Thanks to iPhone, Royalty Growth Is Accelerating Again at ARM Holdings

02/12/2015 5:13 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Based on royalty growth from the company’s licensing of its chip technology, it seems the worry that held this stock down for much of 2014 has been assuaged, so MoneyShow's Jim Jubak is raising his target price as of today, February 12.

It was all about royalties going into ARM Holdings’ (ARMH) February 11 report on fourth quarter earnings. The worry holding the stock down for much of 2014 had been an apparent decline in royalty growth from companies that licensed ARM’s chips to 7% in the fourth quarter of 2013, then to 4% in the first quarter of 2014, and 2% in the second quarter.

Royalty growth had picked up in the third quarter of 2014—to 11% year over year—and the company had guided to mid-teens growth in the fourth quarter. That looked like a recovery, but would the company be able to deliver?

For at least the fourth quarter, the answer is Yes. Royalty growth from the company’s licensing of its chip technology climbed to 16% year over year. (In US dollar terms, licensing revenue grew 30% year over year.) Net profit, consequently rose to $111 million from a loss in the fourth quarter of 2013.

For the rest of 2015, the company said it expects continued momentum in licensing revenue on the strength of growth in smartphone (especially iPhone 6) sales and on the introduction of new smartphones this year incorporating ARM’s 8-A architecture.

Shares of ARM Holdings fell for much of 2014 on the fear that growth in royalty revenue had slowed permanently, but it now looks like the stock bottomed at $39.28 on October 22. As of the close today, February 12, at $50.41, shares have gained 28%. On the technical charts, ARM finally showed the 50-day moving average crossing back above the 200-day moving average in late January. That pattern is usually an indication of a continued upward trend.

The company’s product pipeline also points to continued strength. Its new Cortex A-72 Maya processor has been licensed to a dozen companies, including MediaTek. The design, ARM says, is 3.5 times faster than the ARM processors used in most smartphones sold last year and uses 75% less energy. The company’s new Mali-T880 graphics processor for mobile devices also looks to play into the heated competition among smartphone makers to add bigger displays with more graphics while increasing the speed to the user.

ARM Holdings has been a member of my Jubak’s Picks portfolio since October 25, 2013. My gain during that period has been an un-awe-inspiring 5.52%. But I think ARM is moving into a product and royalty cycle sweet spot. As of February 12, I’m raising my target price for June to $60 a share from the prior target of $56.

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