With results just out, which of the UK's tech titans looks the best bet?
The UK is not blessed with a surplus of big technology companies, but the FTSE 100 does boast two of the world's finest -- ARM Holdings (LSE: ARM) and Autonomy Corporation (LSE: AU).
ARM and Autonomy are very different businesses. £2.6 billion ARM designs microchips, whereas Autonomy, valued at £4 billion, is a software company specialising in intelligent data retrieval.
Yet besides sharing the front row at any alphabetised industry events -- and the same base city of operations, Cambridge -- both ARM and Autonomy are also at the vanguard of the latest trend in technology -- cloud computing, which could represent a new tech boom.
ARM's processors are ubiquitous in mobile phones, as well as newer spin-off devices such as Apple's iPod and its new iPad. These lightweight machines untether people from the traditional desktop and are geared around pulling data off the Internet (aka 'the cloud') more than local processing -- the key aspect of cloud computing.
Meanwhile Autonomy's founder and CEO Dr. Mike Lynch clearly has his head in the clouds, saying this week: "We continue to see our strongest growth in the new models of the software industry such as OEM and cloud computing. Whilst it may still take a little time for people to understand how these models differ from traditional software businesses, we believe the momentum in these areas is accelerating."
So, two exciting companies at the forefront of their industry -- but which, if either, should you plump for?
Both companies released their full-year updates for 2009 this week, so let's start by looking at their financials.
Autonomy: Full steam ahead
Autonomy has been growing strongly for years, but its ability to buck the global downturn has been truly remarkable.
Full-year revenues rose 47% to $740 million in 2009, partly due to the bolt-on acquisition of content management specialist Interwoven; organic growth clocked in at 16%, driven by legislation in the US that's seeing more companies needing to better interrogate their data. Profit before tax was up 55% to $323 million, with earnings per share rising 42% to 97 cents. Already excellent operating margins rose slightly higher to 44%.
These are great figures in dollar terms, but the weak pound versus the dollar makes them even more valuable for a UK-listed company like Autonomy.
What's truly gobsmacking is how a company of Autonomy's size has grown its earnings explosively, year in and year out:
| Year | EPS (p) | EPS growth |
|---|
| 2005 | 7 | +62% |
| 2006 | 21 | +221% |
| 2007 | 31 | +48% |
| 2008 | 69 | +123% |
| 2009 | 98 | +42% |
Earnings per share are up 17-fold in five years!
It's fair to say some investors remain sceptical about how the company can be doing this (they basically argue more cash should be dropping to the bottom line) but it's been an expensive doubt -- the shares are up over 700% in the past five years.
ARM: Handy fourth quarter
ARM's earnings made reasonable reading, too, with its fourth quarter revenues beating analyst's expectations at $85 million versus the $81.5 million expected. Overall sales were down 10% compared to 2008, however, at $490 million versus last year's $546 million.
ARM shrugs the drop off by pointing out the global recession saw global chip demand falling 20% -- in other words, it did better than the market. Nevertheless, earnings per share for the year fell 4% to 5.45p, though the dividend -- yes, ARM pays one -- rose 10% to 2.42p.
One reason for ARM's resilience is its leadership position in high-end mobile products such as smartphones, which means a steady flow of new customers. Last week Apple revealed the iPad, which contains ARM hardware, and the company is pushing out from the mobile phone market (where it claims a 95% market share) to smartcards, TVs, and set-top boxes.
New devices tend to use more chips, too, which means more revenues for ARM.
As 2009's results attest, ARM is more geared to the economic cycle than Autonomy, and its earnings record is much patchier:
| Year | EPS (p) | EPS Growth | Dividend |
|---|
| 2005 | 2.20p | -12% | 0.84p |
| 2006 | 3.50p | +59% | 1.00p |
| 2007 | 2.70p | -23% | 2.00p |
| 2008 | 5.66p | +110% | 2.20p |
| 2009 | 5.45p | -4% | 2.42p |
The broad trend for EPS is upwards, but there's been some bad years.
As ever with dividend payers, the consistent trend upwards here is comforting, even if it represents a yield of just 1.4%, covered 2.4 times.
Outlook for 2010
Both companies are positive about 2010, and the analysts agree.
Autonomy's Lynch says of 2010: "With our unmatched product portfolio, scale and vision, we look forward to the challenges to be presented in 2010 regardless of the environment."
Analysts are looking for around 75p in earnings from his company in 2010, a rise of 25%. With the shares at 1,640p as I write, that puts them on a forward P/E of 22.
ARM's CEO Warren East is more guardedly confident than Lynch, saying: "Given ARM's strong industry position coming into 2010, we expect group dollar revenues for the full-year to be at least in line with current market expectations."
Those expectations have ARM's earnings rising 20% to 6.5p per share, putting them on a forward P/E of 32 on today's share price of 205p.
Both estimates would be affected by big changes in the exchange rate, of course.
Which is better value?
Clearly, neither ARM or Autonomy is going to light a value investor's fire. These are growth stocks, with the high P/Es you'd expect to pay for (potentially) fast-expanding profits, as well as the risks of a share price plunge if they disappoint.
I'd say Autonomy is the one that could outperform expectations. The lower forward P/E is a signal that many investors still don't trust Autonomy's bullishness, let alone its accounts. Yet it's confounded such fears so many times, who's to say it won't in 2010?
Autonomy always looks expensive -- the forward P/E isn't outlandish by its own standards.
As for ARM, it has managed to be at the forefront of the gigantic mobile boom without generating truly extraordinary profits for shareholders -- its shares have only 'doubled' in the past five years, compared to Autonomy's seven-bagging. The trouble is ARM only makes a pittance from each device sold -- estimates I've seen for the income from each iPad sold go under $1, a fraction of the product's minimum price tag of $499.
That said, investors seem to trust ARM's earnings more than Autonomy's, and a P/E in the 30s is a clear bet on a lot more mobile and other ARM-ed devices being sold in the next few years. I agree, but I'd want to see a P/E under 30 to be more confident of actually making any money from investing.
Finally, it's a credit to both companies that they're still independent -- most British tech outfits sell out long before they reach their potential. Both ARM and Autonomy would be attractive and easily digested acquisitions for the big US giants (competition concerns aside) and with the pound weak against the dollar, some bid speculation is probably in the prices.
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