 2012 — and that’s with less than half the company’s 960 licences so far paying royalties, and new licences being signed at over 100 a year.
Cash
ARM’s licensing and royalty model makes for fantastic cash generation. ARM has no bank loans or corporate bond debt, and finance lease liabilities of £5.8 are negligible compared with cash and short-term deposits totalling £386m. Off the top of my head, I can’t think of another FTSE 100 company with no borrowings and a pile of its own cash.
Overall, I’ve been very impressed by the things I’ve learned from ARM’s annual report. However, at a recent share price of 1,000p, ARM trades at 48 times current-year forecast earnings, falling to 40 times 2014 forecasts. As a value-orientated investor, I simply can’t bring myself to pay those kinds of multiples, no matter how much I admire the business.
